As Christine Lagarde prepares to take up her post as the next president of the European Central Bank (ECB), investors are wondering whether the change of leadership will signal a regime shift in monetary policy. Probably not, for two reasons.
The European Parliament has now given its approval for Christine Lagarde to succeed Mario Draghi as president of the ECB. Lawmakers voted 394 in favour, 206 against and with 49 abstentions in the European Parliament’s plenary sitting in Strasbourg on 17 September. She will become the first woman to hold this position. A former antitrust lawyer by trade, she also differs from most of her predecessors in that she has had little monetary policy experience. But don’t expect that to translate into a big change in policy direction.
Calls for Fiscal Help to Continue
Firstly, Draghi has been calling for greater use of fiscal policy to improve the European growth and inflation outlook. To date, his appeals have fallen on deaf ears. Indeed, the latest efforts to promote fiscal stimulus attracted fierce criticism and even rifts in the highest ranks of the European Union. Christine Lagarde, with her background in global politics, could be more persuasive, we believe. Her mission? To convince reluctant euro-area governments that they can and should spend more and/or tax less to boost the economy while the ECB is keeping rates at historical lows, so helping to keep their borrowing costs down. In our view, this fiscal component is the critical ingredient required for a sustained improvement in growth and inflation.
Chief Economist’s Dovish Stance
Secondly, the role of the chief economist is more important than ever, given the loss of a career central banker in Draghi. The current incumbent, Philip Lane, has shown himself to be on the more dovish side of the debate. For instance, in July he highlighted the way that the ECB’s easing policies (including negative interest rates, forward guidance and quantitative easing or QE) had been effective in raising realized inflation. More recently, he has also been vocal in his support for the latest round of easing measures. In a strong rebuttal to the more hawkish council members, he reiterated the ECB’s “unwavering” and “unconditional” commitment to do “whatever it takes to hit our inflation target”.
So, with Lagarde in charge, we believe the ECB’s commitment to the inflation target remains strong and that it stands ready to take further action if required.
Investment Implications
As a result, we expect Lagarde’s appointment to create broad continuity in ECB policy for the foreseeable future.
With the risks to growth still heavily skewed to the downside, high quality government bond yields are unlikely to move higher. Longer-duration government bonds with relatively high underlying risks that enjoy ECB backing have the highest prospective returns—notably, Italian treasuries (BTPs). While the BTP market has already reacted favourably to the news of prospective easing, there is further to go, in our view.
Holding select European credits also looks attractive, as the gravitational pull of ECB buying will likely keep both yields low and spreads tight.
In this environment, we believe a selective approach and dynamic management are the keys to worthwhile returns in fixed income. In euro-area markets where both yields and spreads are likely to be anchored at low levels, dynamic management might appear to have lost its edge. But we believe news flow will still drive price movements and provide opportunities for nimble investors. In fact, euro-area markets trading at such high valuations may be more susceptible to short-term over- or under-shooting. So, while an ultra-low or negative rate environment is challenging, we believe active bond investors can still thrive—even with a new pair of hands at the ECB helm.
