With the market realization slowly dawning that Bernanke will not announce anything of note at this year’s Jackson Hole meeting, especially with the NFP number following the symposium expected to demonstrate another improvement in the economy, and ahead of the FOMC meeting in the second week of September, many hopes were resting on the shoulders of Draghi, whose ECB has now become a backup option when it comes to jawboning markets higher on empty promises.
It is the same ECB which is also expected to announce something, anything on September 6, or else the market will really get angry after “believing” Draghi back in July as he said, and not delivering anything for two months straight. At this point however, the Jackson Hole meeting appears to be a complete dud because as was just reported, Mario Draghi, who was previously scheduled to speak on August 30, has decided to skip the meeting entirely. According to Bloomberg, citing an ECB official, Draghi won’t be attending Jackson Hole forum this year, and the reason given is “due to workload in coming days.”
A very naive interpretation of this news is that instead of flying to Wyoming, Draghi will be hard at work coming up with plans that have already been shot down repeatedly by the Bundesbank. That interpretation will be wrong – instead what he will be doing is hoping this is precisely the impression the market is left with, as a few hollow words buy him a few more weeks of inactivity, in which the market continues its mindless grind higher, even as the economic situation in Europe continues going from bad to worse (see prior post on Spain).
And now that Jackson Hole will be a complete dud, to those for whom prayer is still an investing strategy, here are two conflicting views on what (not) to expect at the next ECB meeting, one from Rabobank saying
Rabobank via Bloomberg:
- Asmussen’s comment that ECB will discuss plans at Sept. 6 meeting may make it more unlikely that “anything firm” will be announced, strategists at Rabobank write in client note.
- Officials could decide they want to look at further ideas
- Even though Asmussen said ECB would only buy bonds with short maturities, central bank will eventually have to commit to purchasing all tenors of debt for purchases to be effective
- Danger with current plan is that it will encourage govts to issue only at short-end, which is not conducive to L/T stability
- Comments signal there will strong element of conditionality in any purchases, any plan will go ahead despite opposition of Bundesbank
That was the bad cop. Here is what “good cop”, JP Morgan has to say:
The ECB occupies a difficult position in the Euro area crisis. While it has acted aggressively to ensure liquidity is provided to banks, many have criticized the ECB’s failure to act as a “lender of last resort” to sovereigns in the region. Others describe its purchases of sovereign liabilities as a back-door form of debt mutualization, which is more properly the preserve of elected politicians. The ECB has been trying to seek the right balance between potentially conflicting aims. It is trying to set the right monetary stance for the region as a whole, and ensure its transmission to the real economy, while contributing to crisis management. At the same time it has been trying to sustain the incentives for necessary fiscal adjustment and structural reform in the region, while encouraging institution building, which would help to facilitate burden sharing at the Euro area level. Recent commentary from Draghi has suggested a shift in gear in the ECB’s approach. Ahead of the ECB’s September 6 meeting we describe the specific form we expect that support to take, through both purchases of sovereign debt and other actions.
Previewing the son of SMP
Guidance has been given to a number of the ECB’s internal committees tasked to design further policy measures, which will then be discussed by the Governing Council as a whole. The ECB will be under enormous pressure to provide more detail on its new approach as it meets on September 6. At the press conference itself, we expect Draghi will outline the broad shape of the approach the ECB has agreed, without tying down specifics. Instead, much will be left to be demonstrated by the ECB’s actions when intervention actually occurs.
There are a number of ways this could be approached, and to some extent the ECB will be feeling its way as the new approach evolves. But we expect the following:
- Portugal first. The ECB has argued that impaired transmission of low rates arising from convertibility premia should be corrected for those countries meeting policy conditionality. On that basis, the case for the ECB to intervene in Portugal is very strong. Successive Troika reviews describe the Portuguese program as on track, but short-term rates for both the sovereign (3-year yields at 5.8%) and effective rates for households and corporates are very high. The case for ECB intervention to aid monetary transmission is clear. The case for action in other program countries is less clear: Irish yields are relatively low, while Greek compliance with program conditionality remains in doubt ahead of the Troika’s latest review. Action based on the rationale of repairing monetary transmission arguably has the best prospect of sustaining a majority on the Governing Council. And on that basis, we expect intervention in Portugal to begin after the Governing Council meeting has concluded.The absence of intervention in Portugal after the September 6 meeting would suggest one of two things. First, that the ECB’s rhetoric on repairing monetary transmission is merely a convenient fig leaf for the provision of support to sovereigns too large to be accommodated by the EFSF/ESM. Or second, it would suggest that it views Portuguese rates as high solely because of the risk of a within-Euro area debt restructuring. By extension, that would suggest the “convertibility risk” premia it will seek to correct are relatively small.
