The European Central Bank has decided to loosen monetary policy further, including lowering its deposit rate by 10 basis points to -0.3 percent and extending its quantitative easing program until March 2017. Despite initial market disappointments, we think these measures should contribute to borrowing costs remaining "lower for longer," underpinning the euro-zone economic recovery and driving investors toward riskier assets.
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European Union flags in front of the headquarters of the European Central Bank in Frankfurt am Main, Germany.
Although European economic and earnings momentum have been positive in recent months, the ECB may have chosen to ease further for three reasons.
First, statements at its Oct. 22 press conference amounted to a pre-commitment to further loosen policy. Given that central-bank credibility is critical in setting market expectations about interest rates and inflation rates alike, we feel that the ECB had little choice but to increase stimulus efforts.
Second, the renewed fall in oil prices since the announcement of the QE program has pushed the normalization of inflation further out.
Third, greater global uncertainty in recent months has skewed the balance of risks to the downside in the ECB's view.
The initial market reaction after the rate announcement was a bounce in the euro against the U.S. dollar, lower European equities and higher core sovereign yields. This is largely attributable to the fact that the ECB actions came in toward the lower end of financial market expectations. Some had expected them to expand the amount of bonds they were buying as part of their QE program.
Yet current low market liquidity can make extrapolating from the initial market reaction ill-advised. Indeed, we believe the ECB moves broadly support a positive stance on euro-zone equities and high-yield credit and a negative stance on the euro (relative to the Norwegian krone in particular).
With respect to equities, the ECB move should underpin euro-zone money growth and corporate earnings, particularly as the latest loan data suggests European credit channels are loosening. Financials in particular should benefit from higher lending volumes and profits as loan demand and supply improve.
With respect to bonds, ECB action was already priced into high-grade debt, as core yields moved deeper into negative territory – around 40 percent of euro-zone government debt now has a negative yield. On the other hand, the hunt for yield this will now spur should further narrow the gap or spread between yields on euro-zone high yield credit and government bonds.
With respect to the euro, the ECB announcement offers limited scope to push the euro/U.S. dollar exchange rate much below 1.05 in three months, in our view. In fact, higher European growth and the probability of growing investor demand for euro-zone assets lead us to forecast EURUSD at 1.08 in six months and 1.10 in 12 months. We still favor the Norwegian krone within G10 currencies.
Finally, investors should continue to monitor Swiss National Bank sight deposit data for signs of intervention from the Swiss National Bank in response to any franc strength resulting from ECB action. We expect the euro-Swiss franc exchange rate to fall toward 1.06. However, we also note that an already slowing Swiss economy can ill-afford such a strong currency against the euro.
We expect the QE program's positive fundamental effects to continue and, if anything, be strengthened by its expansion.
Commentary by Mark Haefele, global chief investment officer at UBS Wealth Management, overseeing the investment strategy for $2 trillion in invested assets. Follow UBS on Twitter @UBSamericas.