ECB "Models" €1 Trillion QE
Update: in direct flashback from the summer of 2011 when the ECB leaked news only to retract it within minutes, this just happened:
- CONSTANCIO: DOESN'T KNOW ABOUT 1 TLN-EURO QE MODEL REPORT
For those who have forgotten, here is the ECB playbook: leak "false" rumor, gauge market reaction, then promptly deny said rumor knowing quite well how the market will respond when the real news hits. Rinse repeat.
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When in desperate need to crush your currency (being bought hand over fist by the Chinese), so urgently need to boost German exports, since you are unable to actually do QE as per your charter, what do you do if you are Mario Draghi? Well, you leak, leak, leak that you are contemplating QE, and then you leak some more. Such as today. From Bloomberg:
- ECB has modeled bond purchases to show impact on inflation, FAZ says.
- ECB bond purchase model show varying results, FAZ says
- ECB tests show inflation could be boosted by a range from 0.2 percentage points to 0.8 percentage points: FAZ
- ECB officials leaning more toward credit-easing policies: FAZ
- ECB wants to work this month with BOE on ABS proposal: FAZ
Like US inflation soared on the $1 trillion QEternity? Can't wait. In other news, expect zero reaction from gold on this latest news that another $1.4 trillion in fiat is about to flood the market. If only inbetween Mario Draghi's jaw bones.
Finally, where did the ECB "get" all of these bright and original ideas? Why Goldman Sachs of course, which released the following overnight:
The ECB left all policy rates unchanged at the end of its policy meeting yesterday. At the press conference, however, President Draghi left the door open to additional conventional and unconventional measures, should the medium-term outlook for inflation deteriorate further. Specifically, Mr. Draghi placed the emphasis on this passage of the prepared statement: “the Governing Council is unanimous in its commitment to using also unconventional instruments within its mandate in order to cope effectively with risks of a too prolonged period of low inflation”. (See European Views: ECB opens the door to QE, April 3).
As we had argued, risky assets and in particular credit products responded well to the announcement, resulting in a further easing of Euro area financial conditions. We continue to like spread products and recommend a long German DAX position. However, we now also recommend selling duration by being short June Bund futures (RXM4) for a target of 137.50 (roughly 2% on the generic yield). We initiated the recommendation at 142.91, with a stop on a close above 145.50 (See Global Market Views: Hedging Long EUR Credit with Short Bunds, April 3).
Today the focus shifts to the US Employment Report for March, which will be important in assessing the underlying strength of the jobs market as we come out of the exceptionally cold winter months. Our US Economics team forecast a 200K print in nonfarm payrolls, and a decline in the unemployment rate to 6.6%. These estimates are broadly in line with consensus expectations (See US Daily: March Payrolls Preview, April 3). A stronger set of data, in our view, would be the catalyst for a further sell-off of the US Treasury market. As we wrote in the March Fixed Income Monthly, we think that maturities spanning 2016-18 look particularly vulnerable.
As discussions on whether or not the ECB could potentially implement QE will take centre-stage in coming weeks, in today’s Daily we summarize our previous research on the institutional characteristics of the Euro area ABS market.
The European Securitization Market: Facts and Figures
The total size of the European securitization market was EUR1.5trn at the end of 2013, about one-quarter of the size of its US counterpart. Securitizations were expanding at a rapid pace before the global financial crisis, with yearly issuance peaking at EUR711bn in 2008. Since then, securitization issuance in Europe has fallen sharply, to EUR180bn in 2013. For reference, total securitization issuance has also declined significantly in the US but since 2009 it has stabilized at a yearly average of EUR1.3trn.
There are significant differences in the size of the securitization market in European countries, and in the type of collateral backing securitization transactions. The UK remains the largest market in Europe, with a total stock outstanding of EUR444bn at the end of Q3 2013, followed by the Netherlands (EUR281bn), Italy (EUR185bn) and Spain (EUR178bn). In 2008, the UK was also the most active market, accounting for about 38% of total European issuance, but since then it has declined materially. In 2013, issuance was highest in the Netherlands (39% of total issuance), followed by Italy (19%), the UK and Germany (14%).
In terms of assets securitized, in 2008 RMBS were by far the largest asset, underlying about 80% of total securitization transactions. RMBS transactions accounted for about 44% of issuance in the first three quarters of 2013, while ABS origination was EUR34bn in Q1-Q3 2013 (about 28% of total origination). The majority of issuance continues to be retained by originators, even though a lower fraction was retained in 2013 than in 2012. Owing to more conservative practices, the European securitization market has performed relatively well; since mid-2007 default rates of European structured finance securities has been 1.1% compared with 15% for US ones (see Helmut Kraemer-Eis, George Passaris, and Alessandro Tappi, SME Loan Securitisation 2.0, Market Assessment and Policy Options, EIF working paper 2013/19).
Securitization of SME Loans in a Nutshell
The securitization of SME loans in Europe began to develop at the beginning of 2000, and its share of the total securitization market increased from about 2% to roughly 8%, reaching an outstanding amount of EUR130bn. About two-thirds of the amount of SME securitizations is concentrated in Italy, Spain, Belgium and the Netherlands. Issuance peaked in 2011 at EUR60bn and declined to about EUR19bn in 2013.
In terms of performance, default rates on SME securitizations have remained low for vintages originated in 2000-2004, when originators were conservative in structuring transactions, and securitized diversified and transparent portfolios of SME loans. This approach was relaxed before the GFC and default rates for later vintages have increased. But, on average, in the stock of outstanding securitized SME loans, the default rate is about 5.5% and it peaks after 50 months.
At the current juncture, credit to non-financial corporations (NFCs) remains constrained. Loans to NFCs were down 3%yoy in February in the Euro area. From the peak reached in January 2009, loans to NFCs are down 10% (or EUR530bn). The decline marks sharp cross-country differences, with lending to NFCs down 1% in Germany relative to a year ago, but down 14% in Spain over the same time horizon.
Large discrepancies exist also in the interest rate charged by Euro area banks to non-financial corporations in the various member states. For example, in Germany, the average interest rate charged on new loans with maturity between 1 and 5 years is 2.7%, while in Italy and in Spain the interest rate for a loan with similar characteristics is 4.84% and 4.22%, respectively. The spread on loans to corporates in Germany and in the periphery is still about twice as large as the current spread between German and Italian or Spanish government bonds. Hence, the supply of credit to corporates remains constrained, particularly in the periphery, both in terms of volumes and in terms of prices.
Helping the Securitization Market Revive Would Mitigate the 'Credit Crunch'
Helping the securitization market revive could help mitigate the 'credit crunch' (see: The Case for ECB Credit Easing, February 2014). Securitizations would have the advantage of (i) providing banks with the means to raise cash directly from investors to fund lending; (ii) freeing up banks’ capital, thus increasing their balance-sheet capacity and supporting further lending; (iii) offering investors well diversified portfolios of credit exposure, and scaling the provision of funds to small companies; and (iv) helping develop a more market-based financial system.
Banks do not find it profitable, both due to the credit risk embedded in lending to SMEs and to the capital charges imposed by regulation, to extend credit and securitize loans. Hence, some form of public intervention seems necessary. The ECB could announce a QE program directed at buying senior tranches of ABS or it could guarantee mezzanine tranches, for example.
Even though this program would be much more limited in size than a QE program of government bond purchases because of the limited size of the ABS market (according to ECB data, there is EUR716bn of eligible ECB collateral in the form of ABS, of which about EUR300bn has already been posted), it would still have the merit of making SME loans more attractive from the perspective of private investors and of sending a strong signal that the ECB is ready to prevent deflation by stimulating credit and the economy.
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