The European Central Bank (ECB) moved to quell a growing sense of panic in Europe’s markets on Wednesday night, announcing a massive expansion of its bond purchases in an effort to douse a fire it had helped to stoke only days earlier.
The Frankfurt-based ECB said it will buy up to another 750 billion euros ($820 billion) in bonds and commercial paper to support the economy and avert a rerun of the euro debt crisis when acute liquidity shortages in various highly indebted states drove the currency union to the point of collapse. The “Pandemic Emergency Purchase Program,” as this new measure is called, far exceeds in scale any mechanism used to quell the euro debt crisis that started 10 years ago.
“Extraordinary times require extraordinary action. There are no limits to our commitment to the euro,” said ECB president Christine Lagarde.
U.S. stock futures bounced in response to the news, before slipping into the red again. Global stocks took a drubbing on Wednesday; the Dow Jones industrial average closed at a level last seen during the Obama administration.
The ECB’s move came after the U.S. Federal Reserve, the Trump administration, and Congress all dramatically ramped up their own policy responses, injecting billions of dollars into money markets and promising unprecedented government handouts to support the economy through the crisis.
“The euro area has caught up with the U.S.,” said Gilles Moëc, chief economist with French insurance giant Axa, via Twitter. “Both legs of economic policy, monetary and fiscal, are now providing massive support.”
Not a minute too soon. Bond markets on both sides of the Atlantic had shown increasing signs of seizing up on Wednesday, in the most desperate dash for cash seen since the depths of the 2008 crash. The euro fell below $1.1000 and the Stoxx Europe 600 index fell as far as 275.92, a seven-year low and 36% off the peak it hit only a month ago.
Bond prices had fallen markedly in recent days, as more and more investors pulled their funds from the markets, forcing mutual funds and exchange-traded funds to liquidate holdings and meet redemption demands.
It’s rare to see bond and stock prices moving in tandem. Money normally flows out of stocks into bonds when investors are feeling risk-averse, depressing yields on the bonds in question.
However, the yield on the 10-year Treasury bond rose as much as 26 basis points to 1.26% on Wednesday as public trust in the effectiveness of the global policy response appeared to evaporate.
Such a loss of trust sends shock waves through all global markets, because the spectrum of U.S. government debt, from three months to 30 years, provides a global reference rate for “risk-free” credit. Rising yields mean tighter credit conditions, more bankruptcies, and a deeper recession. Everywhere. As is usual in times of stress, corporate bond yields are currently rising much faster than government ones.
The rise in eurozone yields was worrying for a different reason, as it reflected the revival of fears that the EU’s currency project could collapse under the weight of national government debt.
Italy, the eurozone country worst hit by the COVID-19 epidemic, is also the one with the biggest debt in the region—over 2.5 trillion euros. At around 135% of gross domestic product, that is a worse position that Greece had at the start of its nightmare in 2009.
While it has been clear for days that the EU would relax its fiscal rules to allow whatever spending was necessary to combat the virus, bond markets had already started to look past the near-term to a point in the future when any sense of collective emergency had passed and all that remained was an even heavier debt burden. The premium, or spread, required of Italian 10-year debt relative to German bunds had more than doubled in less than a month.
Then came Lagarde’s disastrous press conference on Thursday, at which she fanned the flames of speculation by saying, “We are not here to close spreads…There are other tools for that, and there are other actors to actually deal with those issues.”
By Wednesday morning, after similarly harsh comments from Austrian central bank governor Robert Holzmann about the wisdom of saving unviable companies from bankruptcy, the Italian spread had blown out to 320 basis points, and the smell of contagion was in the air. Greece’s spread soared by over a full percentage point. Portugal and Spain, two other countries still recovering from their bailouts in the last crisis, also saw their spreads rise sharply. The euro breakup risk genie was pushing hard at the cork in the bottleneck.
“We believe today’s actions are enough to return Italian spreads to manageable levels,” Nordea analysts led by Anders Svendsen said in a research note. “With the new program in place, it will be easy to increase the amounts further, if necessary, at a later stage.”
Anyone with a vested interest in the euro will certainly hope so. But the failure of recent actions by Washington or Europe to stem the panic has raised fears that no amount of stimulus will turn markets around until the actual medical emergency is seen to be passing.
That seemed as far away as ever on Wednesday, as Italy reported an acceleration in recorded new cases and its biggest one-day leap in deaths from COVID-19 so far, while the overall number of cases in Europe overtook that in China, where the outbreak started.
It was big, bold actions like this, and the spending bill approved by the U.S. Senate on Wednesday, that ultimately turned markets around in 2009. But with analysts now expecting the biggest economic contraction since World War II in the second quarter, further volatility can hardly be ruled out when the markets’ latest stimulus sugar rush fades.
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