Successive Federal Reserve Chairmen from Alan Greenspan to Ben Bernanke have been associated with what financiers call a “put” option. The Greenspan put and the Bernanke put refer to the notion that the central bank supports the economy–and thus the markets–with low interest rates and liquidity. Although central banks officially deny doing it, the perception is that they effectively put a floor under asset prices, like a put option on a stock.
The ECB has seemingly had a similar effect on European markets. Will the unlimited loans to banks at the record low interest rate of 1 percent offered since Mario Draghi took office end up creating a Draghi put?
The benchmark European Stoxx 600 index ended the month of January just 2 percentage points shy of a bull market, up 18 percent since its September low. That’s the biggest gain for the equity market for the start of a year since 1998. Even the VStoxx, a measure of implied volatility for stocks, has fallen to its lowest level since July.
What’s driving it? According to BNP Paribas (BNP:FP), the ECB’s provision of unlimited cash to banks is the cause. Christian Dargnat, BNP’s chief investment officer, told Bloomberg News: “A wall of money was put into place. We’ve started to become more positive. The ECB’s operation was the impetus.” Indeed, BNP Paribas has reduced its cash position in favor of European stocks.
Richard Iley, BNP’s chief economist for Asia, echoed the sentiment in an interview this morning with Bloomberg TV, in which he calls the ECB’s liquidity boost a “game changer” for the European debt crisis.
The ECB effect goes further. Morgan Stanley (MS) upgraded one of Italy’s biggest banks, Intesa Sanpaolo (ISP:IM), to overweight on Feb. 7 despite Fitch downgrading the bank’s credit rating by one notch on Monday night to A- from A. The reason is that the ECB has reduced systemic risk and narrowed sovereign spreads, especially in Italy, and thus driven the earnings upgrade for Italian banks.
The ECB’s actions aren’t just boosting stocks. The CEO of Intesa says that ECB funds it borrowed are being used to buy sovereign debt. “We will use part of ECB funds to buy Italian government bonds, considering that there are significant amounts expiring this year,” Enrico Tommaso Cucchiani said at a Milan conference. Intesa also plans to access more ECB funds at the next auction at the end of the month.
It appears that the Draghi put is supporting the government bond market. Since the ECB began offering unlimited bank loans on Dec. 8, Italian and Spanish bonds have rallied. The yield or borrowing cost on 10-year Italian bonds is down to almost 5.5 percent, the lowest since October, having dropped by nearly 2 percentage points from its euro-era record high hit in November, at 7.48 percent. Spanish bond yields have even fallen below 5 percent, down nearly 2 percentage points from their record high of 6.78 percent in November.
And it’s not only countries on the European periphery that are benefitting: French bonds also have felt the Draghi effect. The “Sarkozy trade” has seen French bonds outperform German bunds as yields on 10-year debt fell from 3.8 percent in November to less than 3 percent.
Without undertaking a program of quantitative easing, or QE, whereby the ECB would buy government bonds and inject cash like the Fed, Draghi’s actions have similarly supported a wide range of asset classes. Even corporate bond yields are near record lows and the euro has hit an 8-week high against the dollar at $1.3237 on Feb 7, despite the Greek debt swap talks dragging on. And there’s more to come. The ECB may cut rates on Thursday or later this year, but it will offer another round of unlimited cash to banks at the end of the month. If markets continue to respond in this manner, it won’t be surprising to be hearing more about the Draghi put alongside the Bernanke put.