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Draghi Powers Down Bonds


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What's going on?

The President of the European Central Bank (ECB) made some comments on Tuesday that investors interpreted to mean that higher interest rates in the eurozone are on their way. And that’s a bigger deal than it sounds…

What does this mean?

In recent years, the ECB has been directly buying European bonds in an effort to help the economy grow (click here for background). By buying the bonds, the ECB has been pushing up bond prices – which pushes down bond “yields”, a.k.a. interest rates (why? click here). Now that the eurozone economy is growing more quickly, the ECB is likely going to decrease the amount of bonds it buys each month. This should have the effect of pushing down bond prices and pushing up interest rates – which, in turn, increases demand for the euro (because investors move their money where they can earn those higher interest rates). Relatedly, the euro rose on Tuesday to its highest level versus the dollar since September 2016.

Why should I care?

For markets: European and US bonds sold off in response to the comments.

If the ECB buys fewer European bonds, that’s clearly bad for the price of European bonds. But it also impacts other bonds, including US bonds. Why? Many global investors in recent years have sold European bonds (essentially to the ECB) and bought US bonds with the proceeds. If the ECB buys fewer European bonds, there is less money to buy US bonds, which pushes down their prices and pushes up US interest rates.

The bigger picture: The ECB’s move would be in line with the actions of other major central banks.

For years, central banks around the world have been trying to support their economies by keeping interest rates low (which encourages borrowing and, thus, spending). But major central banks are now moving in the opposite direction (albeit, in the ECB’s case, very slowly). This gradually removes a major tailwind for economic growth and, by extension, stock prices.

Originally posted as part of the Finimize daily email.

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