QE Won’t Stop Deflationary Pressures, Say Bond Investors

Fixed income investors are still concerned about deflation in the Eurozone despite the European Central Bank’s €1.1 trillion ($1.2 trillion) quantitative easing (QE) project, according to a Fitch Ratings survey.

Two-thirds of fixed income experts polled by the ratings agency said the risk of deflation was high within the currency bloc, while only 27% said QE would address low inflation.

The ECB began buying German and Italian government bonds yesterday, leading to many bonds also eligible for purchase by the bank trading at negative yields.

“Protracted deflation would be negative for sovereigns and banks,” wrote Fitch analysts Monica Insoll and Michael Larsson. “It could lead to higher real interest rates, rising real debt burdens, a weakening of asset prices (and therefore collateral values) and asset quality, and deferred consumption and investment. Addressing problem loans will be more challenging should deflation take hold.”

Fitch has previously warned that deflation in the Eurozone could cause underperformance across asset classes and prompt investor outflows.

Despite concerns about deflation, the survey respondents said QE was likely to provide a short term boost to capital markets, as similar stimulus programs have in the UK and the US.

Fitch analysts Monica Insoll and Michael Larsson said investors’ lack of belief in QE as a stimulus for economic growth was evident in their views on other areas.

“Investors have toned down their expectations for companies to invest in machinery and equipment as well as mergers and acquisitions,” the analysts wrote. “Instead, they think treasurers will be more cautious, holding on more tightly to cash and paying back debt.”

QE was expected to boost demand for higher-yielding fixed income instruments, such as high yield debt and investment grade corporate bonds, according to the survey.

The survey questioned 77 fixed income managers, analysts, and strategists during January and February.

Related Content: European Deflation to Hit Asset Managers’ Bottom Line & LGIM: Why Central Banks Are Wrong on Inflation