ECB safety blanket for risk assets wearing thin

Spanish and French government bond yields are going their separate ways after trading in lock-step for more than a year, a shift that reflects waning investor confidence that central bank monetary policy can underpin risky assets. The European Central Bank’s €1.5tn bond-buying programme has proved a powerful buffer for lower-rated eurozone bonds, restraining yields during China’s currency devaluation and the subsequent market turmoil last August and from political uncertainty linked to elections in Spain and Portugal. However, that impact is waning as investors question whether the ECB has enough ammunition to achieve its goal of lifting inflation towards its 2% target, protect the eurozone economy from global headwinds and bolster the confidence that has helped boost demand for risky assets. Spain’s 10-year bond yield has risen more than 10 basis points this month while its French equivalent has fallen more than 10 bps to 10-month lows at 0.50%. “The premise of post-crisis policy has clearly been to boost demand by boosting asset valuations which, in turn, creates a positive wealth effect,” said Richard McGuire, head of rates strategy at Rabobank. “The longer this goal proves elusive, the greater the risk investors question the efficacy of this policy and, as such, are forced to face up to the fact that risky assets may never be justifiable from a fundamental perspective,” he added. McGuire said the fact that peripheral government bond spreads have become tightly correlated with volatility in European stock markets is another sign that investors are less confident in the ECB’s ability to boost risk assets. While the European STOXX Volatility index spiked higher last August after China devalued the yuan, a rise in Portuguese bond yields was limited thanks to ECB bond-buying. But this month the two have moved together, with Portuguese bonds caught in the crossfire of risk aversion. “Given all the ECB measures that are there, the expanded version of QE doesn’t appear to be helping the spreads of peripheral countries and risk premiums remain elevated and volatile,” said Commerzbank strategist Rainer Guntermann. He said that while there were “home-made” problems in Portugal and Spain that helped explain a rise in yields, many investors were also disappointed that ECB policy was not working as well as it did in its in initial stages. The ECB launched its quantitative easing programme in March 2015 and extended it in December by six months to March 2017.