Late last week the ECB president, Mario Draghi jawboned the world’ markets with the statements:
Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough. To the extent that the size of the sovereign premia hamper the functioning of the monetary policy transmission channels, they come within our mandate
These words set off a short burst of ‘risk on’ as equity markets rose and periphery bond yields fell. However, as I wrote early this week , although there does appear to be some political agreement that action needs to be taken the details of exactly what will be done are vague at best. Before Europe can actually move forward with any concrete plan there are a number of outstanding issues that need to be addressed, most important of which is a decision by the German constitutional court of the validity of the ESM.
The wording of Mario Draghi comments suggest some sort of ‘big bazooka’ action which has led to speculation that we will see some form of implementation of pseudo lender of last resort for the Euro. This plan would include the re-starting of the ECB’s secondary market bond buying program (the SMP) mixed with new primary market purchases via the EFSF/ESM. In order to provide even more fire-power the ESM could be granted a banking license, along the same lines as the EIB, which would have then allowed it to leverage up via the ECB. This part, however, appears to have already hit a road block:
German Chancellor Angela Merkel’s coalition rejected granting the permanent euro rescue fund access to European Central Bank liquidity via a banking license, as the Finance Ministry said it saw no need for any such move.
The rules of the European Stability Mechanism don’t provide for refinancing through the ECB, the ministry in Berlin said today in an e-mailed response to questions. The ministry isn’t holding talks on the topic nor are secret meetings taking place on such proposals, it said.
So without leverage at best we are back to EFSF/ESM primary market purchases and the SMP in the secondary markets. But these two options also face some significant issues.
Firstly, as we have seen with previous bailouts and the last Spanish bank plan, the use of the emergency facilities does not come without strings attached which is why Spain continues to claim it doesn’t need their use. Secondly, the EFSF/ESM currently has around €400bn in available funds while Italy and Spain have combined over €1trn in financing needs through to 2014. If both countries require primary market support and we assume that the 50% rule applies then the emergency funds would be eaten up sometime by late 2014. On top of that there is the assumption that both the SMP and ESM operations would sub-ordinate private sector bond holders which potentially further decreases private sector demand for any sovereign debt under these programs.
In terms of a renewed SMP Mario Draghi also appears to be facing some internal challenges. The German Bundesbank has already made it clear that it is against further SMP purchases so you can assume a no vote from the 2 Germans on the executive council. As I explained earlier in the week, Germany actually only holds 2 votes out of 23, but that doesn’t mean they will not be supported by other northern European central banks. My reading of the situation is that Draghi will have the numbers to re-start the program but if he is successful he will once again be forced to limit its action to appease some council members.
I’m obviously speculating and we will need to wait until Thursday ( Friday Oz time ) to find out exactly what Mr Draghi’s “it will be big enough” plan actually is, but as we saw with the Swedish banking bailout one of the keys to its success was the emphasis on open ended funding. With his overzealous statements of last week I fear Mario Draghi has set expectations that high, so if we only get a capped SMP, or even worse no SMP at all, then I expect market disappointment. Given the constraints it is quite possible that Draghi is about to under deliver on the expectations he has created.
Spanish and Italian yields reversed direction and began to rise again overnight which suggests markets are also becoming concerned about Draghi’s ability to deliver.