Today is the second anniversary of Mario Draghi’s “Whatever it takes” pronouncement during the darkest days for the euro. Let me share with you some thoughts on how that event probably changed the course of the Eurozone.
Draghi’s speech did what it was supposed to do – it preserved the euro and it calmed the economy and the financial markets – without costing a single euro. The most important measure of success is that after the speech, the Outright Monetary Transaction Program (OMT), which allowed the European Central Bank (ECB) to buy short-term bonds from euro governments, was not utilized even once. The bottom line: The speech and the program were nothing more than a communications initiative, albeit an extremely adept one.
Fluctuations in the financial markets, as well as uncertainties regarding them, were curbed, credit costs for governments, banks and (to lesser extent) companies were lowered – particularly in the countries that were most at risk. Confidence in the euro’s future – which had been dwindling – and the economic prospects of the eurozone were re-established. As investors, we have always been confident with respect to the euro, and we were able to take advantage of spread tightening and a recovery of European equities from depressed levels.
Bond Markets in the Eurozone: The Magic of “Whatever it Takes”
Today, two years later, I believe that the state of the monetary union is notably improved: The eurozone economy is growing, even if only moderately, as austerity has largely run its course. Ireland and Portugal have left the bailout fund. Developments in Spain and Italy give reason for moderate optimism. Some of the main imbalances between core and peripheral countries (current accounts, labor costs, productivity) are under adjustment. In the European elections, populist opponents of the euro failed to rack up points, except in France. A break-up of the eurozone is no longer an immediate threat.
Nevertheless, many problems are yet to be solved: disinflationary tendencies, sluggish growth, disparate rates of recovery in the northern and southern countries, weak lending demand from the private sector and high fragmentation in credit market conditions.
To address all of this, more is needed than communication and low interest rates. In its meeting in May, the ECB adopted unconventional measures including, among others, negative deposit rates and a program to boost lending to companies. And we could speculate as to whether a Fed-style QE could be a further option for the ECB.
However, we believe that the ball is now more in the court of other policy-makers. Promoting reforms at a sensible pace without stunting growth will be crucial. The current level of unemployment, especially youth unemployment, has to be addressed quickly, before it becomes a source of social instability.
No Reasons to Be Complacent
GDP Recovery Very Slow and Fragmented
High Unemployment Rate in Some EU CountriesSource: Bloomberg, data as of July 10, 2014.
A pan-European infrastructure program may be a suitable tool to stimulate growth as austerity fades from the scene. Another key agenda item is the gradual correction of the euro’s birth defect: namely, the creation of a monetary union without common economic and fiscal policies.
We understand this will not be an easy process. Individual countries will have to relinquish political and fiscal power. But this will likely be the only way to build a stronger union and promote stability and prosperity in the long run.