Deflation takes hold on European Central Bank
By Laif Meidell, CMT, president of American Wealth Management, and portfolio manager of the AdvisorShares Meidell Tactical Advantage ETF (MATH)
The fear of deflation getting its grip on the Eurozone was very much on the mind of European Central Bank President Mario Draghi on Thursday as he surprised the financial world by further reducing the ECB’s main refinancing rate from 0.15 percent to 0.05 percent.
Earlier this summer, in a move to motivate lenders to put their money to work, Draghi introduced negative interest to those lenders wanting to park their money at the central bank. This meant that instead of earning interest on their deposits, they now would be charged interest. On Thursday, Draghi continued to drive his point home by raising the charge on those deposits at the central bank from 0.1 percent to 0.2 percent.
In response, short-term bonds in Germany, France, the Netherlands and Austria fell into negative territory causing investors to sell Euros in exchange for higher yielding assets. The Euro fell to its lowest level since May 2013. On the other hand, stock investors cheered the news by driving stock prices throughout Europe higher.
With the ECB having done most everything within its power, short of launching its own full-scale quantitative easing program, some economists speculate the only option left on the table is the outright purchase of bonds like we’ve seen by Federal Reserve.
After having spiked to an annual high last Thursday, bonds have been in retreat all this week with only the 90-day Treasury bill, the shortest maturity, able to hold its ground. The poorest-performing bond indexes this week were the S&P/Citigroup International Treasury Bond (Ex-US) Index, declining 2.1 percent during the past five trading days, and the Barclay’s U.S. 20+ Year Treasury index, losing 2.02 percent over the same period.
Remember, in recent weeks, investors, particularly in Europe, have been shifting funds into high-quality bonds, driving prices higher, in response to the deteriorating economic news from countries throughout the Eurozone. Although this week’s decline in higher-quality bond prices has been sharp, at this point it might be best interpreted as a sigh of relief as the ECB takes additional steps to aid its struggling economies.
This commentary originally published in the Reno Gazette-Journal. Performance numbers used in this article were obtained through eSignal and are not guaranteed to be accurate.