Yesterday was quite an extraordinary day especially in Italian markets. However I wish to move on to consider things from the new tower of the European Central Bank. So as we move geographically to the Grossmarkthalle in Frankfurt we would have seen concern and probably not a little panic. The phone lines would have been burning between Frankfurt and the Bank of Italy as they discussed how to respond. At first this would have been on a tactical level about the ongoing QE ( Quantitative Easing) bond buying programme but of course the higher echelons and strategy would pretty quickly have been in play. However you spin it the billion Euros or so a week of buying of Italian bonds might have lasted all of thirty minutes if that if it was spent all in one go! I do not know if the weather was the same as in London but the storms were appropriate.
There was no formal Governing Council Meeting but I am sure that President Draghi and the Executive Board would have been in contact and others would have taken an interest. Some may have had a wry smile as up to this week the main issue would have been the location of the meeting next month in Riga Latvia. There the issues would be corruption, money-laundering and in some respects the ECB trying to put itself outside the legal system. Now the question on everyone’s minds would be Italy and the political crisis triggered there and in particular the impact on debt markets
What could the ECB do?
The obvious first move concerns the QE bond buying. This is something of a new situation as it is the first case of a major bond market facing a price rout with both flow QE as in ongoing purchases and a stock of it as the ECB has bought around 342 billion Euros of Italian government bonds so far. Thus the latter would not be sold and it would have been bought mostly from those who might have done in the situation unfolding. Yet it was not enough and the ECB has tied its own hands.
What I mean by this is that in order to get its 19 constituent nations to agree to the QE plan it buys according to their Capital Key. This is the effective shareholding of each country and reflects factors such as their relative GDP and Italy is approximately 17.5% so that is what it gets. There is scope to vary this but not a lot as Mario Draghi explained in January.
The ECB doesn’t favour certain countries over others in its PSPP purchase programme implementation. As you know, purchases are guided by the ECB’s capital key, which takes into account GDP and population. Now, focusing excessively on any particular purchase period, for example on 2017 only, could result and yield wrong interpretations. The overall stock of Eurosystem PSPP holdings is the relevant metric for any assessment of the programme and not the recent purchase flows.
Back then too much German debt was held and too little Portuguese.
These flows can differ as the design of the programme is flexible and the distribution of actual purchases often deviates from the ECB capital key.
So whilst there is flexibility there is nowhere near enough especially as the numbers would be released next Monday and everyone would see. Actually I think the flexibility was used up last Wednesday when the ECB in baseball terms stepped up to the plate and then withdrew. No doubt there were discussions about modifying the programme but I doubt they got far and the word nein would not have been needed.
Some have been suggesting the ECB could buy more but at the moment that is a non-starter. Of course we have seen such things change but persuading German and other taxpayers to potentially bankroll a new coalition government in Italy hoping to “spend spend spend” will not be easy.
Securities Markets Programme
This was used in the Euro area crisis.
About e220 billion (bn) of bonds (par
value, excluding redemptions) were acquired from 2010 to early 2012. Greece, Ireland, Portugal, Spain, and
Italy.
As described it does seem to fit the bill.
First, purchases within the SMP occurred during a severe sovereign debt crisis, when sovereign yields in several euro area countries were high, rising, and volatile.
Of course you could argue that in spite of yesterday’s surge in Italian bond yields with the ten-year around 3% as I type this that is not high compared to the 7% of the Euro area crisis. Also the programme is shown as terminated on the ECB website although 84 billion Euros of bonds are still held.
However it is worth noting because the replacement called OMTs or Outright Monetary Transactions have never been used.
Outright Monetary Transactions will be considered for future cases of EFSF/ESM macroeconomic adjustment programmes or precautionary programmes as specified above.
That is an issue because Italy is not in one and you could hardly see Mr. Sissors persuading the Italian parliament of much at all right now let alone this. That is unfortunate from the point of view of the ECB because like the SMP it operates like this.
Transactions will be focused on the shorter part of the yield curve, and in particular on sovereign bonds with a maturity of between one and three years.
This matters because there have been some extraordinary events in short dated Italain government bonds. As recently as the fifteenth of this month the two-year yield was negative reflecting the easy ECB monetary policy and the -0.4% Deposit Rate. Yesterday it rose as high as 2.8% and today it is 2%. So some extraordinary moves with t hose who bought a fortnight ago feeling rather silly I guess.
Wider Moves
The issue here for the ECB is that not only has it been tapering its QE programme but it has been hinting at its end. That makes it awkward to fire it back up. Of course should the current weaker patch for the economy persist then it might provide an excuse/reason but it is just as true that the effect on inflation from the higher oil price is pushing in the opposite direction.
Comment
The ECB finds itself between a rock and a hard place in two respects. The first is that additional bond purchases might turn out to be an own goal if the likely governing coalition returns to its proposal involving the ECB writing off 250 billion Euros of it.Next comes the issue of Greece which does not qualify for QE in spite of enormous efforts and it might reasonably ask how a fiscally expansionary government in Italy qualifies?
There could be specific efforts to help the Italian banks although of course they have received an extraordinary amount of help as it is! Most still seem to be troubled and burdened with bad and sour loans. Mario Draghi was always very keen on buying Asset Backed Securities which I always thought was a way of helping the Italian banks in particular but as we look we see a barrier.
At the time of inclusion in the securitisation, a loan should not be in dispute, default, or unlikely to pay. The borrower associated with the loan should not be deemed credit-impaired (as defined in IAS 36).
Here is my suggestion for the ECB loudspeakers from The Sweet.
Does anyone know the way, did we hear someone say
(We just haven’t got a clue what to do)
Does anyone know the way, there’s got to be a way
To blockbuster
Meanwhile the Euro has recovered a bit today and is above 1.16 versus the US Dollar.
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