A New Factor To Consider In The Bond Market: The ECB Has Ended Its Quantitative Easing

by: John M. Mason

The quantitative easing of the European Central Bank, begun in early 2015, has ended and will create a new and different factor in bond markets.

ECB activity over the past four years has not only increased world liquidity, but it has also impacted relative capital flows throughout the world, especially in the US and UK.

What the ECB does going forward is uncertain, especially with the news that economic growth in Germany and other areas of the eurozone is now slowing, so stay tuned.

The European Central Bank (ECB) has ended four years of quantitative easing.

For four years, the ECB has been increasing its portfolio of government bonds. Starting this month, this is no longer the case.

The activity of the ECB over this four-year period has been significant, impacting not only the amount of liquidity in world financial markets, but also impacting the distribution of investment money in the world.

In the first case, the ECB has acquired $2.5 trillion in government securities over the four-year time period.

The second case, the situation is a little more complex. Because of the massive amount of securities bought by the ECB, its purchases, from time-to-time, were greater than the net new amount of debt being issued by the governments.

This is because the biggest countries in Europe have been running capital account surpluses. As a consequence, a shortage of top quality debt appeared, which meant there was European money looking around for high-grade investments.

Jefferies Group LLC, the investment bank and financial services company, has estimated that investors from eurozone have picked up a net €525 billion of US debt and €158 billion in UK debt since the start of 2015, around the time the ECB began its period of quantitative easing.

The result? The ECB effort cycled eurozone current account surplus into US and UK debt, helping to keep interest rates down in those countries.

So. The ECB has now stopped its efforts at quantitative easing.

But, what does this mean for the future or interest rates, the flow of capital internationally, and the stability of the financial markets?

Right now, the future impact of this reality is unclear.

For one, the European community is facing an economic slowdown, a slowdown that has been joined by the Germans, the largest economy in Europe.

Thus, the EU might be entering a new economic phase where it is growing much more slowly that the United States.

This will raise issues for the ECB that relate, not only to the relative rates of growth of their economies, but also about relative currency rates.

Added on top of this the fact that the United States government is facing growing deficits, which will produce rising US debt levels, but Germany, the largest economy in Europe is now running balanced budgets. This, too, should impact relative capital flows.

What if the rates on German bunds go up, now, relative to the interest rates in the US? How will this impact world financial markets?

How will the ECB respond to this?

How will the Federal Reserve respond to this?

As I have written before concerning these European funds coming to America, just as the inflows impacted the relationship of various parts of the bond market, so outflows will also cause a change in what we see happening in the markets.

For one, we saw a lot of money flow into the US seeking yields and this drove down the yield on US Treasury Inflation Protected securities (OTC:TIPS) even taking them below zero for a while.

After the election of Donald Trump in late 2016, we saw foreign monies leaving the United States, and the yields on TIPs popped up above zero again.

These international flows of risk averse monies can have significant impacts on relative rates of interest.

And, this is all I am stating at this time. The European Central Bank has stopped its quantitative easing. This will impact European financial markets, but it will also impact world markets.

What we don’t know is exactly how this change will work out because there are so many other things at work, like the slowing of economic growth in the eurozone community.

Furthermore, Mario Draghi, the current president of the ECB, leaves office on October 31, 2019. So, within the ECB we have the uncertainty not only of what Mr. Draghi might do in the rest of his term, but the uncertainty of who the new president will be and what that new president might due once in office.

So, stay tuned and be alert. Certainly the change in the position of the European Central Bank needs to be considered amongst all the other uncertainties impacting bond yields and bond markets, both in the US and in the world.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.