Managers hoping to see new era for fiscal policy

As the European Central Bank prepares to usher in a new president, money managers are hoping that fiscal policy developments will take precedence over monetary measures in the eurozone.

During Mario Draghi's eight years at the helm of the ECB, eurozone interest rates were cut and have been languishing in negative territory. The central bank also launched, reduced and then restarted an asset purchase program. More recently, the central bank launched a new effort — interest rate tiering — to partially shield banks from the cost of keeping their overnight liquidity reserves with the ECB.

Even so, money managers agreed that over his time as president, the limitations of monetary policy have been demonstrated.

Mr. Draghi's tenure revealed the limits of a unified monetary policy and a disseminated — or fragmented — fiscal policy, said Tom Clarke, portfolio manager on the dynamic allocation strategies team at William Blair & Co. LLC in London. Among eurozone finance ministers there does not appear to be an consensus going forward on a unified fiscal policy, he said.

"The ECB can't change that and it's one of the reasons why the eurozone will remain an unresolved issue," he said. "It will not necessarily lurch from crisis to crisis, but will always be affected by this."

As the limits of monetary policy are realized and "skepticism about its effectiveness is growing, financial markets will probably turn their attention to other policy tools," said Silvia Dall'Angelo, London-based senior economist at Hermes Investment Management. She added that expectations surrounding fiscal policy, or coordination between monetary and fiscal measures, are rising.

That's a lot of pressure for incoming ECB President Christine Lagarde, who until Sept. 12 was managing director of the International Monetary Fund — the first woman to be appointed to both positions. Her resume also includes time as finance and economy minister of France, again, as the first woman in a Group of Seven country.

Money managers said her background in politics sets her apart from previous ECB presidents and also gives them hope for what she may achieve in what they think could be a challenging period.

"I think (Ms. Lagarde can push fiscal policy) — she is not a classical central banker, not an economist, but is very experienced when it comes to the political context," said Mauricio Vargas, senior global economist at Union Investment Institutional GmbH in Frankfurt. "It is very clear that the ECB did and delivered what it could do, but now it is up to other actors — mainly fiscal policy — to combine and give the additional needed support to regain traction."

However, Mr. Vargas said monetary policy will still be important in other ways, namely "whenever we see any doubt on the stability of the eurozone."

Managers also highlighted decisions made by the ECB's governing council at its September meeting and presented by Mr. Draghi. He announced a further round of stimulus, including restarting the net asset purchase program of €20 billion ($21.9 billion) per month effective Nov. 1; further cutting the interest rate on the deposit facility used by banks in the region to make overnight deposits by 10 basis points to -0.5%; and the introduction of a tiering of negative deposit rates for banks. Following the announcements, some eurozone central bankers came out in opposition — something highlighted by managers.

Ms. Lagarde comes in "at a pretty difficult time as it is evident (Mr.) Draghi used the opportunity of his departure to effectively push through the current policy package against quite a lot of opposition, which has been quite vocal," said David Riley, chief investment strategist at BlueBay Asset Management LLP in London. "Lagarde is coming into an ECB where — not wholly dissimilar to the (U.S. Federal Reserve) — the leadership challenge will be at least as great as it was for her predecessor, where there is a large divergence of views. It's going to take all of her leadership skills to actually lead and bring the governing council closer together and be more supportive of whatever policy actions they take. I'd like her to bring … back some greater discipline and remind other members of the ECB that it is a key institution for the eurozone and once a collective decision has been made, there is a collective responsibility to support that decision. Her background and record is such that you might think she has the skill set to deliver on that," he said.

Calls for fiscal support were not just made by money managers. In his final media conference Sept. 12, Mr. Draghi said: "In view of the weakening economic outlook and the continued prominence of downside risks, governments with fiscal space should act in an effective and timely manner."

But Ian Samson, assistant portfolio manager at Fidelity International in Hong Kong, who recently relocated from London, said monetary policy should not be dismissed.

"A lot of people are talking about the need for fiscal stimulus in the eurozone," which he said could be down to Ms. Lagarde's background in politics — she was finance minister in France — or because during his final press conference Mr. Draghi seemed to have "passed the baton to fiscal policy. We also continue to believe that just because of the speed with which you can act and the way monetary policy tends to get in all the cracks, monetary policy is still the best tool for cyclical demand management rather than fiscal," said Mr. Samson.

He said the firm does not see fiscal policy "forthcoming in (the) next 18 months."

Eoin Walsh, partner and portfolio manager at TwentyFour Asset Management LLP in London, said market participants will be observing how Ms. Lagarde leads the ECB.

"Convincing various member states, particularly Germany, that fiscal support is needed could be key. Markets will be watching closely to see if she will pick up where Draghi's dovish tone left off. We certainly hope she has this attitude, though the jury is out for the time being," he said.

Money managers will also be watching markets closely for any impact from the change at the ECB's helm.

Ms. Lagarde's "fight will be to create consensus, tame the hawks and really communicate with markets. Whenever any president or governor of a central bank comes in, there is usually a volatile teething period … where they can misunderstand markets (and vice versa) — so they need to learn how to communicate with markets quickly," Mr. Samson said.

For now, Fidelity International is underweight Europe and putting more focus on emerging markets — "where there is the most space for monetary policy to boost growth. What Europe needs for a stable upswing is a pickup in China and its emerging trade partners," he said.

And European financials are a big focus for managers. "The pain the ECB is causing financials makes it quite hard to get too excited about a significant portion of the European equity market," Mr. Samson added. The MSCI European Financials index gained only 2.6% annualized over the last almost-decade, lagging the MSCI Euope index by 4 percentage points, and was down 19.2% in 2018. For the year through Oct. 11, European financials gained 9.6% while European equities as a whole were up 16%.

After the latest — and Mr. Draghi's last —ECB meeting held in September, BlueBay is positioned for lower interest rates, a flatter yield curve and tighter credit spreads. "We also thought they would introduce tiering and have increased in some strategies exposure to European bank capital," Mr. Riley said.

Going forward, William Blair's Mr. Clarke said the team is considering whether the ECB's negative interest rate policy and quantitative easing "encourages the persistence of zombie companies, which crowd out growth of new or reformed smaller companies, and therefore cause bigger differentiation between leaders and countries which have not reformed. These unproductive and unprofitable firms are propped up by ECB policy."