The question many investors might be asking themselves today is, “how much is the right amount?” A tepid reaction to yesterday’s European Central Bank announcement of the status of asset purchase programs indicates that ECB president Mario Draghi has yet to convince market participants that the bank is doing all it can, despite his indications that the bank will continue to implement liquidity measures. Today in the U.S., the critical Department of Labor employment situation report should boost equity markets, as September nonfarm payrolls increased by 248,000 jobs, rebounding after disappointing numbers in August (which were revised higher). For investors already on edge after pullbacks in U.S. stocks, the stronger-than-forecast report could bring some relief on the ability of the U.S. economy to keep up momentum in spite of problems in Europe and Japan and a slowing China and might signal a less dovish tone for Federal Reserve policymakers.
U.K. service sector data shows slight cooldown. Markit U.K. service industry purchasing managers index (PMI) data for September showed activity cooling moderately, with the headline index registering at 58.7 versus a prior 60.5. Although slightly below consensus forecasts, in aggregate the subindexes for employment and prices advanced, supporting the view of some analysts that a recovering economy in the nation could justify tightening by the Bank of England in the intermediate term.
Small businesses get relief from Abenomics. The Japanese Trade Ministry today unveiled a new initiative aimed at assisting small businesses negatively impacted by a weakened yen on the back of aggressive easing by the Bank of Japan. With an economy dependent on energy imports, the nation’s private sector is feeling the impact of rising relative costs for fuel. Prime Minister Shinzo Abe’s administration continues to see a long term-positive impact in a lower valued currency as it will make Japanese-produced goods more competitively priced for export. Some critics, however, argue that geographic diversification of production by large Japanese companies largely dulls the intended impact.
Iron ore shipments decline in Australia. Data released today from Port Hedland Port Authority, one of the world’s largest iron ore export terminals and the largest in Australia showed shipments of iron ore to China dwindling to 29.8 million tons in September from a record high of 32 million in 2013, as total export shipments declined. Closely watched as an indicator for overall Chinese economic activity, a moderating growth for basic material demand is a critica point for the Australian economy.
U.S. nonmanufacturing activity data scheduled for release. ISM non-manufacturing index levels for September will be announced today with consensus forecasts for a slip in the headline index, down from strong August numbers. A primary driver for gains in the prior report were from the employment subindex, a positive signal in contrast to Department of Labor payroll data for the month.
Portfolio Perspective: ECB Operating With One Hand Tied Behind its Back — Adrian Miller, GMP Securities
It’s clear from the reaction of euro zone stocks, bonds and the euro that the ECB’s details of its asset-backed securities and covered-bond buying program fell flat. And we agree. This is the second such disappointment after the limited takedown of the first long-term refinancing operation (TLTRO) in September that generated demand of just €82.6 billion ($104.3 billion).
Keep in mind, when it comes to unconventional monetary policy designed to stabilize and encourage economic growth and break a deflation spiral, size matters. And at first glance, the ECB’s initial stab at its purchase program will not be large enough. While Draghi, sensing a potential problem in just focusing on higher quality securities as the pool of available issues was relatively small had argued for including mezzanine ABS, it seems his attempt to dip into this pool will be insufficient.
While Draghi has previously indicated the scope of the asset purchase program would ultimately add €1 trillion to the ECB’s balance sheet over the life of the program — revealed as being at least two years — Draghi did not identify the intended size of the asset-backed securities and covered bond purchase programs. Also, with an understanding or expectation that the asset-backed securities program will boost origination of asset-backed securities issues as bank shed the underlying loans, though the extent of the pick-up in origination is questionable, the ECB made it a point to include primary as well as secondary issues.
A big point of contention in the ECB’s decision to delve into mezzanine asset-backed securities is that these issues must be guaranteed. But whose guarantee? Local governments have already indicated they are not interested in providing such guarantees. Also, France and Germany have been particularly adamant about refusing such guarantees by saying in an unpublished paper, “investors could be tempted to rely on the guarantee rather than to conduct their due diligence by examining the transactions and underlying assets and it would be very difficult for the public sector to disengage without undermining the market.”
Adrian Miller is the director of fixed-income strategies for GMP Securities, a wholly owned subsidiary of Toronto–based GMP Capital.
