Johnson: Reasons to be Skeptical of ECB Stimulus

Key differences between the eurozone and the U.S. could make the ECB's bond buying program less effective than the Fed's, says Morningstar's Bob Johnson.

Jeremy Glaser 23.01.2015
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Jeremy Glaser: For Morningstar, I'm Jeremey Glaser. After months of speculation, the European Central Bank finally announced their quantitative easing program. I am here with Bob Johnson--he is our director of economic analysis--for his take on it.

Bob, thanks for joining me.

Bob Johnson: Great to be here today.

Glaser: So, let's start with the size of the program; it's a little bit bigger than some of the leaks from earlier this week [indicated]. Can you describe what the ECB is going to be doing?

Johnson: They will be buying investment-grade debt from throughout Europe, and they will buy about €60 billion a month, starting in March and going through September 2016--and even after that, it can be extended more. So, it's kind of an open-ended program at a pretty high amount. That €60 billion, by the way, translates into roughly $70 billion worth per month. And to give you some feel for it, the latest QE program from the U.S Fed was about $85 billion a month. I don't think that made it quite to a full year of purchases [before] they started shrinking it again. So, it's clearly a large program, almost as large as the U.S. program--and larger than expectations.

Glaser: Now, how is this program going to be administered? There is some talk about how the national central banks are actually going to be taking on some of the risks here. What does that mean? How is it actually going to work in practice?

Johnson: They haven't spelled out all the details yet; those are yet to come. And there is always a little bit of a devil in the details. But it looks like some of the buying would be pushed down to the national central banks and then backstopped by the European Central Bank--but not all of it. So, it's not quite as open-ended or as easy as the U.S. program was; but I'm sure that part of this is a mechanism so that it doesn't look like the ECB is just blanket-buying debt from, say, Greece or whatever. It has to go through a mechanism of that country buying and then backstopping it through the Central Back.

Glaser: Now, what's the purpose of this program? Is it really just inflation as they are talking about, or do you think it has that broader role to try to revive the European economy?

Johnson: Well, the European Central Bank and most of the national banks in Europe are different from the U.S. central bank. Their banks are all charged with one mission: to control inflation. In the U.S., we have the dual mandate of employment and inflation. So, they've always got to be a little careful to couch it, even if their intent is otherwise, that it's all about inflation. They're saying it was negative 0.2% in December. Given that it was a deflationary rate, they say they had to act because the goal was 2%. [And because] all they're interested in is inflation, and since it's under 2%, [they say] that they needed to act. The reality is that Europe's economy has been dreadfully slow. Union-wide, the unemployment rate is like 11.5% versus well under 6% here in the U.S.--just to give you some perspective. So, they are still in a world of hurt, and this program also has some hopes of stimulating the economy; but they probably won't publically say that.

Glaser: So, how successful do you think this program can be? We saw that, in the United States, QE seems to have been at least happening at the same time as economic expansion. In the U.K., there was some success there. Jury is still out in Japan. Will this program actually be able to accomplish those gains?

Johnson: I am very, very skeptical, but certainly the mechanism will be way different than it is in the U.S. So, maybe I am not grasping the full picture. But rates there are already very, very low, and they don't have a big housing or a big auto market to stimulate. [No one is going to say] "Oh, gee, rates are a little bit lower--boy, we're going to race out and buy that car." In fact, even in the U.S., stocks and bonds went up because of the extra liquidity; but even on that front, in Europe, the stocks and bonds aren't as widely held. People have pensions that are funded by the government, less individual stocks and bonds. So, they're not going to see the wealth effect that was one of the key parts of the U.S. program. They will be missing that.

On the other hand, the mechanism where this may work is that European bonds just become so unattractive that all foreign buyers sell everything they've got and then sell their euros and then go invest in another country. What that does is drive the euro down, and we've already seen it fall from $1.45 against the dollar all the way down to $1.15 earlier this morning. That's a huge move, and that will make Europe more competitive. That will be the mechanism where this may work.

The question is what products do they have [that this is going to] dramatically help? That's a little bit of an open question. Certainly, vacation and tourism is on the front end of all of that, but will that be enough to move the needle or create the kinds of jobs that they really want to create over there? That's another question. Some of the details in this program are still a little foggy to me. So, I'm not convinced that this is a truly open-ended program like the Fed program was.

Glaser: Given how far the euro has already fallen in anticipation of this program, is there really a lot of room for it to go much lower?

Johnson: You know, in almost every [instance]--and especially in the U.S., which I have more familiarity with, but even to a degree Japan and the U.K.--[when it comes to] the speculation, they have to prepare the market for this type of thing. They can't shock people and ruin all the dealers, instantaneous shock and awe and have this big program out of the clear blue. So, they kind of warm the market up to it. In the U.S. case, it was kind of a three-month advance thing. Here, we've been talking about this for, I don't know, three, four, or five months. With all that, everybody kind of builds it in already. And then by the time they actually start doing the buying, interest rates are on the way back up again, and I think that's going to happen again this time.

Glaser: Finally, what's the impact of this on the United States? Are we going to see any big impacts to the U.S. economy?

Johnson: There are two schools of thought on that. One is that, obviously, with a stronger dollar and a weaker euro, that's going to have a pretty negative effect on U.S. exporters. And I think that's probably true. It will have some. But as I've said many times in these videos, Europe is only about 3% of our GDP, and a lot of it's locked in Boeing airliners and soybeans and stuff that isn't very [dependent on the health of the economy]. So, I really don't see it being a huge hurt from there. It's certainly going to make overseas more of a headwind than the tailwind that it's been, but I don't think that's probably the biggest effect. I think probably it's a positive effect in keeping commodity prices low because of their slow economy. So, that's a big positive for the U.S., but I do think that the strong currency is going to hurt a bit.

One of the other things I have heard kicked around--another school of thought--is that U.S. markets are just going to jump because now these European assets are all unattractive because of the low rates, and money is the ultimate fungible commodity, so they'll borrow from European banks. And where is the best economy in the world right now? Well, the U.S. So, our stock market will be the beneficiary of that bubble, in the same way as when we did QE, emerging markets were what bubbled up. This time around, maybe it's the U.S. stock market. I'm not so sure I'm entirely there, but that's one school of thought that's out there.

Glaser: Bob, thanks for your analysis today.

Johnson: Thank you.

Glaser: For Morningstar, I'm Jeremy Glaser. Thanks for watching.

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Jeremy Glaser  Jeremy Glaser is the Markets Editor for Morningstar.com.

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