ECB standard package on a historical day

Amid severe market collapses, dramatic corona measures and energetic central banks in the UK and United States, the ECB package was somewhat underwhelming.

Even on a "normal" trading day in times of the coronavirus crisis, the package of measures presented by the European Central Bank (ECB) yesterday, Thursday, would probably have made little impression. The expectations for the ECB were already high, perhaps because it seems obvious that the ECB can only contribute a small part to solving the corona crisis. That may be the reason why it did not even try to meet the expectations of the markets, as they would probably only have been satisfied if the ECB had over-fulfilled them. What really matters to (institutional) investors was shown by the market reactions to certain statements by Christine Lagarde. When she emphasized that it was not her job to reduce risk premiums (of periphery bond yields). There are other instruments and people responsible for this. This was, so to speak, the opposite of Mario Draghi's assurance to do "whatever it takes" to ensure the common currency's survival. These seemed to be the wrong words, at the wrong time for liquidity-dependent capital markets. 

How dysfunctional the markets were on Thursday, March 12, will probably only become clear in the coming days. It was an extraordinary day, even in comparison to the already turbulent days before. Not only because of the record movements in capital markets. The Dax' loss of 12.2% was the second highest in its history, the S&P 500's loss of 9.51% was its second highest since 1987. The volatility of stock markets  (as shown by the CBOE Volatility Index (Vix) for the S&P 500 and Euro Stoxx 50) reached the record levels of the worst days of the financial crisis in 2008. Other markets mainly surprised by their malfunctioning. Not only for corporate bonds, but even for U.S. Treasuries trading has proved difficult at times, until the U.S. Federal Reserve (Fed) intervened by injecting and promising several trillion dollars to the market. Indicating the liquidity needs of certain investors, gold was down, not up. The day was also historic because it saw many countries go into crisis mode in dealing with the coronavirus. The crisis, and the awareness that combating it must be a top priority, arrived everywhere yesterday: in Europe at both the country and European-Union (EU) level and in the United States at the level of states, companies, associations and the federal government.

Of course, these were not easy conditions for the ECB. After the other major central banks presented their proposals, the ECB rounded off the international rescue package with a targeted package for the time being. However, in doing so it acted much less aggressively than the others. Christine Lagarde made it clear right at the beginning of her press conference that fiscal policy is required in this economic environment. She accordingly called on European governments to pursue a coordinated and substantial fiscal policy, with flanking measures from the ECB. However, it was no longer a shout-out but almost a plea, which in turn could be seen as an admission of the limited possibilities of the ECB in this case.

Given its limited resources, the ECB, following its own analysis, focuses on targeted measures. Essentially, these are liquidity measures for banks in order to continue to guarantee lending, albeit at even lower interest rates. In view of the markets' expectation that a major monetary-policy package would be delivered, the positive effect of these measures has been completely lost. Specifically, the ECB is launching a new program for granting longer-term loans to commercial banks (TLTRO) to provide immediate liquidity support to the financial system at an interest rate of -0.5%. In addition, the conditions for the already existing TLTRO-III program for the period from June 2020 to June 2021 will be further improved with an interest rate between -0.25 and -0.75%. In its role as a supervisory authority, the ECB has decided to relax the capital requirements of banks. All of this serves to keep incentives for banks high and to support lending. But the central bank cannot force commercial banks to do so. Therefore, the success of the program will also depend on the willingness of governments to issue guarantees or sureties for companies.

The bond purchases for 2020, which have been increased by 120 billion euros and focus mainly on corporate bonds, should also help to improve the financial environment. The deposit rate, on the other hand, was left at -0.5%. Here it seems as if the market had hoped for a stronger signal.

Are these measures sufficient? In view of the situation, which is worsening by the day, we believe it is certainly too early to answer with a "that's it". The ECB had to admit how quickly the external parameters can change based on its own growth forecasts. The expected gross-domestic-product (GDP) growth rate for the Eurozone was only reduced from 1.1 to 0.8% for 2020, which puts the ECB well behind the curve. It conceded, however, that this growth forecast takes into account neither the oil-price shock nor the recently expanded coronavirus defense measures of the various countries. The pressure to do more should therefore remain high.

Appendix: Performance over the past 5 years (12-month periods)


02/15 - 02/16 02/16 - 02/17 02/17 - 02/18 02/18 - 02/19 02/19 - 02/20

Dax

-16.7%

24.6%

5.1%

-7.4%

3.3%

S&P 500

-6.2%

25.0%

17.1%

4.7%

8.2%

Source: Bloomberg Finance L.P. as of 2/28/20
Past performance is not indicative of future returns. Forecasts are based on assumptions, estimates, opinions and hypothetical models that may prove to be incorrect.

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