March 12, 2015

This week the European Central Bank started its Quantitative Easing Program (“QE”), which boils down to an attempt to increase the amount of money in circulation while lowering interest rates, thus, on paper, boosting the economic activity of the region. As QE means more Euros in the global system, the Common Currency should underperform its peers. This debasement process has largely been anticipated by financial market operators, who have been selling the Euro and buying European stocks en masse. At time of writing, the Euro is 11% lower than at the beginning of the year, while European stocks are 14% higher.

Meanwhile European corporations as well as households have accumulated large balances of cash since 2008, which sit idle on account rather than being recycled back into the economy for productive usages. This, in turn, is a reflection of various structural effects, including the aging of the European population:  older people generally enjoy higher savings because they have accumulated more wealth than younger people. Increasing inequality also pushes the average savings rate up, as Keynes teaches us that propensity to consume is lower for richer people.

The pressure is mounting on these large cash balances to find a better home than European assets, which become less attractive by the day compared to foreign bonds, stock and real investments. This is because QE means that foreign currencies are likely to increase against the Euro while foreign assets in general, and bonds in particular, generally offer a better yield than domestic ones. Good European “signatures” such as the German government or the best corporations, already borrow at zero percent or even less (“lend us EUR 100, we will give you back EUR 100 in 10 years”), and with a massive new buyer in town these rates have little chance to increase any time soon.

The outflow or European money towards foreign assets (mostly bonds) has started (EUR 300bn over the last three months, net), and is accelerating. Deutsche Bank estimates that no less than a net EUR 10 trillion (yes, EUR 10.000 billion!) should exit the Eurozone by the end of the decade. In practice, this means that for every 10 Euros of wealth created, approximately 1 Euro will be sent abroad.

Where is all this cash going? Mostly to bonds in the US, Canada, and to a lesser extent the UK. Over the long run, this means (even) lower bond yields in these countries, and perhaps higher equity valuations. These jurisdictions are therefore better off for European QE too. In the meantime, investors looking for a bargain should stay clear of European bonds, where the upside is almost inexistent and where currency risk is high.

MONOGRAM CAPITAL MANAGEMENT

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