What Can You Expect From QE in Europe? | Charles Schwab

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What Can You Expect From QE in Europe?

June 19, 2015

Since March, the European Central Bank (ECB) has sought to lower long-term interest rates and stimulate growth through monetary policy—an approach known as quantitative easing, or QE.

In the United States, the Federal Reserve implemented quantitative easing to help combat the recession; the policy remained in place from 2009 to 2014. The program had its critics, but many market watchers agree that it helped markets and the economy rebound. 

The European QE experience may not be the same, due to differences in politics, fiscal policy, the length of the central bank’s bond-buying programs and market forces.

The ECB’s QE program: A shorter timeline

One of the first points of distinction emerged when the European Central Bank said it expects its program of quantitative easing to last for 18 months. (In contrast, when the Federal Reserve introduced its third round of quantitative easing, or QE3, it indicated that the program would be open-ended and run as long as needed.)

“Whenever you put an expiration date on something, all eyes begin to focus on the end date,” says Jeffrey Kleintop, chief global investment strategist at Charles Schwab. “There’s some question as to whether the European Central Bank might begin to taper quantitative easing before it gets to the end, and how markets might react once tapering begins.” 

The European Central Bank has created a relatively short runway for achieving self-sustaining economic momentum and investors might get nervous when the stimulus program begins to wind down. Both conditions create the potential for additional market volatility over the short term, Jeffrey notes. The volatility and lack of momentum could prompt the ECB to extend QE beyond 18 months.

A different approach to borrowing

The ways in which companies borrow money and raise capital is another key difference between Europe and the United States. “In Europe, companies borrow most of their money from banks, not by issuing bonds, as in the United States,” says Jeff. As a result, the ECB’s efforts to make it easier for European companies to borrow in the bond market by stimulating demand for corporate bonds may be less effective than the Federal Reserve’s efforts were in the United States. 

No unified fiscal policy

In some ways, the current backdrop of the 19-country eurozone may sound similar to the United States during its most recent recession: high unemployment, low growth and volatile financial markets. But the similarities end there.

“Europeans share a central currency but no central government and no central fiscal policy,” says Francisco Torralba, senior economist for Morningstar Investment Management. “In Europe, each country has its own fiscal policy.” 

The lack of a unified fiscal policy may be one reason the eurozone economy has stagnated for longer than the United States. Another reason could be simply that the European Central Bank waited much longer than the United States to begin its program of quantitative easing.

“The United States, of course, has had its own share of challenges in recent years with coordinating monetary and fiscal policy,” says Torralba. “However, the U.S. government has relied more heavily on fiscal stimulus than Europe, and the Federal Reserve began its program of quantitative easing much earlier than the European Central Bank.”

Room for growth in European asset prices

While the European economy had already started to rebound before the ECB implemented its program, quantitative easing seems to be helping to reinvigorate the economy, at least so far. “The main effect of the European Central Bank’s bond-buying program has been to raise asset prices for both stocks and bonds, and to lift the confidence of both financial markets and consumers,” says Morningstar’s Torralba.

Still, we think European stocks may present opportunities for growth, thanks in part to QE. Right now, Europe lags the United States in the recovery phase of the economic cycle, so European stock valuations are currently lower than those of U.S. stocks. In addition, because the eurozone has had quantitative easing in place for a shorter time, European stock prices may still have room to rise.

Chart: Monetary policy looks different in Europe

What you can do

  • Europe is in a period of transition, and while you might want to sit tight to see how European QE efforts unfold, it’s also a good time to reexamine your international stock allocation.
  • Consider adding some international exposure—especially exposure to Europe—to your equity holdings for the intermediate term.
  • Talk to a Schwab Global Investing Specialist at 877-806-4205 to discuss your international investments.

Important Disclosures

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision. 

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed. 

International investments are subject to additional risks such as currency fluctuation, geopolitical risk and the potential for illiquid markets. Investing in emerging markets may accentuate these risks.

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