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European Markets Will Continue to be Major Source of Volatility, According to Standish

Report from BNY Mellon Investment Manager Raises Concerns about Divisions within ECB

The European markets are likely to continue to be a significant source of volatility as divisions within the European Central Bank (ECB) inhibit its ability to put the region on a firmer footing, according to Standish Mellon Asset Management Company LLC, the fixed income specialist for BNY Mellon.

Standish made the observations in its April Outlook, written by Thomas D. Higgins, global macro strategist at the firm. The conflicting viewpoints of members of the ECB's governing council appear to limit the bank's actions, according to the report. Standish said that it does not believe the ECB will move to reduce volatility and improve liquidity until the sovereign spreads in Spain and Italy approach previous highs.

"Our expectation is that Europe will continue to be a source of global financial market volatility in the coming months," said Higgins.

Higgins continued by commenting that the large disparities in economic growth and inflation expectations between euro zone economies may complicate the European Central Bank's (ECB) ability to act. Monetary policy is too loose for Germany and too tight for almost every other country in Europe, according to the report.

"The ECB's long-term refinancing operation (LTRO) has certainly helped to reduce systemic risk in the banking system," said Higgins. "However, the LTRO's honeymoon with investors may be ending as they realize that the flood of liquidity does nothing to address Europe's underlying solvency problems."

David Leduc, Standish's chief investment officer said, "The volatility is likely to lead to continued range-bound trading for rates near term."

The Standish paper recognizes that European leaders need to take a number of steps to safeguard the future of the euro. These may include:

Lifting restrictions on the free flow of capital and labor across borders,

  • Harmonizing tax entitlement programs,
  • Developing a true pan-European budget that allows for transfer payments from stronger to weaker regions in the currency area, and
  • Creating a true euro zone bond issuance program.

Such measures could take years to implement, but investors likely would take comfort that Europe would be working toward a common goal, according to Standish. These actions are advisable so that the debt-laden peripheral European nations can escape from a pattern of recessions, which drive down government revenues. The lower revenues typically result in more austerity, followed by further economic weakness, the report said.