- Unlimited only in the short run. Asked whether potential bond purchases will be unlimited or not, Draghi stated “we don’t know” but they need to be “adequate to reach their objectives.” We expect the ECB will be prepared to devote much more in resources to sovereign support than seen under the prior SMP, in terms of both the overall size of the support effort (the old SMP totaled €220 billion at its peak) and the maximum rate of purchases (the prior peak was €22 billion in a single week and €56 billion in a single month). The ECB will likely be prepared to make unlimited purchases of debt to place a limit on some yield spreads on a short-term basis. But the rate at which the ECB is acquiring debt will be continuously monitored by the Governing Council. If its purchases remain elevated for an extended period, the ECB’s discomfort will be expressed in a number of ways. These will include slippage in the yield target, pressure for corrective fiscal action, and pressure on countries to seek a full package of support from the EFSF/ESM where appropriate.
- An implicit but moveable yield objective. We do not expect the ECB to announce any specific numerical target for yields. But its actions will likely demonstrate that it is attempting to set a maximum spread over the path of the expected policy rate for short-term debt. That objective will be monitored alongside the quantity of purchases required to achieve it.
- Not just bills, but sovereign only. Draghi stated that that the new effort “will be focused on the shorter part of the yield curve, which will introduce discipline also on the long part.” Some have suggested this means ECB support will only cover T-bills. But we doubt that an ECB decision to purchase bills alone would act to “discipline” the longer end of the curve—even countries with very high bond yields have been able to continue to issue T-bills to local banks. Our best guess is that the ECB is flagging a shift toward a concentration of its purchases on 2- to 3-year sovereign debt. We do not expect purchases of private sector debt (such as covered bank debt) will be part of the policy response at this point.
- Building trust on seniority will take time. Draghi has stated that market concerns about the seniority of the Eurosystem holdings of debt “will be addressed.” The ECB is likely to state that it will be treated pari passu with other investors in the future. But it is difficult to make that commitment credible given the potentially volatile circumstances in which further sovereign debt restructuring may take place. We do not expect the ECB will opt to take losses on its holdings of Greek debt at this point to provide a demonstration of its pari passu status: it is not clear that it would prove a convincing guide for investors to their future treatment, and there are broader considerations about the timing of official debt relief for Greece that suggest it will not be forthcoming now.
- Sterilized, and not likely to limit LTROs. Our best guess is that the ECB will sterilize its purchases by offering 1-week bills, as under the prior SMP. The ECB is unlikely to view the liquidity injected through this mechanism as a substitute for that provided via LTROs, which channel liquidity to those banks that need it most, and against a wide range of collateral.
How would this differ from the prior SMP?
The “old” SMP came into being in the early hours of a Monday morning at an emergency summit to deal with Greece in May 2010. It suffered from the perception that it was hastily conceived and its aims were ill-defined, and that the ECB was not sufficiently committed to the program to keep bond yields low in the face of sustained selling. With the Euro area as a whole in recession, and doubts about politicians’ ability to create a large enough liquidity hospital for both Italy and Spain, this effort by the ECB is likely to be much more determined. The prior SMP was also undermined by public opposition from German members of the Governing Council and Executive Board (Axel Weber and Jurgen Stark). These objections helped foster the impression that, in the absence of German support, the ECB’s interventions in bond markets were always likely to be half-hearted. This time around, the ECB appears to have reached out for at least German tolerance, if not outright support, for its actions. And the ECB’s insistence on a formal support request and hence conditionality prior to sovereign support appears to have secured the implicit backing of the German political leadership. Objections to ECB bond purchases have already been voiced by the Bundesbank.
Draghi noted those objections at the last press conference. But he reminded journalists that Governing Council members “act in a personal capacity”—i.e., that they are not necessarily reflective of “national” positions.
An easier collateral framework
Aside from purchases of sovereign debt, the ECB has indicated that it is working on changes to its collateral framework in order to stimulate loan creation. In particular, it could reduce haircuts on individual loans to make it easier for smaller banks to fund these via ECB repos. We expect Draghi will announce the outline of changes in this spirit at the September meeting, with the details to follow in subsequent weeks. Banks will be able to take advantage of the new collateral regime by swapping collateral under existing repos. We expect a further LTRO operation before the end of the year, raising the impact of the collateral changes. There is an outside chance that the specifics of another LTRO are also announced on September 6. Though the forecast anticipates that the refi and deposit rates will be cut (the latter into negative territory), we continue to think that is most likely to occur in October.