Just in case futures buying algos forgot what the regurgitated "catalyst" that activated the overnight ramp was, the ECB was kind enough to remind everyone that the main event over the past 12 hours was the Deutsche Bank leak that while the ECB will not announce outright QE any time soon, thus denying the rumor spread in the past weak by the likes of Citi and JPM, the formerly preannounced and thus already priced-in (by the EURUSD which was about to take out 1.40 a few months ago) ABS purchase program, or as DB called it "private QE" is about to be unleashed. The ECB confirmed this earlier this morning when it announced that it had appointed BlackRock, the world’s biggest money manager, to advise on developing a program to buy asset-backed securities.
In other words, BlackRock wil strongly advise the ECB to purchase all those subprime auto loan and rental-securitized ABS securities that Blackrock currently holds. Keep an eye out for UofPhoenix CCC-rated student loan securitization OWICs.
In yet other words, Europe's largest public-sector hedge fund has just hired the world's largest private-sector hedge fund to "fix things."
One thing is certain to come out of this: nothing in Europe will actually be fixed, but at least Blackrock's Christmas bonuses will be the highest ever.
BlackRock Solutions, a unit of the New York-based company, will provide advice on the design and implementation of a potential ABS-purchase plan, an ECB spokesman said in response to e-mailed questions. Safeguards against any conflict of interest are included in the agreement, the spokesman said.
ECB President Mario Draghi said in June that the central bank is intensifying preparations to purchase ABS as it strives to revive the faltering euro-area economy. While the effort could help revitalize a $1.9 trillion market that has contracted 34 percent since 2009, and at the same time inject liquidity into the financial system, officials have yet to agree on what such a program should look like.
BlackRock’s contract requires it to ensure effective separation between the project team working for the ECB and its staff involved in any other ABS-related activities, the spokesman said. External audits related to the management of conflicts of interest will be made available to the ECB. The company, headed by Chief Executive Officer Laurence D. Fink, had more than $4 trillion of assets under management last quarter.
The final decision on the design and implementation of any ABS-purchase program will be taken by the ECB’s Governing Council, and the execution will remain the responsibility of the central bank, the spokesman said.
And here is the ECB's oracular equivalent of Jon Hilsenrath, DB's team of Wall and Moec, explaining what is about to happen next week (ABS) and what isn't about to happen any time soon (QE). From DB:
Private QE in September
- We are bringing forward the timing of private QE (ABS purchasing) to 4 September. Recent weak data and Draghi's latest comments on inflation expectations we think are enough to believe the ECB will supplement the TLTRO in the next few months. Our baseline is to expect this as soon as the next ECB meeting on 4 September, but this is a very close call. An announcement could wait, although the markets will be unhappy to be told that inflation expectations are potentially dis-anchoring if the ECB has no new policies to announce.
- What we expect is not generic QE with government bond purchases, as other central banks have done. We believe the ECB will engage in private QE, that is, ABS purchasing as a complement to the TLTRO. If private QE does not emerge in September, we think it will follow shortly thereafter.
Our baseline had been to expect the ECB to initiate private QE in early 2015. Our view is that the ECB won’t want to take any chance with the capacity of the TLTRO to alone end this protracted period of low inflation. We thought the preliminary staff estimates for 2017 HICP inflation, to be published in December, could be the trigger for private QE or to at least give rise to a more vocal debate on QE.
Mario Draghi's speech in Jackson Hole was significant, in our view. It opens the door to earlier action by the ECB. It is a close call, but we now think the ECB will announce private QE (ABS purchasing) on 4 September. There are several reasons for the faster move to private QE.
First, recent real economy data have been disappointing, e.g. Q2 GDP and August PMI. There are several distortions which might have weighed on GDP in Q2, overpowering the underlying momentum of the recovery. This includes weather and holiday effects. The geopolitical uncertainties of the Russia/Ukraine situation might have also have dragged. The geopolitical effects are lingering into H2. We recently reduced our forecast for euro area GDP growth in 2014 to 0.8% (from 1.1%) in 2015 to 1.3% (from 1.5%), but most of this revision was due to the weaker than expected Q2 2014. There remains vulnerability in growth expectations for H2 and into 2015, as hinted at recently by the Bundesbank in its monthly report.
Second, HICP inflation has continued to undershoot expectations. In fairness, the downside surprises this year come predominantly from food prices. Core inflation, though a little volatile, has effectively moved sideways this year around 0.8-0.9% yoy. The trouble is the Russia story is now spilling into the inflation debate. Russia's ban on imports of certain European foods is set to increase supply and dampen prices further. The low point in the HICP inflation cycle has not been reached yet.
