Quick note on ECB

Published on March 26, 2014

Our CEO Sassan Ghahramani has been invited to co-host Bloomberg radio with Kathleen Hayes and Vonnie Quinn today from 11 to 12, and the ECB may come up as a topic.

We will not be sharing any new information that we have not provided clients, but nevertheless want to make sure clients remember where we have been on the ECB and share some early reactions we have on the recent comments from Bundesbank President Jens Weidmann in that context.

Bottom line: we think the most important takeaway from Weidmann is in a greater willingness and an opening to an attempt to come at least to a common stance on what sort of QE may or may not be appropriate – in theory. That does not signal that the conditions are in place for embarking on what would still be quite a controversial move – certainly not by the next meeting – but could make the ECB more comfortable in utilizing (markets might say “exhausting”) some of its more conventional measures in the near term if needed – i.e. non sterilization of SMP bonds and perhaps an LTRO. We still do not think there is a lot of enthusiasm for negative rates due to its potential negative consequences.

As a reminder:

We wrote a report on Feb 28 called “ECB: Signaling the QE Option.” We are enclosing the key excerpts on QE below and have added some more comments afterwards re: Weidmann yesterday. From the report:

*** Most important of all, however, ECB officials are already seriously considering the option beyond those more limited measures down the line of the outright purchase of government bonds as a part of the full “360 degree” view of the toolkits they have been talking about. And here, markets may be far too focused on the 175 billion-Euro liquidity impact of a halt to SMP sterilization and missing the signal effect in the precedent that would be set for bond purchases were the ECB to stop sterilizing that bond portfolio. ***

The Big Bazooka: Bond Purchases

One challenge with taking any of the smaller measures is that the ECB officials understand they will immediately have to address what they would do to ease next if needed, and that would be large scale government bond purchases.

The ECB is of course allowed to buy government bonds on the secondary market. They have done so in the past through the SMP program and have threatened to do so with the OMT. They are not allowed to directly finance government debt, and QE has always been extremely politically sensitive.

But here is where there has been perhaps the most quiet, yet dramatic, shift in ECB thinking, namely, what was formerly taboo has become another matter of fact weapon in their arsenal.

In regards to the politics and the German Constitutional Court challenge to the OMT program, that has been kicked over now to the European Court of Justice in Luxembourg, the ECB view is that the OMT program is intended to avoid a break-up of the Eurozone, and so clearly within its mandate. For all practical purposes the court ruling should be moot either way, for the reason that a break-up threat is no longer a real problem – touch wood.

In case of large scale purchases of government bonds, ECB officials understand they would need to make sure they are not distorting one sovereign market over another, meaning they would need to buy German bunds as well as Italian BTPs even though Germany clearly doesn’t need lower yields. That would ensure it is not seen as monetary financing of fiscal policy, but rather as straight monetary policy.

And that is where the Bundesbank’ s already stated support of a halt to the sterilization of SMP bonds on the ECB’s books – on the grounds that it is pure and simple monetary policy – becomes so interesting as a precedent.

Additional comments on Weidmann yesterday:

What Weidmann was referring to was exactly the notion (and internal discussion within the ECB) of buying bonds on a weighted basis across the Eurozone that we talked about in the report, and the argument that it may not, in that case, constitute monetary financing, but rather be strict monetary policy. In fact, that is correct, and the majority of the ECB already believe that, but Weidmann says in his mind that is still problematic. He nevertheless says “never say never” on QE as an option, and says there is a need to find a common position.

So there indeed continues to be a small softening from the Bundesbank, as we flagged on Feb 28, and that is now catching the markets’ attention, and that in fact started with the BUBA making the distinction in sterilization of SMP bonds versus non sterilization.

If you remember from what we wrote on SMP sterilization then, the BUBA message was that they basically were still adamantly opposed to the SMP purchases, but once it was on the books, they didn’t care whether the bonds were sterilized or not sterilized as that is a monetary policy decision, and not financing of government debt. That, in conjunction with the ECB’s ability to buy sovereign bonds on the secondary markets, continues to imply basically the main question and “legality” issue re: monetization of debt is about what the INTENT of the bond purchases is.

The ECB has said for example that the SMP purchases were in order to keep the Eurozone from breaking up, so in fact they were justified in going in and hand picking Italian, Greek, Portuguese debt etc. That argument in our opinion is in fact on shakier ground on the fiscal monetization restriction than a blanket agreement to buy European bonds across the board to lower financing conditions for the Eurozone (which is what QE would be). Weidmann yesterday said he thinks that the latter would still be tantamount to a “Eurobond,” i.e. mutualization of debt.

Strictly speaking that again could be very problematic for Germany (the ESM and OMT court cases are all about limiting the country’s exposure, and Germany ultimately is a guarantor of the ECB), but not of the ECB restriction of financing of government debt.

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