The COVID-19 epidemic is sinking the prospects for the world economy into macroeconomic projections developed by the staff of the European Central Bank (ECB). As we could already imagine, the conclusion is that this year the global activity will be significantly lower than the previous forecasts.
Due to this sudden change in the economic outlook, we have seen in these weeks a volatility in the financial markets triggered, rises in risk premiums and stock market collapses driven by an investment panic in which lower future flows in business activity of listed companies are being discounted.
Against this background, yesterday, the ECB led by Christine Lagarde showed the heavy artillery to start the purchase of temporary assets of public and private sector securities and trying to counter the reality reflected in the markets in recent weeks. This new pandemic emergency purchase program has a volume of 750,000 million euros and purchases will be promoted until the end of 2020.
The program will cover all eligible assets under the current quantitative easing program, public and corporate debt, and will be extended to commercial documents of sufficient credit quality, including Greek government debt.
But most striking of all is that the ECB will consider increasing your self-imposed limits. The ECB will be able to buy debt with a maturity of only 70 days (previously it was established for up to one year), and there will be no limit to buy no more than 33% of the debt of any country in circulation.
With these measures to intervene in the secondary debt market, there was a shift in the expectations of investors, with falls in risk premiums due to falling debt returns. The most extreme case we have in Greece with a fall of more than 200 basis points for Greece's 10-year bonds, going from an IRR of 4% to a level slightly below 2% and reducing the gap between the debt of the strongest economies in the Eurozone.
Intervene until you break the limits
If we add the measures promoted by the European monetary authority together with those already established during 2020, we will see a total intervention of 1.1 billion euros, the largest annual amount of a program. This amount will have to be added to the almost 5 trillion of assets accumulated in purchases.
This is not the first time that we have seen the ECB act in a fully interventionist way, but yes it is the first time in which it is intended to break the previously established rules.
Venturing into the commercial paper market is new to the institution, but the most contested measure would be to raise the limits set at the start of the program in 2015, because it would address concerns that the central bank would violate European Union law by funding governments.
Till the date, the limit level of 33% of outstanding bonds had approached the reference bond issuer Germany and some smaller countries. Breaking the limit, it is intended to focus your stimulus where it is most needed and extend it for the time desired.
It is not clear that this action can be carried out because there is legal challenge behind, because the Court of Justice of the European Union specifically pointed out these thresholds in a 2018 ruling when it argued that the ECB was not breaching a monetary financing ban.
A 'fake' debt market
In a scenario of non-intervention in the debt market, those countries that pose greater risks in relation to their high levels of public debt and the evolution of their respective deficits are punished with higher interest for the issuance of their debt.
In this way, a clear relationship is established between interests and risk. Those countries that find it impossible to finance themselves in the markets due to the high interest demanded, they must adjust to their financial reality by balancing income and expenses in favor of budget stability. Therefore, market mechanisms allow a clear identification of the underlying risks of the issuers.
But the existing problem is that the European monetary authority has long forgotten the fundamentals of the market, and aims to curl the curl, increasingly, to maintain the perception of risks in isolation.
All this has created a unprecedented financial bubbles in the fixed income market, both public and private, that is evident in the bonds with negative nominal returns and, therefore, a flight forward is sought, breaking the limits.
It is hoped that in the face of external shocks such as the one we are currently experiencing, those countries identified as more risky due to their high accumulated public debt and constant public deficits, their situation is not taken into account. Hence the proposal of the Eurobonds to further blur the risks incurred.
The existing problem of all these increasingly interventionist measures, it is the lack of credibility that a market that is excessively manipulated and increasingly vulnerable to an economic shock can have. For this reason, during the month of March we have once again seen how the yields of the European bonds of the periphery have escalated strongly.
The situation is complicated, if profitability is eliminated from the low-risk asset (or a negative profitability is attributed to it), governments obviously lack incentives to undertake measures of budgetary responsibility, reality is disguised with a debt bubble, and investors are being pushed increasingly to look for riskier assets to maintain the profitability of their portfolios and protect themselves from inflation, however low it may be at present. And that investments are channeled to high risk, without fundamental support.