The Eurozone’s near-term outlook is challenging. The economy shrank by 0.7% quarter on quarter in the fourth quarter of 2020 and is likely to decline again in the first quarter of 2021 because of virus waves. But the Eurozone is set to rebound from the second quarter of 2021 as vaccines are distributed. Furthermore, the European Central Bank (ECB) may be getting ready to follow the Bank of Japan (BoJ) and deliberately keep government bond yields very low for years to reflate the economy. This would benefit Europe’s lagging stock markets.
Source: Bank of Singapore, Bloomberg
Japan suffered two ‘lost’ decades of deflation after its equity bubble burst at the end of the 1980s. In 2013, the Bank of Japan responded by printing money aggressively, helping the economy return to inflation while also sparking a major turnaround in Japanese stocks. The chart above shows the Nikkei began to trend higher from 9,000 under the BoJ’s quantitative easing.
Source: Bank of Singapore, Bloomberg
In 2016, to give the economy further support, the BoJ committed to keeping 10Y government bond yields ‘around zero percent.’ Its policy of ‘Yield Curve Control’ (YCC) deliberately stops yields from rising and thus benefits borrowers. Since 2016, the Nikkei has rallied from 16,000 to 28,000, its highest levels since its bubble burst at the end of the 1980s as the chart above shows.
Source: Bank of Singapore, Bloomberg
The ECB may be preparing to follow the BoJ and cap bond yields to help reflate the Eurozone. The ECB hasn’t set a formal yield target but it now seeks ‘favourable financing conditions’ to ease funding costs for banks, firms and households.
This could turn out to be very similar to YCC. Thus, the ECB’s new stance over time may help revive European stocks that are still below their 1990s internet bubble levels as the last chart shows.
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Version: July 2020