What will central banks buy next? Big questions for markets this week
The ECB, volatility and Bank of England buying in focus
by: Dan McCrum and Gavin Jackson
The ECB governing council meets next week for the first time since June with the data since suggesting little change in the direction of the EU economy. So it would be a surprise to many if there was an announcement of fresh monetary easing, such as cutting the deposit rate further below zero.
One question some are asking, however, is what policy tools are left to central banks in a future slowdown, or if current measures are not enough. Could the ECB follow the example of Japan, buying assets such as equities?
Morgan Stanley argues that it would take serious risk of deflation for the ECB to do so, and that an Exchange Traded Fund structure might help to avoid questions of ownership rights.
For instance, the Bank of Japan ETF purchases cover several indices initially amounted to 3.75 per cent and more recently were increased to 7.5 per cent of asset purchases. A similar magnitude in the euro area would translate into annual purchases of as much as €72bn, while committing a similar proportion of the ECB balance sheet, 2.5 per cent, would translate into €82.5bn of stock buying.
What will break the market calm?
In late August, there were days when the only thing to talk about was the lack of market movement to speak of. The Vix index, an indicator of implied volatility for the US stock market, has crept up from a mid-August low but remains at a quiescent 13, just over half the level of June’s post-Brexit spike.
It may reflect the view of a gently expanding economy, supportive central bank and an election which Hillary Clinton is expected to win comfortably, but not by so much she can end six years of Washington gridlock.
Or then again, is it a market without momentum or conviction? As Andrew Lapthorne, strategist for Société Générale, says: “It reminds me of the tail-end of a long bull market. The bears give up, because they have been bludgeoned to death by rising prices.”
What will the Bank of England’s plan to buy corporate debt look like?
At the start of August, the BoE said it would follow the European Central Bank in purchasing corporate bonds. In total, it plans to buy a £10bn portfolio of corporate bonds to help boost the British economy and ward off a potential slowdown falling the EU referendum.
The policy helped launch a wave of sales of sterling-denominated debt, which led to the busiest ever August for the market as companies rushed to take advantage of cheap financing.
Prices for high-grade corporate debt have also jumped, as yields on bonds have fallen in anticipation of the bank buying the debt of non-financial companies which contribute to the British economy.
Investors are still waiting for further guidance from the Bank, including when the scheme will start. It has previously said that further details would come in “early September”.
A bigger question, however, is the one which has hung over all the efforts to stimulate the economy by suppressing borrowing costs: with the impact of Brexit still unknown, do companies have a good reason to take on more cheap money?