Is Lagarde the Right Choice for ECB Chief?


Jul. 5 2019, Published 2:50 p.m. ET

Lagarde as ECB president

In a surprise move, the first female managing director of the IMF (International Monetary Fund), Christine Lagarde, was nominated as the president of the ECB (European Central Bank) on Wednesday. She’ll be the first female president of perhaps the most complicated central bank in the world. She’s set to succeed Mario Draghi—also known as “Super Mario”—who’s well known for his “whatever it takes” attitude toward monetary policy. Lagarde’s term will start on October 31 after Draghi steps down.

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European bond yields drop, equities gain

Germany’s Jens Weidmann, a hawk, was also in the race, but European leaders zeroed in on Lagarde. The markets expect Lagarde to continue Draghi’s accommodative stance. With the expectation of a rate cut in September and more stimulus to follow, European bond yields hit multiyear lows on the news of Lagarde’s nomination.

Italian ten-year bonds, which hit a high of 3.78% last year, dropped 50 basis points this week to reach 1.65%. Italy is expected to be the biggest beneficiary of quantitative easing. Yields on Germany’s ten-year bond dropped to -0.401%, below the ECB’s deposit rate of -0.4%.

As bond yields and bond prices moved in opposite directions, European bond prices rallied on Lagarde’s nomination. European equities rose on Wednesday on the back of the expectation of an economic boost. The pan-European broader STOXX 600 Index gained 0.85% on Lagarde’s nomination, while Germany’s DAX closed 0.71% higher. The iShares MSCI Eurozone ETF (EZU), which invests in Eurozone equities, gained 1.06% on Wednesday. SAP (SAP), the ETF’s largest component, gained 0.6% on the day.

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Europe’s economic gloom

Lagarde’s nomination comes at a time when the ECB is trying hard to boost growth. The Eurozone manufacturing PMI (purchasing managers’ index), a leading indicator for the European economy, suggested that the Eurozone’s manufacturing sector remained in contraction in June. Spain’s and Austria’s manufacturing PMIs were at multiyear lows. Germany, the region’s manufacturing powerhouse, continued to see manufacturing sector contraction in the month. The Eurozone’s GDP growth rate came in at 1.9% in 2018, 1.7 percentage points lower than the global average.

However, services have been a bright spot for the 19-country group. Ireland and France are also positive outliers.

Lagarde’s focus will likely be on fostering ties within the Eurozone by building consensus, something she’s done effectively at the IMF.

What are the key challenges facing Lagarde?

The ECB policy rate has been at zero since 2016. Inflation in the Eurozone also remains subdued. The already low interest rate coupled with low inflation makes the job of the ECB president a tough one. Traditionally, central bankers used lowering interest rates as a tool to boost inflation and growth. With interest rates already at zero, the ECB will have to move into the negative territory. The evidence of the benefits of negative policy rates is weak. The Bank of Japan has kept its policy interest rate at -0.1% since early 2016, when the ECB nearly adopted a zero-interest-rate policy. However, inflation has failed to pick up beyond the target level, putting pressure on economic growth.

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However, monetary policy isn’t the only area that should concern Lagarde. Keeping the Eurozone flock together amid the Brexit saga is a tall order. Across the Eurozone, nationalism is on the rise, threatening the unity of an already fragile coalition. The divide between the South and the West is still troubling many. How Lagarde will manage to engage all stakeholders and make the group stronger will decide her success. For starters, how the benefits of the expected quantitative easing can be fairly shared among the member countries will be the most pressing question before the nominee.

Will Trump be happy?

President Donald Trump has long been at odds with US trading partners. While the US-China trade war has drawn the most worldwide attention lately, Europe isn’t far behind. Trump has accused America’s European allies of playing an unfair game. He accused the ECB of manipulating the euro for trading benefits in a tweet the same day Lagarde was nominated. He’s also been at war with Fed Chair Jerome Powell, demanding a more accommodative monetary policy. Trump recently announced two new Fed nominees—both dovish—to push the Fed to cut interest rates. Markets widely expect a rate cut this month.

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The reason for Trump’s anger is simple. A zero-interest-rate environment in Europe means a weaker euro, as capital flows to higher-yielding markets and assets. A weaker euro puts European exporters at an advantage. In short, a weaker euro means Airbus (EADSY) will have a cost advantage over Boeing (BA), and Airbus might be able to provide better deals to secure a higher market share. Similarly, Siemens (SIEGY) may end up trumping General Electric (GE) in securing power plant orders.

Trump will certainly be not happy to see the ECB pursuing accommodative policy under Lagarde. Moreover, Lagarde’s reaction to Ivanka Trump at the G20 may have already angered the president.

Is Lagarde the right person for the job?

While Lagarde lacks the macroeconomic expertise that most central bankers possess, she isn’t new to policymaking. At the IMF, she led Argentina’s $56 billion bailout. She’s also widely credited with rebuilding the reputation of the IMF, which was lost after a disastrous Greek bailout. She’s also a tough negotiator—something the ECB will need in order to hold its ground if the trade war reaches central banks.

How Lagarde adjusts to the new role and the new setting will be interesting to see. Her record shows that she’s no stranger to surpassing expectations.

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Who will replace Lagarde as the IMF chief?

Lagarde’s unexpected departure from the IMF has left the succession race wide open. Traditionally, the top job at the IMF has been held by a European, while the World Bank has been headed by an American. Lagarde has certainly raised the bar for the role.

The New York Times recently reported that Singapore’s senior minister, Tharman Shanmugaratnam, was among the early short-listed candidates to replace Lagarde. Tharman has headed the International Monetary and Finance Committee in the past. Agustin Carstens, Mohamed El-Erian, and Mark Carney are some of the other names under consideration.

Whoever takes on the role will have to deal with economic instability in countries such as Argentina, Turkey, and Venezuela. He or she will also have to maintain the IMF’s role in the current trade war environment.

What does this mean for you?

What does this mean for your portfolio? It all depends on the monetary policy stance Lagarde takes and what your portfolio holds. If her decisions and actions spark an interest rate war around the world (especially with the US), it would be wise to move your investments into bonds and safer sectors. High-dividend-paying noncyclical companies may outperform the broader market in that scenario.

In such an environment, utilities generally do well, as they exhibit certain bond-like characteristics. You can gain exposure to utilities by investing in the Utilities Select Sector SPDR ETF (XLU). NextEra Energy (NEE) is the ETF’s largest constituent. NEE has a dividend yield of 2.41%. Duke Energy (DUK), the ETF’s second-largest constituent, has a dividend yield of 4.16%.

Consumer staples is another sector that could beat the market in such an environment. You can gain exposure to the sector by investing in the Consumer Staples Select Sector SPDR ETF (XLP), which invests in companies such as Proctor & Gamble (PG), the Coca Cola Company (KO), PepsiCo (PEP), and Walmart (WMT). All these companies have low betas, meaning they’re much less volatile than the broader market.

Government bond ETFs such as the iShares 20+ Treasury Bond ETF (TLT) and the iShares US Treasury Bond ETF (GOVT) tend to do well amid accommodative monetary policy. If you want to gain some international bond exposure, the iShares International Treasury Bond ETF (IGOV) is an option.

For exposure to European equities, you can invest in the Vanguard FTSE Europe ETF (VGK) or the SPDR EURO STOXX 50 ETF (FEZ).


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