Some U.S. investors awaiting the normalization of global monetary policy may be tempted to hang a “mission accomplished” banner when the Federal Reserve unveils the timetable for winding down of its $4.5 trillion balance sheet—an announcement that is widely expected to come in September.
But those who are concerned about how a wave of liquidity from quantitative easing is distorting asset valuations and contributing to the low volatility across financial markets they should watch European Central Bank President Mario Draghi’s speech Friday afternoon at the global central banker symposium under way in Jackson Hole, Wyo. Though the Fed has been tightening monetary policy in the last few years, the ECB continues to purchase 60 billion euros a month of assets and is a long way from raising rates.
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Here are four charts compiled by Deutsche Bank market economists that illustrate the impact of the ECB’s bond-buying program.
The first one shows the leaders in printing money in the last 10 years. The use of extraordinary monetary policy in the wake of the 2007-09 recession was first pioneered by the Federal Reserve, quickly followed by the Bank of England. The Fed’s use of QE ebbed and flowed until it halted purchases in 2014. The Bank of Japan and finally the European Central Bank picked up the baton and continue to snap up assets. With two of the world’s largest central banks still buying bonds, the Fed’s efforts to normalize monetary policy remains overshadowed by their counterparts’ decision to keep the monetary spigot loose.
Investors who are convinced the ECB’s actions are throwing the eurozone’s financial markets out of whack will get a lot of mileage out of this chart. It shows the yield for the 10-year Treasury
the so-called “risk-free” asset, now matches the yield for a European junk bond of the same maturity. As European investors get caught up in the hunt for returns, they have driven the valuations for the diciest parts of its markets to multidecade highs. Bond prices go up when yields fall.
Meanwhile, the ECB’s measures have pushed interest rates on a swath of sovereign debt across the eurozone into negative territory. Even central banks in other European countries outside of the economic bloc and in control of their own monetary policy, like the Swiss National Bank, have felt the effects of the ECB’s bond-buying program. Pension funds in the Netherlands, many of which rely on long-dated creditworthy bonds, have been vocal that the prolonged use of QE is challenging their ability to deliver the investment returns needed to support their citizens’ retirement.
The final chart shows investors in European bond markets have run for the exit doors since 2014, when the ECB started to print money. Although equities in Europe have attracted steady inflows, the drop-off in fixed income investments have been precipitous. The exodus of cash into higher-yielding bond markets like the U.S. and, to a lesser extent, emerging market paper. Analysts suspect this is why U.S. Treasury yields still sit at historically low levels even though the Federal Reserve has already implemented four quarter-point rate increases in the current tightening cycle.