Janet Yellen, chair of the U.S. Federal Reserve, left, with Mario Draghi, president of the European Central Bank, during the Jackson Hole economic symposium in Moran, Wyoming, on Aug. 22, 2014.
Federal Reserve Chair Janet Yellen’s economy may be enjoying some unintended support from European Central Bank President Mario Draghi.
By nudging the euro area closer toward all-out quantitative easing, Draghi is pushing European investors into U.S. Treasuries, reducing the yields on the securities which help dictate borrowing costs for American mortgages and other loans, according to Pierre Lapointe and Alex Bellefleur of Montreal-based brokerage Pavilion Global Markets.
What they call the “Draghi Dividend” explains part of the 50 basis-point drop in the 10-year Treasury rate since the start of the year, which occurred even amid signs the world’s largest economy is strengthening. That hands Yellen’s Fed another form of stimulus even as it cuts back bond-buying of its own and readies to raise interest rates as soon as next year.
“They’re getting some outside help in keeping interest rates low,” said Lapointe in a telephone interview, adding that the outside support will give policy makers some extra comfort when they do come to raising their benchmark. “It’s all very positive and the Fed will like it.”
As of the end of May, $3.4 trillion long-term U.S. Treasuries were owned by euro-area residents, up from $2.8 trillion a year earlier, according to U.S. Treasury Department data.
ABS Program
“We suspect that European accumulation of Treasuries will only have accelerated since then, as it has become increasingly obvious that QE in the euro zone is about to happen,” said Lapointe and Bellefleur in their Sept. 4 report.
While Draghi has held back from buying sovereign debt as the U.S. Fed has done, he announced last week that the ECB would start purchasing private-sector assets next month. He left the door open to fully-fledged government-bond buying if the euro-area economy keeps deteriorating.
Quantitative easing in Europe would be aimed at underpinning inflation expectations in the region and also leave those investors selling bonds to the ECB looking to reinvest the resulting cash in higher-yielding assets, according to the Pavilion report.
Talk of QE alone is enough to make U.S. Treasuries at 2.4 percent more attractive to those investors than Italian debt paying a similar amount or German 10-year bunds yielding less than 1 percent, Lapointe and Bellefleur said, adding that U.S. dollar assets become even more attractive to Europeans as the euro weakens.
Debt Burden
Another positive for the U.S. is that the lower Treasury yields help its government, companies and households reduce their debt burdens as economic growth tops long-term interest rates. “Higher long-term rates would make this more complicated, as continued deleveraging would require materially higher income growth, or nominal debt reduction or both.”
The upshot is that as Draghi tries to boost his own 18-nation economy, he may be lifting that of Yellen’s too.
“The gradual pricing in of euro-QE contributes to lower long-term yields in the U.S., which is effectively a stimulative spillover from the ECB’s policy,” said Lapointe and Bellefleur. “The U.S. is enjoying long-term yields as low as a few years ago, but with a considerably stronger economy. This is a very positive factor for the U.S. economy.”
To contact the reporter on this story: Simon Kennedy in London at skennedy4@bloomberg.net
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