It's one of the most pressing - and fluid - conversations among market participants these days: the question of when (and if) U.S. economic data will improve to the point where the Federal Reserve will announce a rate hike. Credit Suisse thinks the answer might be a little later than many think: amid softer jobs data, the bank recently pushed back its call for an increase from June until September. But all the attention on the Fed's deliberations shouldn't distract from the equally important and related issue of monetary policy across the Atlantic. The European Central Bank's implementation of its latest round of monetary stimulus - an open-ended commitment to purchase 60 billion euros in sovereign bonds per month - is having such an impact on markets that Credit Suisse has taken to calling ECB president Mario Draghi "truly radical."
Indeed, says Ric Deverell, Credit Suisse's head of global fixed income research and economics, Europe's QE plan is "far more aggressive" than those employed in the U.S. or Japan. The bank's is mopping up so many bonds that it has created an outright supply shortage, which is pushing bond prices higher and yields further into negative territory. German 5-year bond yields are currently yielding negative 0.15 percent. The lowest 5-year bond yield ever seen in the U.S. is 0.54 percent. Even 30-year German yields have fallen to 0.50 percent, much lower than the all-time lows of 2.22 percent in the U.S. and 0.98 percent in Japan.
Many institutional investors have been left with little choice but to eschew the European bond market, because they're unimpressed by - or are actually restricted from - purchasing paper that guarantees a loss if held to maturity. As a result, a significant change in capital flows is afoot as investors rotate from European to U.S. bonds. At the same time, the fact that dividend yields in Europe are high relative to government bond yields is also encouraging both retail and institutional investors to shift into stocks. "Negative government bond yields have the potential to be highly supportive for European equities," Deverell says.
Already, equity mutual funds are seeing strong inflows. In Italy for example, inflows into such funds were 2.3 billion euros in February, five times as great as in January. "We suspect that this will continue," says Andrew Garthwaite, an equity strategist in Credit Suisse's Investment Banking Division. "The implications for global capital flows are substantially underestimated in many circles." As for institutional investors, there is plenty of room for pension funds in continental Europe to take on more equities, and Credit Suisse expects them to do so. Weightings in euro equities are only 12 percent, 10 percent and 6 percent for Italy, Spain and Germany, respectively.
The ECB bond purchases are also driving down borrowing costs for some European companies to record lows. At current rates, interest charges will fall by more than 20 percent for some borrowers, which would boost earning per share by some 15 percent, according to Credit Suisse.
Then there's the weakness of the euro, which has depreciated 22 percent against the dollar since last May - a trend that is especially positive for European exporters. Credit Suisse remains bullish on the dollar versus the euro, and estimates that another 10 percent depreciation in the euro would add 8 percent to earnings per share for euro equities. It should come as no surprise that European equities are outperforming global equities in dollar terms for the first time since 2004. The euro economy is improving too: Credit Suisse projects that it grew between 2 and 3 percent in the first quarter. All of this, combined with the impact of negative bond yields, is enough for Credit Suisse's global equity strategy team to make continental European equities its second biggest overweight after Japan.