Third, although credit flows were better recently (and the credit impulse positive) and signs of some (limited) improvement in bank funding costs and margins are perceptible, the benefits of the TLTRO are lagging and might not have a strong enough bearing over current conditions to quickly stabilise growth and inflation expectations.
Fourth, the crucially, market-based inflation expectations have declined in the last couple of weeks. The SPF survey-based indicator showed the first increase in the 5-year ahead inflation expectations balance for about 2 years, despite drops in nearer term expectations. But the rise was tiny (1.86% from 1.84%).
The current crop of ECB Executive Board members seems keen to take a steer on medium-term expectations from market breakeven rates. These have weakened in the last couple of weeks. Draghi referred to this in unprepared comments in his speech at Jackson Hole on Friday. He said B/Es point to "significant declines at all horizons". The 5Y5Y inflation swap he singled out as falling 15bp to below 2%. This is the third time the 5Y5Y has fallen below 2% since the start of the credit crisis. Draghi said "this is the metric that we usually use for defining medium-term inflation".
Draghi said the Governing Council "will acknowledge” these developments with inflation expectations and within its mandate "will" use all available instruments needed to ensure price stability over the medium term. There is a definitiveness to the message. Having questioned the stability of inflation expectations, it would be very difficult for the ECB to credibly claim on 4 September that inflation expectations "remain firmly anchored", at least not without announcing a new policy to better anchor those expectations.
On balance, we think the data and Draghi's comment puts pressure on the ECB to accelerate the next phase of monetary easing. We believe the ECB will accelerate the announcement of a private QE (ABS purchasing) to 4 September. Draghi has some history of deviating off-script at a conference and subsequently convincing the Council to act. For example, his "whatever it takes" precursor to OMT in mid 2012.
The risk is the Council plays for more time, arguing that Q2 GDP was distorted, inflation is close to its trough, that once inflation starts rising after the trough it could help stabilise inflation expectations, that the TLTRO benefits are still to be seen, the EUR exchange rate is declining, etc. But one way or another, it feels to us like ABS purchasing begins before December.
Our view is the ECB announces a "private" QE, that is, not sovereign bond purchasing and not a mixed package of private and public purchases. We don't expect sovereign bond purchasing to be ruled out, but it faces political, legal and technical questions in a way that private QE does not. Government bond purchases will remain in reserve for a more outright deflationary episode.
How effective is ABS purchasing? The objective will be to incentivise banks to lend. The incentive depends on exactly which ABS the ECB purchases and in what scale. The TLTRO is implemented in a way to not directly incentivise mortgage lending, but in July Draghi intimated that the set of assets the ECB would consider for ABS purchasing includes RMBS. This raises the set of existing ABS by 10 fold to about E500bn. Draghi talks about incentivising a new market for ABS, implying the ECB focus may be more on primary (new ABS) rather than secondary (existing ABS). Still, the ECB can play the portfolio reallocation channel for QE by purchasing existing ABS.
The ECB has talked of a twin track effort on ABS -- regulatory easing as well as a commitment to ABS purchasing, if it proves necessary. At last month's press conference, Draghi implied that the purchasing decision is not conditional on achieving regulatory easing. Proposals have been published for an easing of the Solvency II capital charges on ABS, but no action has been taken yet. Beyond changing the capital charges to incentivise banks to lend and create ABS, the best way for the ECB to do so is by buying the mezzanine tranches of ABS. It is not obvious that the ECB has the risk appetite for this.
If the ECB does not have an appetite for mezzanine, the route to the success of ABS purchasing will be via the expansion of the ECB balance sheet and the impact of this on the EUR exchange rate. Our FX strategists reckon that of the roughly 4% decline of the euro trade-weighted index since March roughly a quarter of this was the negative deposit rate and the remainder implies an expectation of roughly E300bn of ECB balance sheet expansion. ABS purchasing will have to go beyond this to keep the EUR on a downward trajectory. Maybe this is what the ECB has most in mind. As Draghi said on Friday, outright ABS purchases "would meaningfully contribute to diversifying the channels for us to generate liquidity".
To summarise, recent data and Draghi's latest comments we think are enough to believe the ECB will supplement the TLTRO in the next few months. Our baseline is to expect this as soon as the next ECB meeting on 4 September, but this is a very close call. An announcement could wait -- but the markets will be unhappy to be told that inflation expectations are potentially dis-anchoring and the ECB announces no new policies to address this. But what we expect is not generic QE with government bond purchases, as other central banks have done. We believe the ECB will engage in private QE, that is ABS purchasing as a complement to TLTRO. If private QE does not emerge in September, we think it will follow shortly thereafter.