The European Central Bank (ECB) delivered a robust package of monetary policy measures on June 5 and promised more to come if needed to help stave off deflation and support the eurozone’s fragile economic recovery. Among the moves announced were interest rate cuts, including a negative interest rate on excess deposits that banks hold with the ECB, and new facilities to support bank lending to small businesses. We asked David Zahn, portfolio manager for the Franklin Global Government Bond Fund, for his thoughts on what these latest measures could mean for investors.
What in this recent ECB announcement stands out for you?
The big thing that stands out to me is that the ECB continues to be very accommodative. The exact details of the announcement didn’t seem as important as the sheer surprise it brought the market, I believe. People were not expecting the ECB to do something this aggressive. Some market participants were expecting quantitative easing (QE)—a program of issuing currency specifically to purchase financial assets—in this latest announcement. I didn’t think QE would happen as quickly as that. But I believe we are still on a journey, and there are still more measures to come in various different forms, quite possibly ending up in quantitative easing towards the end of this year or the beginning of next.
Which of the announcements should have the most impact on investors?
I think the proposed targeted longer-term refinancing operations (TLTROs), which will allow banks to borrow from the ECB at ultra-low rates, are what people will be most focused on because they offer the prospect of cheap funding to banks for a considerable amount of time – four years. The ECB has also reasserted that it will consider taking further quantitative measures in the future other than cutting interest rates. It has confirmed that, if economic data continues to be poor, it will do more.
How have the announcements been received by the markets so far?
The ECB telegraphed the rate cut quite well, in my view. The TLTROs are being framed with a more appropriate term – in the past they tried to do them too short, and that gets them into other issues. I think the market has seen the announcements as more evidence of the ECB’s accommodative approach. We sense too that ECB president Mario Draghi was more dovish in his speech. I think overall that’s very positive for European fixed income. But I also think there’s more that can be done, and he’s left the door wide open for more to happen.
And what is your view of the approach?
We think the ECB is looking to hit on various different levers, but one of the main ones is getting bank lending back on track, and I think that’s important because if you get bank lending going it tends to help growth. I like the fact that Draghi has not tried to pin the ECB’s success all on one particular strategy. He’s put out several different ways of creating liquidity. The ECB will probably see which one works best and do more of that, or try something different. We see evidence that the ECB is trying different things to increase liquidity and attempt to reignite inflation in the eurozone.
Tell us about the impact of the announced negative interest rate on the ECB’s deposit facility.
I think it’s largely symbolic. It’s only on the excess reserves that the banks hold, so I don’t think it’s going to have much of a market impact. Instead, I think the move suggests that the ECB will continue to be accommodative.
What is the impact of this going to be outside the eurozone?
The ECB action reflects the fact that central banks in different parts of the world are in very different parts of the economic cycle. In Europe, the ECB is very clearly still loosening policy and will continue to do so, we believe, for several years. Meanwhile, Japan is also doing outright quantitative easing and is printing money. But the US is starting to reduce the amount of quantitative easing. Globally it means that there is more liquidity being produced into the world than there was previously, and I think in general that’s reasonably supportive for asset prices.
For investors, what potential value does that present?
In general, I think it means investors may want to look at European assets, because it appears that accommodative actions are continuing. Obviously my remit is the bond market, and I think there is value to be found there, but I think there could be other areas that potentially offer value too. In this environment I believe what some might perceive or classify as “risk-assets,” including high-yield corporate bonds as well as equities, could likely do better than they would if the ECB wasn’t taking these types of measures.
What does the future hold for the markets, and ECB, in your view?
The main possibility, in our view, is outright quantitative easing and the purchasing of bonds. I think that’s still out in the future. Draghi has made it clear that’s in the ECB’s remit and is something they could consider longer-term. I think he is doing an excellent job of having the market do a lot of the work for him as yields had been on the decline, and this latest round of actions is likely to maintain that trend.
We believe Draghi has signaled that rates have likely been cut as low as they’re going to go. In previous statements, he had said rates could go lower, but on this occasion he said only that rates will remain low. He has made it clear the ECB will take other unconventional measures if required by the economic data, particularly if inflation and growth forecasts are revised lower.
David Zahn’s comments, opinions and analyses are for informational purposes only and should not be considered individual investment advice or recommendations to invest in any security or to adopt any investment strategy. Because market and economic conditions are subject to rapid change, comments, opinions and analyses are rendered as of the date of the posting and may change without notice. The material is not intended as a complete analysis of every material fact regarding any country, region, market, industry, investment or strategy.
To get insights from Franklin Templeton Investments delivered to your inbox, subscribe to the Beyond Bulls & Bears blog.
CFA® and Chartered Financial Analyst® are trademarks owned by CFA Institute.
What Are the Risks?
Franklin Global Government Bond Fund
All investments involve risks, including possible loss of principal. Changes in interest rates will affect the value of the fund’s portfolio and its share price and yield. Bond prices generally move in the opposite direction of interest rates. Thus, as the prices of bonds in the fund adjust to a rise in interest rates, the fund’s share price may decline. Special risks are associated with foreign investing, including currency rate fluctuations, economic instability and political developments. Investments in developing markets involve heightened risks related to the same factors, in addition to those associated with their relatively small size and lesser liquidity. Changes in the financial strength of a bond issuer or in a bond’s credit rating may affect its value. Derivatives, including currency management strategies, involve costs and can create economic leverage in the portfolio which may result in significant volatility and cause the fund to participate in losses (as well as enable gains) on an amount that exceeds the fund’s initial investment. The fund may not achieve the anticipated benefits, and may realize losses when a counterparty fails to perform as promised. Currency rates may fluctuate significantly over short periods of time, and can reduce returns. The fund is also non-diversified, which involves the risk of greater price fluctuation than a more diversified portfolio. These and other risk considerations are discussed in the fund’s prospectus.