The ECB Remains Focused on Its Targets

The European Central Bank (ECB) surprised markets once again on April 21 with the timing of some important announcements and also the scope of its bond purchasing program. While the ECB kept all three of its policy interest rates on hold — as expected — and the size of its asset purchase program unchanged at EUR80 billion a month, ECB President Mario Draghi provided new details in a news conference on the implementation of the bank’s program and on the scope of what assets it can buy. At a high level, Draghi summarized by saying that the ECB’s monetary policies are working, but they need time to be more effective.

Markets react positively — for a moment

Draghi used the word “patience” and suggested that interest rates will remain low for an extended period (or go lower), well past the horizon of the ECB’s bond purchase program. He also said that inflation could turn negative in 2016 but would recover in 2017 and 2018 — with the future path of inflation being supported by monetary policy, global recovery and base effects. Draghi did not talk the currency down as we had expected, and discussions of a pick-up in inflation and improving conditions were received positively by the markets: Immediately after the ECB announcement, the euro strengthened by around 0.6% versus the US dollar to 1.14, yields on 10-year German bunds rose by around 1 basis point, and the EURO STOXX 50 Index rose by about 0.4%.1 These moves were, however, short-lived as the EURO STOXX 50 Index quickly gave up its gains and the euro-US dollar exchange rate retraced back toward 1.13 later in the day.

When asked about Brexit fears (fears that the UK will leave the European Union), Draghi said markets should expect continued uncertainty ahead of the UK referendum, however, he said he expected the risk of spill-over to the eurozone to be limited.

Welcome details on the corporate sector bond purchase program:

1. Purchases will start in June 2016 and will be conducted by six national central banks.

2. Investment-grade euro-denominated bonds issued by non-bank corporations will be included. (This means insurers will be included, which was not expected.)

3. Purchases will be conducted in the primary and secondary market. (We believe the primary market is key to achieving effective size of purchases.)

4. Eligible paper is between six months and 30 years of maturity and must have a minimum rating of BBB-.*

5. Issuers must be established in the euro area. (If their parent is not based in the euro area, issuers can be eligible if all other eligibility criteria are fulfilled.)

6. The ECB can buy up to 70% of an issue’s size.

7. The ECB will make its holdings transparent on a weekly and monthly basis.

In Invesco Fixed Income’s view, the upshot is that these details are broader than what the market had expected, especially the inclusion of insurance company bonds and the plan to participate in the primary market.

However, two key items are still not disclosed:

1. The size of the corporate bond purchase program. (We believe this is sensible since the ECB will likely want to maintain flexibility to adjust this to achieve its objectives.)

2. Details on the process of bond purchases. (For example, will the ECB buy bonds directly from issuers? What will be the role of asset managers?)

In our view, the absence of these details does not change the positive technical support for European credit, and the announcement certainly reinforces it. In terms of Invesco Fixed Income’s strategy, we see value in European credit and point to value in credits that the ECB is not currently targeting, such as banks, subordinated paper and European high yield bonds. This is because the ECB is now competing with other investors in the credit market, which could potentially create a “crowding out” effect. In other words, we see a potential spill-over of demand for other credit assets outside of the ECB’s mandate, which, we believe, could present attractive investment opportunities.

1 Source: Bloomberg, LP

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Important information

*A credit rating is an assessment provided by a nationally recognized statistical rating organization (NRSRO) of the creditworthiness of an issuer with respect to debt obligations, including specific securities, money market instruments or other debts. Ratings are measured on a scale that generally ranges from AAA (highest) to D (lowest); ratings are subject to change without notice. NR indicates the debtor was not rated and should not be interpreted as indicating low quality.

For more information on rating methodologies, please visit the following NRSRO websites: and select “Understanding Ratings” under Rating Resources on the homepage; and select “Rating Methodologies” under Research and Ratings on the homepage; and select “Ratings Definitions” on the homepage.

The EURO STOXX 50® Index measures the performance of blue-chip eurozone equities.

Fixed-income investments are subject to credit risk of the issuer and the effects of changing interest rates. Interest rate risk refers to the risk that bond prices generally fall as interest rates rise and vice versa. An issuer may be unable to meet interest and/or principal payments, thereby causing its instruments to decrease in value and lowering the issuer’s credit rating.

The risks of investing in securities of foreign issuers can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.

The dollar value of foreign investments will be affected by changes in the exchange rates between the dollar and the currencies in which those investments are traded.

The performance of an investment concentrated in issuers of a certain region or country is expected to be closely tied to conditions within that region and to be more volatile than more geographically diversified investments.

Junk bonds involve a greater risk of default or price changes due to changes in the issuer’s credit quality. The values of junk bonds fluctuate more than those of high quality bonds and can decline significantly over short time periods.

The information provided is for educational purposes only and does not constitute a recommendation of the suitability of any investment strategy for a particular investor. Invesco does not provide tax advice. The tax information contained herein is general and is not exhaustive by nature. Federal and state tax laws are complex and constantly changing. Investors should always consult their own legal or tax professional for information concerning their individual situation. The opinions expressed are those of the authors, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.

All data provided by Invesco unless otherwise noted.

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