What to Watch Out for After the ECB Meeting

Benno Galliker watched Mario Draghi’s conference on stimulus measures broadcast on TV on Thursday. He had some long stocks, and the market was currently in a rally.

“I don’t know what to do now,” he said, being among 17 people in trading in Luzerner Kantonalbank in Switzerland. “You have to wait.”

At the same time, waiting was sorrowful while what had been the greatest Volatility for the Euro Stoxx 50 Index sharply disintegrated following the ECB decision in the Draghi period. Voices were silenced when Dragi announced that he didn’t expect more reductions of interest rates.

“It’s OK. As we’re still higher it is good,” Galliker said.

In the evening, the Euro Stoxx 50 had lost all its growth, closing 1.5% lower. Banks that had gained more than 7% before, cut their growth to less than 1%. The euro increased by 2%, showing the biggest increase since the rate decision on December 3.

Prior to Thursday, economists expected a reduction in interest rates. What the ECB announced overcame their expectations: the central bank cut all three main rates, enlarged its bond purchase to 80 billion monthly and allowed the buying of corporate debt.

“It was the day with two opposite narratives,” stated Kevin Lilley, who deals with equities at Old Mutual Global Investors. “It’s weird to think that on a day when the ECB decreased the rates and increased QE, the euro strengthened, stocks went down and yields grew.”

The market reaction gives an example of the trend of the latest months: central banks can’t do anything when there’s a need to calm down the markets. The Euro Stoxx 50 changed by more than 5% during the day, its biggest change since August.

“By using non-traditional monetary policies, central banks didn’t stimulate the markets, but added volatility,” wrote in e-mail Michael Shaoul, CEO of Marketfield Asset Management. “Everything now is more complicated than it was 2008 in the U.S. or at the beginning of 2012 in Europe, when the movement to non-traditional policies caused development of long bull markets.”

For Benno Galliker, the matter was that the banks stayed. He purchased some bank shares right after the decision on rates - he was too nervous about the news before it was announced, he said.

“While they’re outperforming, I’m satisfied,” he added. The Euro Stoxx Banks Index closed the day 0.9% up. “Not the best day, but still OK for me.”

Up till this moment, the benchmark for the ECB’s stimulus performance had been the Exchange rate, but now things have changed after the European Central Banks Meeting on Thursday. From now on, eurozone corporate bonds will be the crucial barometer that investors need to pay attention to. ECB’s purchase programme marked the shift of Draghi’s strategy, with the previous strategy focusing on lowering the government bond yield curve, which in turn caused the euro to devalue in order to boost inflation and increase exports. The gap between company debt yields and government bonds will be of vital importance.

For this strategy, there are pitfalls as well, and success largely depends on the companies’ investment appetite. The European Central Bank’s previous strategy to lower the overall cost of borrowing has caused euro bond issuing by companies from the U.S.