| LONDON, June 6
LONDON, June 6 If it wasn't fully apparent
before Thursday, it's crystal clear now: the central banks of
the euro zone and United States, the two most powerful monetary
authorities in the world, are moving in opposite directions.
What's less obvious is whether the flood of measures the
European Central Bank has just announced will strengthen or
weaken the trend this year for Europe's stocks, bonds and main
currencies to broadly outperform their U.S. counterparts.
Earlier this week, the gap between some of these European and
U.S. prices reached their widest in years.
Thursday's ECB measures include a historic cut taking its
overnight deposit rate below zero and 400 billion euros ($545
billion) of cash for banks to lend on in a campaign to defuse
the threat of deflation, revive corporate borrowing and spark
growth across the 18-nation bloc.
Across the Atlantic, meanwhile, the Federal Reserve is on
track to close out its bond-buying programme later this year,
winding down stimulus. If the economic recovery doesn't falter,
it could start raising interest rates next year.
Euro zone banks and investors unwilling to pay for the
privilege of depositing cash at the ECB dumped their euros for
dollars on Thursday. This pushed the premium to access dollars
in the forward currency market, measured by benchmark
three-month cross currency basis swaps, to its highest since
June last year.
In government bond markets, where the connectedness of
global economies has historically forged close trading
relationships between major debt benchmarks, an anomaly has
emerged. The difference between the yield on two-year U.S.
Treasuries over comparable German bonds rose to 35 basis points,
the widest gap in seven years .
The questions now for investors are: is there any juice left
in these trades? If so, how much? Where are the most lucrative
areas to play this policy divergence?
Traders say that many large financial institutions are now
selling U.S. Treasury bonds of maturities out to 10-years and
buying German equivalents to take advantage of the differing
official rates outlooks.
"It is clear that the ECB is at a very different stage of
the cycle than the Fed and thus, on a relative value basis, the
European bond market still looks like the place to be," said
Gary Jenkins, strategist at LNG Capital in London.
The prospect of another wave of European liquidity and
investors' hunt for yield matched perfectly on Friday. The yield
on 10-year Irish, Spanish and Italian government bonds plunged
to their lowest levels ever. Remarkably, less than four years
after having to seek an international bailout, Ireland can now
borrow for 10 years at cheaper rates than the United States.
STOCK & ROLL
It is not just bonds that present opportunities.
"This could still be constructive for equities and other
growth assets relative to government bonds," said Neil Williams,
chief economist at Hermes Fund Managers in London.
"But it's too little to late to snuff out the deflation
risk. The ECB will have to capitulate eventually and do
full-blown QE (quantitative easing). The ECB has overpromised.
The big risk is that it underdelivers," he said.
Germany's DAX popped above 10,000 points for the
first time ever immediately after the ECB's action on Thursday.
But Wall Street has been printing record highs on a near daily
basis for weeks.
The daily correlation between the S&P 500 and DAX hit 0.949
this week, its highest in three months. But bearing in mind the
highest possible correlation is 1:1 suggests that correlation
will soon start to weaken, as it has done consistently over the
last 20 years at these lofty levels.
Williams reckons the U.S. economy will grow faster than the
euro zone over the next couple of years so Wall Street should
outperform euro zone stocks, despite the ECB's more
Others, such as Brian Jacobsen, portfolio strategist at
Wells Fargo Asset Management, said U.S. investors are becoming
increasingly "intrigued" by opportunities in European markets.
He would be prepared to go "heavily overweight" into European
stocks, he said.
The ECB's impact on foreign exchanges was fleeting. The euro
initially plunged a cent to a four-month low around $1.35
, only to snap back and end the European trading day
The conventional wisdom is that the ECB's drive to push
monetary policy in the opposite direction to that of other major
central banks like the Fed and bank of England should pressure
the euro to weaken.
But the ECB's policy measures will attract foreign
investment into European assets, which will put upward, not
downward, pressure on the currency.
"You've got a lot of conflicting pressures. The short euro,
long dollar trade has been one that people have had on since the
beginning of the year and it has not played at all well," said
said David Riley, head of credit strategy at Bluebay Asset
($1 = 0.7345 Euros)
(Graphic by Vincent Flasseur; Editing by Ruth Pitchford)