Draghi’s press conference was NOT unexpected

On Thursday 3 December 2015 ECB president Mario Draghi indicated that he will extend the asset purchase program for another 6 months (this translates to another EUR 360 billion of liquidity) and apply a rate cut of the deposit rate with 10 additional basis points (from -0.20% to -0.30%). Markets had expected more, something like a significant step up in the monthly stimulus of EUR 60 bln. But this was not what Draghi had in mind at the press conference. With hindsight Bloomberg concludes that markets may have been blinded with “irrational exuberance”.

 

Financial media emphasized the enormous disappointment on the financial markets. Eg Bloomberg reports that:

The European Central Bank’s 360 billion-euro ($393 billion) stimulus boost and rate cut on Thursday, which was in line with the president’s wishes, sent the euro soaring and stocks and bonds tumbling as disappointed investors matched reality to their expectations.

 

And Federal Reserve Chair Janet Yellen commented that “the market expected some actions that were not forthcoming.”

 

Whether or not Draghi had signaled for more and hence market participants have been left disgruntled, is no longer significant. The ECB’s decision to not ramp up the monthly amount of EU 60 bln is what counts.

 

The point I want to make here is that markets weren’t that shocked and much of the coverage was exaggerated. To illustrate my point look at the daily returns of the Euro Stoxx 50 index for the past 7 years.

Rplot01

Daily Log Returns Euro Stoxx 50 Index

The log returns show some correction but we cannot substantiate any claim to hectic markets at this point in time. The adjustment is not even a once-in-a-100 days event (exception to a 99% VaR).

 

After fitting a GARCH(1, 1) model to the index we can illustrate how the volatility is developing. We see some increase in volatility but the only valid conclusion is that market movements are back to a normal level after a serene period that followed the August rise in volatility.

Rplot02

Volatility of Euro Stoxx 50 Index

My conclusion: market participants had already absorbed the decision to not ramp up. It is rather the financial press that’s hectic than the financial markets.

 

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Over Folpmers
Financial Risk Management consultant, manager van een FRM consulting department, bijzonder hoogleraar FRM

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