As the falling oil price and improved exchange rates create a significant tailwind for Europe’s corporate sector, QE creates positive momentum for risk assets. With yields on sovereign debt suppressed as a big buyer enters the market, investors are increasingly encouraged to take more risk. However, the picture is not all rosy.
A DARKER PICTURE FOR LIABILITIES
While the impact of QE is likely to be positive for risk asset prices in the short-term, the impact on UK pension fund liabilities is less welcome. As QE pushed yields on European bonds lower, driving more demand for UK bonds, institutions have been watching their liabilities soar.
The Pension Protection Fund estimated aggregate deficits in PPF-eligible schemes were a record £367.5bn at the end of January 2015, up a whopping £101.2bn in the space of a month and a staggering £321.1bn since the end of January 2014 when deficits were estimated at just £46.4bn. This news comes as a big blow to UK corporates who have been ploughing tens of billions of pounds into their pension schemes to plug deficits. Those deficits keep getting bigger as interest rates continue to fall.
A DARKER RISK/RETURN PROFILE
One of the long-term impacts of QE will be to further deteriorate the risk/return profile across the region.
“Investors are encouraged to take more risk,” explains Guilhem Savry, investment manager in the Cross Asset Team at Unigestion, “but the expected yield for the next 10 years is also lower so the risk/ return profile is very deteriorated.”
The impact on high yield assets, for example, has already been clearly seen. By mid- February, yields had already fallen on European high yield assets as investors piled in to the space on the back of the ECB’s 22 January announcement. Blackrock figures showed the European high yield market was yielding approximately 3.9% by 12 February, down from 4.1% just prior to the ECB’s announcement.
Aon Hewitt’s global head of asset allocation, Tapan Datta, believes European high yield is trading at extraordinarily tight prices, but QE may prove to be a “major distorting factor” pushing yields even lower as the presence of big buyer ripples through the market.
LONG-TERM STILL GLOOMY
Many experts also worry the impact of QE, lower oil prices and a weaker euro will be relatively short lived.
A senior allocator at one of the UK’s largest pension funds remains staunchly bearish on Europe, saying they struggled to see how Europe could avoid a Japan-like period of stagnation without fiscal policy union. This person believes ultimately that the eurozone will break up, but will bumble along for a long time before that eventuality is reached.
“QE is less and less impactful versus 2009,” they argue. “We have already seen such compression of asset prices and forcing them lower is forcing people to go outside of Europe to spend their risk budgets. Equities may pop up in the short term because of QE, but that is not sustainable. Without central control of fiscal policy Europe cannot avoid a Japan-style period of deflation.”
Aon Hewitt’s Datta also warns that longterm factors in Europe ought to constrain how much enthusiasm investors have to invest in the region. “Ultimately,” he argues, “economic improvement in Europe is held back by bad demographics, a crisis of animal spirits and doubts about the future of the currency union. While there might be more comfort in the short term, the long term picture is more troubling.”
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