JP Morgan On JC Trichet's Third Attempt At Pulling Off Paulson's Bazooka: Advance Thoughts On More ECB Bond Purchases
Today the market surged after it was announced that JC Trichet has finally thrown in the towel and will launch some version of "buy the everything" program made so popular by his bald transatlantic late-afternoon genocide buddy over the last two years. Subsequently the market surged more on a rumor that America would send a mega dose of viagra to make Trichet's "bazooka" even bigger by boosting America's, er, IMF contributions to what will soon be a multi-trillion bail out. Lastly the market surged some more when that last rumor was proven to be false. Which is why tomorrow at 7:45 am Eastern (with conference to follow 45 minutes later) the hapless Pinata formerly known as Jean-Claude Trichet, whose every action is now predicated by the markets, better have something good to announce or else the market will go up so more... just as it will if there is no news. So for all those who wish to know why buying stocks is a guaranteed way to make money now that nothing at all matters, here are JP Morgan's advance thoughts previewing the ECB action, as well as Greg Fuzesi's observations on additional bond purchases.
The ECB had hoped that external liquidity support for Ireland would reassure and calm financial markets. This has not happened and that creates a lot of uncertainty ahead of tomorrow's policy meeting. The situation remains very difficult. Nevertheless, we only expect the ECB to announce a delay to its exit strategy, rather than any dramatic U-turns or policy actions. The main policy interest rates will also be left unchanged.
On the nonstandard liquidity measures, it is very clear that the ECB would like to proceed with a gradual exit. It does not want banks to rely too much on its cheap and generous funding, and thereby delay necessary balance sheet adjustments. But, this exit strategy was always conditional on interbank markets normalising further; only then can the ECB scale back its intermediation and lender of last resort function. A short delay to the exit has now become likely. We therefore expect the ECB to announce that unlimited liquidity provision will continue at maturities up to three months during the first quarter of next year.
There is little reason for the ECB to worry about distortions from this delayed exit, given that intense market pressure is providing enough (and possibly too much) of an incentive for governments and banks to act. Of course, reverting back to competitive bidding at the ECB's three month refinancing tenders would not be a huge change, especially if the amounts offered were very generous at first and as the ECB would still be offering unlimited liquidity to all banks at maturities of oneweek and one-month. But, it would be very hard to communicate this to nervous financial markets. Therefore, why rush the exit and take the risk?
In fact, calls have become louder on the ECB to not only delay its exit but to expand its support. Some commentators are arguing that the ECB should step up its sovereign bond purchases into the trillions of euros. We would stress that such an action is not equivalent to the QE undertaken in the US and UK. QE in the US and UK is essentially about how to continue to add monetary stimulus when the overnight interest rate hits the zero bound. The growth and inflation outlook is not pushing the ECB in this direction. And if the ECB were to step up bond purchases in the current environment, it would be monetizing the debt of sovereigns who cannot access capital markets due to concerns about solvency. While the ECB would characterize this as a temporary [HAHAHA] liquidity measure - to enhance the transmission of monetary policy through dysfunctional markets - the risk is that the central bank is making itself subservient to the fiscal authorities. The amount of debt that would be monetized would then be determined by the extent of the fiscal consolidations that sovereigns were prepared to engage in.
Trichet's comment yesterday that markets are underestimating policymakers' resolve was interpreted by some as hinting in the direction of additional asset purchases. Of course, the government bond purchase programme remains active. But, we doubt whether the ECB sees large-scale government bond purchases as appropriate. And even more generous liquidity provision by the ECB to banks is not really the solution to the underlying problem. If the central bank feels that markets are to some extent overreacting, as Trichet suggested yesterday, it will try to act as "anchor of stability" rather than adopt policies that it cannot easily get out of. The ECB wants governments to do more.
Finally, new growth and inflation forecasts, including for 2012, will also be presented. On growth, the ECB will continue to forecast a gradual recovery with growth averaging around 1.5% annualised, although it could note some near-term upside risk due to the upbeat business and sentiment surveys. On inflation, the latest ECB forecast in September showed core inflation rising from around 1% oya this year to 1.7%oya by late 2011, despite the still low level of GDP. This "normalisation" of inflation is remarkable and will likely get extended into 2012, with both headline and core inflation only slightly below target. This forecast would have a hawkish feel to it, even though the ECB will probably still describe it as suggesting contained and moderate inflation pressures over the medium-term and even though the policy interest rate will remain very firmly on hold for now.
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