Wednesday, April 24, 2013

With the ECB easing inevitable, periphery yields hit new lows

As France and Germany PMI measures converge on the rest of the Eurozone and with the area as a whole in a contraction mode, it is becoming increasingly clear that the ECB is likely to ease monetary policy further.

Composite Output PMI (reading below 50 indicates contraction; source: Markit)
Markit: - Activity fell sharply again in both manufacturing and services. While the former saw the steepest rate of decline for four months, the latter saw the downturn ease slightly compared with March.

New business fell for the twenty-first successive month, with the rate of deterioration accelerating for the third month in a row to signal the steepest decline since December. Marked falls were seen in both manufacturing and services.
Some have been hoping that the ECB will follow the Fed, the BOJ, and the BOE into the brave new world of QE on an unprecedented scale. The probability of such action is quite low however because the ECB does not have the dual mandate of the Fed and (for now) is only focused on price stability. The ECB also may hold back on buying periphery debt until/unless the nations request "assistance".

Even if the central bank commences some bond buying, it is unlikely to be large and would probably end up being sterilized. Nevertheless in preparation for this easing action by the ECB, yield hungry investors bought sovereign bonds across the board. Italian and Spanish yields dropped to the lowest level since 2010.

In an economy that may be close to becoming deflationary, the drive for yield seems to override sovereign risks. This move in yields is especially remarkable given that less than a year ago the Spanish banking system was teetering on collapse (see post).
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