The ECB is contemplating new stimulus programs to try to instill some level of inflation into the Eurozone. Right now inflation is well below the target 2% and is potentially headed to zero or worse. While that is unlikely, it is possible which is what is motivating Draghi to start to even introduce the conversation about stimulus and QE which to date has been taboo. This should give investors in European assets some pause and should at the least create a series of projections that run the gamut of 2% inflation to possibly negative .25%. One also needs to consider what debt will be available at what rates when it comes time to exit.
While we have no way to intelligently know or even forecast what will be the situation Europe in three to five years, Given the Crimea invasion and the high chance Russia will instigate further encroachment into Ukraine and neighboring countries, nobody knows what could happen. While real war between NATO and Russia is extremely unlikely, one can never be certain. Much more likely is a battle of sanctions, gas supply constraints, restrictions on exports, suspended business dealings, and general uncertainty. While I have covered this before, it is the impact on banking and interest rates that is the current subject. Maybe due to the uncertainty the ECB lowers rates further to sustain what will be a weakened Eurozone economy. Maybe investors require a much higher risk premium depending on where this all goes over the rest of 2014. Maybe both happen.
Will investors want to buy hard assets in Poland, Czech Republic, or any of the frontline countries to Russia. Russia just raised gas prices to the Ukraine by 80%. What if he does that to Germany to retaliate for sanctions. Unlikely, but very possible. Right now Italian and Spanish bonds are selling at the best prices in many years. What happens if there is a black swan even like Russia making a major move as they seem to be planning and really causing disruption to the currency and bond markets. Rates could rebound in these places. Likely that could present real opportunities for all cash fund buyers form the US who could rush in with rescue capital or to buy up assets from the banks to give them new needed liquidity.
Unfortunately Obama and Merkel have done almost nothing to show Putin they will act. In fact their actions so far have very likely encouraged Putin to go further and to use gas and his relations with Syria and Iran, and his veto in the UN as further leverage to keep Obama afraid to really act forcefully. Putin is betting on more of the same words and no real action form the US. He has bulldozed Obama on Syria and he has played Iran well. He has more cards to play with his advanced anti air missile defense systems and other means. He increased defense spending 44% while Obama wants to hollow out American military strength. What message do you think Putin gets from all of that.
The US economy is barely growing after five years. The real unemployment rate is still 12.7%, the employed to population ratio is lower than in 2007, and after five years we just reemployed the 8 million who lost their jobs. Problem is over that same five years there are an additional 11 million people in the US and that will continue to grow at about the rate of 2.2 million per year. That is why the ratio of employed to population is getting lower by the year as the economy stays stagnant. If this continues then the US deficit will remain intractable and our economy will remain weak. That will put pressure on defense spending and Putin knows this, just as he knows defense spending is not something Obama will likely increase materially.
In summary there is no way to really predict where rates may be in Europe in a year from now. Very likely Draghi will lower them and maybe go to QE. Also likely investors may require a risk premium late this year or next. When you do your projections for European investment hoirizons you need to do a range of rates and outcomes.
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Joel Ross
Joel Ross began his career in Wall St as an investment banker in 1965, handling corporate advisory matters for a variety of clients. During the seventies he was CEO of North American operations for a UK based conglomerate, and sat on the parent company board. In 1981, he began his own firm handling leveraged buyouts, investment banking and real estate financing. In 1984 Ross began providing investment banking services and arranging financing for real estate transactions with his own firm, Ross Properties, Inc. In 1993 Ross and a partner, Lexington Mortgage, created the first Wall St hotel CMBS program in conjunction with Nomura. They went on to develop a similar CMBS program for another major Wall St investment bank and for five leading hotel companies. Lexington, in partnership with Mr. Ross established a hotel mortgage bank table funded by an investment bank, and making all CMBS hotel loans on their behalf. In 1999 he formed Citadel Realty Advisors as a successor to Ross Properties Corp., focusing on real estate investment banking in the US, UK and Paris. He has closed over $3.0 billion of financings for office, hotel, retail, land and multifamily projects. Ross is also a founder of Market Street Investors, a brownfield land development company, and has been involved in the acquisition of notes on defaulted loans and various REO assets in conjunction with several major investors. Ross was an adjunct professor in the graduate program at the NYU Hotel School. He is a member of Urban Land Institute and was a member of the leadership of his ULI council. In 1999, he conceived and co-authored with PricewaterhouseCoopers, the Hotel Mortgage Performance Report, a major study of hotel mortgage default rates.
