Thursday, November 26, 2015

26/11/15: Counting Down to ECB's Big Surprise...


Counting the week to December 3rd ECB meeting, I have to ask one simple question: does anyone over in Frankfurt has a clue what they are doing?

Earlier this week, Reuters reported on a conversation with an unnamed ECB source

Here’s what we have learned:

  1. Things are far from smooth in the Euro area. We had some serious talking up on Money Supply side earlier this week, and we had incessant chatter about improving credit conditions. We even had promises of accelerated purchases in December (to offset holidays). But the ECB still appears to be directionless in so far as it still views QE road as insufficient. Menu of options is as wide as ever: more government bonds buys, deeper cuts to deposit rates, including a possible two-tier charge, purchases of municipal and regional debt, and even “buying rebundled loans at risk of non-payment has been discussed in preparatory meetings, although such a radical step is highly unlikely for now”. You really have to wonder: do they have any sense of direction (other than strictly forward)?
  2. "There are some who say you should surprise markets. But you cannot surprise indefinitely. Sooner or later, you are bound to disappoint." That is per ECB official. Wait a second, sooner or later? Just how many iterations of this circus will we be looking at? ECB’s commitment (rumoured) to push through a major surprise is a desperate bet. If surprise works, markets are likely to overshoot fundamental valuations on all fronts: from EUR/USD and EUR/Sterling to major equities indices and bond prices. But overshooting is not likely to hold unless the ECB continues to surprise the same markets. If, as likely, inflation remains anchored at low levels over the time of these surprises, the ECB will find itself in a situation where the only way to trigger any positive response from the markets will be to double down on every turn. Scared yet?..
  3. ”We have deflation, so you have to do something," said a second person. "How this all looks in a few years, nobody knows." And that is the scary bit - it appears that no one is willing to venture a field view deeper than a few months. Back to that directionless driving…
  4. Things, however, are clearly not working for Count Draghul: “Failing to [surprise the markets with expanded QE] so risks disappointing investors who expect ECB policy-setters to bolster a one-trillion-euro plus programme of quantitative easing when they meet on Dec. 3, in a move so significant it has been dubbed 'QE2’.” It seems the Euro area monetary policy is now equivalent to showing up in an alligator park with a crate of chickens: the faster you throw them, the closer you get to becoming a meal yourself, yet try not throwing any at all and you are a meal. And as an aside, what kind of a strategist bets on surprise and then pre-leaks all possible routes for such a surprise?..  
  5. Meanwhile, the gators are getting a sight of the chicken man slipping into their pond: “One person familiar with the matter said [non-performing loans that ECB might consider buying] could be packaged with more creditworthy loans before being put up for sale [to ECB]. "You could buy rebundled non-performing loans, combined with good loans," said the person. "If we get to that, then things are very bad.”” Oh dear, slice-and-dice tranches of MBS anyone? The ECB is moving closer and closer to tracing Lehman strategy ca 2006…
  6. If the ECB does buy municipal and regional debt, we are in yet another fiscal corner. Buying such paper will absolutely nothing to stimulate private sector capex. But it will loosen the purse for local governments, thus undoing all the ECB-led efforts to reign in fiscal profligacy. And, given the horrific state of public finances across the Euro area, it will set up the ECB to support municipals and regions for many years to come.

So for now, we have captain Draghi steering the ship at faster speeds and with greater determination. Except we don't quite have any idea of the exact course. Thursday should be fun…

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