Investors have been hyper-focused on every word that comes out of every Federal Reserve official since October, but when the European Central Bank (ECB) made a major policy reversal last week, the markets yawned.
Ten years ago, Warren Buffett described the 2008 financial crisis as akin to a heart attack. The Fed, acting as a physician, prescribed zero interest rates and when that wasn’t enough, they tried an experimental strategy known as quantitative easing.
While Buffett was talking about the US, the rest of the global economy had the same heart attack and the European Central Bank (ECB) and the Bank of Japan (BoJ) prescribed the same medicine as the Fed.
While the US got off its medicine a few years ago, the ECB and their President, Mario Draghi, didn’t see fit to take their patient off the medicine until three months ago. Good news, right?
Well, yes, but last week the ECB reassessed the situation and decided that the patient was still too sick to go without medicine. More specifically, they cut their economic growth forecast from 1.7 percent to 1.1 percent.
As a result, the ECB said that they would keep interest rates lower for longer than expected, at least to the end of 2020, and will make cheap loans to banks in a program called Targeted Longer-Term Refinancing Operations or TLTRO.
Well, this time it’s called TLTRO III because this is the third round. The idea is if banks have access to cheap money, they will turn around and lend the money to the customers and stimulate the economy.
One of the interesting things about the ECB’s surprise announcement is that the market didn’t care. European bond yields fell along with the euro, and while European stocks jumped initially, the gains were short-lived and ended the day lower.
Investors who already believed that European growth is slowing quickly came to believe that the ECB is more worried about the economy than previously thought.
Despite the magnitude of the policy shift, investors may not take notice this week either since there will be another vote this week on Prime Minister Theresa May’s plan to exit the European Union at the end of the month.
The last vote in January was a disaster for May since her plan was roundly rejected by Parliament. The scheduled exit is at the end of the month, so the markets will undoubtedly focus more on the Brexit news this week than the ECB’s policy announcement last week.