German executives are growing more confident, Spanish borrowing costs have never been lower, and stocks are rising across Europe.
Crisis, what crisis?
But all is not as it seems. At the end of last week, the European Central Bank started buying asset-backed securities, part of a new program to unblock credit and goose the euro-zone economy by expanding its balance sheet by some €1 trillion ($1.24 trillion).
This is not necessarily why things are suddenly looking up today.
More than anything, what markets are reacting to are strong hints dropped by ECB president Mario Draghi that, although the central bank’s bond-buying program has only just begun, he’s already willing to expand it. If the euro zone’s dangerously low inflation rate doesn’t pick up soon, “we would step up the pressure and broaden even more the channels through which we intervene, by altering accordingly the size, pace and composition of our purchases,” Draghi told a banking conference.
Analysts are taking this as a sign that the bank could soon break the taboo against buying government bonds, the main method of “quantitative easing” in the US, UK, and Japan but a politically fraught move in the 18-member euro zone.
Given the persistent weakness of the euro zone economy, Draghi may not have a choice—there may not be enough private-sector securities to buy to give the euro zone a big enough economic jolt.
Take those German business-confidence numbers. A survey of executives by the Ifo Institute jumped unexpectedly in November, following six straight months of decline. But this closely-followed indicator—which has a decent track record as a leading economic indicator—is consistent with only weak growth, at best:
And what about Spanish bonds? The 10-year government bond yield dropped below 2%—two percent!—for the first time ever today. In the land of 24% unemployment, it’s hard to believe that this rock-bottom yield is down to anything but Draghi’s hint that he might start buying government bonds soon. “Market participants have been focusing on Draghi’s speech,” an analyst explained to Bloomberg. “He’s the one who sets the pace.”
The rally in European stock markets today is being paced by banks, another sign that hopes of expanded ECB stimulus are fueling the rally—when the central bank buys bonds and other securities, it purchases them from banks, after all. “Investors are being forced to consider separating weak fundamentals with bullish stimulus,” another analyst told Bloomberg.
And so as you scan the spate of good news putting a spring in the market’s step today, don’t lose sight of those “weak fundamentals”—in essence, the euro zone economy has moved from the emergency room to the intensive-care ward. Either way, it depends on the ECB for life support.