Sign up for Equitymaster's free daily newsletter, The 5 Minute WrapUp and get access to our latest Multibagger guide (2018 Edition) on picking money-making stocks.

This is an entirely free service. No payments are to be made.

Download Now Subscribe to our free daily e-letter, The 5 Minute WrapUp and get this complimentary report.
We hate spam as much as you do. Check out our Privacy Policy and Terms Of Use.
Will the ECB follow the Fed? - Outside View by Asad Dossani
  • MyStocks


Login Failure
(Please do not use this option on a public machine)
  Sign Up | Forgot Password?  

Will the ECB follow the Fed?
Dec 6, 2010

As the European crisis continues, the European Central Bank (ECB) is doing what it can to contain the fallout. Most recently, they have decided to purchase the bonds of peripheral European countries in order to bring down their borrowing costs. They have achieved temporary success as bond yields did fall and the euro did rise.

The Fed's response to the slowdown of the US economy has been quantitative easing. They purchased US government bonds on a large scale to keep yields low, and allow the government to easily finance its deficits. Effectively, this is printing money to finance government expenditure.

Many are expecting the ECB to eventually follow the same route as the Fed. It is already showing signs of this through its bond purchases. However, the have not committed to a full-scale quantitative easing program like the Fed has.

The biggest problem for the peripheral European countries is their rising bond yields. Not only do that have large debts and deficits, but they are also finding it increasingly difficult to borrow money to finance these deficits. The high yields are a signal that the market is pricing in a certain risk of default on these bonds.

Unfortunately, the high bond yields make their future much more uncertain. They may end up needing a bailout or defaulting simply because the market expects this to occur, and their bonds are priced to reflect this. This is where the ECB can come in to prevent this from occurring.

European authorities have three options to deal with the debt problems in the periphery. First, they can continue to bailout countries like they have done with Greece and Ireland. Second, they can allow these countries to restructure their debt, thereby making bondholders suffer the losses. Third, they can embark on a quantitative easing program and buy government bonds on a large scale.

The first option is very unpopular politically. European governments will try as much as possible to prevent future bailouts from occurring. They may find that this is not possible in some cases, but they will certainly try and avoid it.

The second option is probably the best in the long-term, as it puts the losses directly on to those who invested. After all, why should taxpayers pay for investment losses by private investors? Unfortunately this option is unlikely to occur, primarily because the main investors in peripheral European government bonds are German, French, and British banks. They certainly do not want a situation where their banks suffer large losses on these bonds and then need a bailout themselves.

The third option is the one that is least costly, politically speaking. It is not the best way to deal with a debt problem, but it is the easiest way. For this reason, it is quite likely that the ECB will embark on greater bond purchase programs in the future. Therefore, to answer the initial question of the article: Yes, the ECB will end up following the Fed to deal with the debt problems.

Disclosure: I do not hold the currency/commodity viewed/opined in this column

Asad is an Economics Graduate from The London School of Economics who has also been a part of the currency derivatives team of Deutsche Bank in London. Currently pursuing his PhD at the University of California San Diego where he's researching on Algorithmic Trading Strategies, Asad will be your direct line for answers to all the questions you might have on short-term investing. A part of the Equitymaster Team since 2010, Asad has been sharing his knowledge on short term trading strategies with our valued readers, like you, through our various services. In fact, at the last count, his weekly newsletter, Profit Hunter, was being delivered to more than 100,000 smart traders across the world!


The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

Equitymaster requests your view! Post a comment on "Will the ECB follow the Fed?". Click here!


More Views on News

Sorry! There are no related views on news for this company/sector.

Most Popular

The Foundation for Sensex 100,000 is Laid(The 5 Minute Wrapup)

Feb 17, 2018

Top three reasons for Tanushree's presentation at Equitymaster Conference to be centered around a possible 30% correction.

The Era of Easy Money is Coming to an End. What Happens Now?(Vivek Kaul's Diary)

Feb 9, 2018

The easy money policy of the Federal Reserve of the United States, which drove up stock markets all over the world, is ending, with the Federal Reserve looking to shrink its balance sheet.

The Markets Want Your Money. Don't Give It to Them.(Smart Contrarian)

Feb 9, 2018

MFs are having a gala time taking money from over-eager investors and funneling it into equities. Smart investors, though, know better than to do that.

The Big Gamble(The Honest Truth)

Feb 15, 2018

Once you accept the fact that elections are round the corner and that this budget is geared to reach a 40% target, everything makes sense.

NPAs Set to Rise Further with New RBI Rules(Chart Of The Day)

Feb 15, 2018

The RBI overhauls bad loan framework. Banks may come under additional pressure due to rising NPAs and increased provisioning.


Small Investments
BIG Returns

Zero To Millions Guide 2018
Get our special report, Zero To Millions
(2018 Edition) Now!
We will never sell or rent your email id.
Please read our Terms