“While Europe may tick along for some time in a low-growth, low-volatility, low-interest rate equilibrium, our concern is there is little fiscal firepower left to deal with any shock and we would not rule out significant volatility in the future,” Edison’s George states.
And while markets may be willing to accept little reward for lending to highly indebted eurozone nations, that may not persist in the long term. Lower-rated eurozone bonds have been trading at record lows, despite the bleak outlook for growth in the region and increasing government borrowing. At the beginning of December, German 10-year Bund yields fell to an all-time low of 0.69%, while the yields on Spanish, Italian and Greek 10-year bonds stood at 1.89%, 2.04% and 7.91% respectively.
THE ECB
With a poor growth outlook and growing debt problem, how can Europe avoid a Japan- style delaftionary trap?
“It is very simple,” says Genzo Kimura, economist at SuMi TRUST. “The ECB needs QE. It is a simple answer, but a very difficult one to reach agreement on. The current inability of the ECB to act decisively is adding to the disinflation pressure.”
The prospects for fully-fledged QE in the form of sovereign bond buying looked brighter as the rhetoric from policymakers continued to build in early December and would provide support to help raise the growth expectations for the region in 2015. ECB Vice President Vitor Constancio said in late November the bank would have to asses the situation in the first quarter of next year and, if no progress was made to the inflation prospects of the region, the bank would “consider buying assets, including sovereign bonds in the secondary market”.
However, considerable resistance remains to a sovereign bond buying programme, not least from the inflation-fearing Germans, who have challenged the legality of such action. Lascelles, among others, believes Germany should be willing to run larger deficits to help stimulate the continent as a whole.
LOWER INVESTMENT RETURNS
Investors are already being forced to look outside their comfort zone in terms of their risk profile to find returns, which potentially leaves them with increased sensitivity to shocks as they hit with little hope governments will be able to combat those shocks.
“Investors should expect much lower returns in the future,” Campbell warns. “Rates will be low for a very long time and the recent policy moves of the ECB have compressed spreads to very tight levels.”
If the ECB does manage to push through full-blown quantitative easing, and a multi-decade Japan-style period of stagnation is avoided, high debt levels and the deteriorating demographic profile of the region will dampen long-term growth and reduce the region’s ability to absorb future shocks. Investors therefore, need to be wary.
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