BNP Furious That Draghi "Jumped The Gun"

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Ken Wattret who is chief Euroarea economist for BNP is quite furious with Draghi: the reason? Precisely what we warned last week: that Draghi is posturing and attempting to bluff the Bundesbank into accepting his "conditions." End result, Buba called the bluff and the ECB blew it in a fashion so spectacular that Draghi actually had to defend himself from reporters who were mocking him and the ECB with questions if the ECB won't get its inflation call wrong "again." It also prompted the head of the Central Bank to spin off Mario Draghi FX trading advisory, of which he is the sole employee, and issue the following Series 7 and 63 unauthorized advice: not to short the EUR, which incidentally was the dumbest thing he could say, because the one thing that can save Europe is if its currency keeps sliding (much to the benefit of Germany) in the process boosting Europe's manufacturing sector. That he openly warned against this is perhaps precisely why the EUR tumbled just after he said it. Trust us: the Chairsatan would love if investors were shorting the USD. Anyway, back to Draghi and the biggest French bank which realizes all too well one simple thing: Draghi no longer has credibility, and all those European banks which rely on the ECB for their day to day operations (like BNP) are suddenly far more exposed than ever before.

Specifically:

The ECB could have sweetened the pill of no action on debt purchases today with a few other initiatives but opted not to. This is compounding the sense of disappointment. There was a reference in the Q & A to other things the ECB could do, including LTROs, collateral requirement changes etc, and a hint towards something coming in September.

 

The lack of detail on all the above is a major problem. There were a few more details here and there in the press conference, including the ECB buying in short maturities, but it would have been far better for Mr Draghi to have kept quiet and deliver the "big splash" when there was sufficient agreement to allow the details, and the action, to follow in short order.

 

Expectations should have been much better managed and Mr Draghi's credibility is taking a hit accordingly. Hence the numerous questions in the press conference about whether the Governing Council was onside. He swatted those away, suggesting his comments in London had strong support, but the sense that he jumped the gun last week, at a cost to his and the ECB's credibility, will linger.

Bottom line: Draghi bought the markets a quick 5% rise for month end markups. In the process he made sure that nobody will ever again "believe" him.

From BNP

The markets response to the press conference is very negative, which is no surprise on the basis of the failure to live-up to the comments made by Mr Draghi in London a week ago. The bar had been well and truly raised and the ECB has under-delivered. (This is a common thread of eurozone crisis response, just think of all those summit meetings in the past!)

The way we saw it ahead of the press conference, the preferred route for the ECB is for the EFSF - for now, and then the ESM - to take the lead in sovereign market interventions, which would bring an explicit conditionality. The ECB would be willing to back this initiative with its interventions but would not front-run the process. This assessment has been strongly reinforced by what we heard today.

The conditionality is key. So the governments have to request the assistance to set the wheels in motion. The worse the adverse reaction in markets, the more likely the politics will fall into place. The problem is, of course, the stress in markets and ongoing uncertainty in between times.

The ECB could have sweetened the pill of no action on debt purchases today with a few other initiatives but opted not to. This is compounding the sense of disappointment. There was a reference in the Q & A to other things the ECB could do, including LTROs, collateral requirement changes etc, and a hint towards something coming in September.

On policy rates, there was a comment in the Q & A to it "not being the time" for further action. This suggests that our call of a move in September holds together, for the refi rate at least, in tandem with the new staff projections.

The decision regarding the rate on the deposit facility is a complicated one. The reference to the ECB being in "uncharted territory" is instructive: the ECB wants more time to assess the effects of the cut to zero and to mull over the pros and cons of going sub-zero.

Still, this is a secondary consideration, the real issue is how to interpret the "guidance", to use Mr Draghi''s words, towards a potentially more radical intervention by the ECB in the sovereign space.

To quote the relevant parts of the statement...

"The Governing Council extensively discussed the policy options to address the severe malfunctioning in the price formation process in the bond markets of euro area countries. Exceptionally high risk premia are observed in government bond prices in several countries and financial fragmentation hinders the effective working of monetary policy. Risk premia that are related to fears of the reversibility of the euro are unacceptable, and they need to be addressed in a fundamental manner. The euro is irreversible.

 

In order to create the fundamental conditions for such risk premia to disappear, policy-makers in the euro area need to push ahead with fiscal consolidation, structural reform and European institution-building with great determination. As implementation takes time and financial markets often only adjust once success becomes clearly visible, governments must stand ready to activate the EFSF/ESM in the bond market when exceptional financial market circumstances and risks to financial stability exist - with strict and effective conditionality in line with the established guidelines.

 

The adherence of governments to their commitments and the fulfilment by the EFSF/ESM of their role are necessary conditions. The Governing Council, within its mandate to maintain price stability over the medium term and in observance of its independence in determining monetary policy, may undertake outright open market operations of a size adequate to reach its objective. In this context, the concerns of private investors about seniority will be addressed. Furthermore, the Governing Council may consider undertaking further non-standard monetary policy measures according to what is required to repair monetary policy transmission. Over the coming weeks, we will design the appropriate modalities for such policy measures."

 

There is plenty of information to digest in there. Key points include: the references to the need for strict conditionality; that governments must take the initiative; the recognition of concerns over seniority; and the possibility of acting in a size "adequate to reach the objective".

But what is the objective? What are "outright money market operations"? How will the seniority issues be addressed?

The lack of detail on all the above is a major problem. There were a few more details here and there in the press conference, including the ECB buying in short maturities, but it would have been far better for Mr Draghi to have kept quiet and deliver the "big splash" when there was sufficient agreement to allow the details, and the action, to follow in short order.

Expectations should have been much better managed and Mr Draghi's credibility is taking a hit accordingly. Hence the numerous questions in the press conference about whether the Governing Council was onside. He swatted those away, suggesting his comments in London had strong support, but the sense that he jumped the gun last week, at a cost to his and the ECB's credibility, will linger.

That said, amid the hullaballoo over whether Mr Draghi has mismanaged the communication in a spectacular way, and the adverse market reaction as a result, there is a risk of losing sight of the progress made over the past month.

At the 5 July press conference, we were told that the ECB did not discuss any unconventional measures at the policy meeting and the suggestion was that there were no additional initiatives in the pipeline. A month later, the ECB is talking about a potentially very different outcome. If the communication had been handled more effectively, that may have been today''s story.

The circularity of the process is also an important consideration. If the reaction in markets is bad enough, it will increase the likelihood that the countries which have been reluctant to ask for assistance will have to ask, opening the door for the EFSF/ESM involvement and conditionality which will then bring the ECB into play.