Did Mario Draghi Leak The Goldman Memo On Next ECB Steps

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Just a few hours before someone (cough Draghi cough) leaked the details of the sterilized - though unlimited, peripheral spread-reducing - though not capped or fundamentally-based, SMP 2.0, Goldman Sachs released their 'view' of what Super-Mario will do. Rather unsurprisingly, almost verbatim, the rumors fit that 'guess' rather well as the chaps at Goldman fully expected demanded this 'compromise' solution. They also expect no rate cut - since economic data is not a broadly dismal and falling as it was - but do expect further non-standard measures including collateral-easing (which has been pre-announced to some extent in the 'credit-easing' camp).

 

From 4:26ET this morning...

Goldman Sachs, ECB preview: Spelling out the detail

Bottom line: The main focus of this Thursday’s ECB meeting will be a further clarification of the modalities of the sovereign debt purchases President Draghi announced at the August meeting. We do not expect an announcement of a specific yield or spread target or cap for rates. Rather, we think the Governing Council will signal its intention to steer short-dated government debt towards levels it deems as consistent with fundamentals and which does not reflect a conversion risk. This range, however, is unlikely to be specified further – not least because the candidate countries for support have yet to make their requests to the EFSF and accept the implied conditionality, which Mr. Draghi has identified as a precondition for sovereign purchases. This will leave the ECB with considerable tactical room for manoeuvre. We also expect a further loosening of collateral requirements.

 

The economic situation – not improving, but also not worsening

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Our own Current Activity Indicator, which uses a broader range of monthly indicators, has also moved broadly sideways, although it signals a slightly more pronounced decline in activity than the composite PMI (-0.2%qoq). Thus, the economic situation, when compared to August seems not to have changed in a significant way.

Because of this we also think that the Governing Council will stick to its medium term forecast of a very gradual recovery with downside risks dominating

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The Flash estimate for Euro area inflation stood at 2.6%yoy in August after +2.4%yoy in July.

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We think that neither the economic nor inflation outlook has changed to an extent that would merit, in the eyes of the Governing Council, a further rate cut. In fact, we expect policy rates to be kept on hold for the foreseeable future.

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Spelling out the details of SMP 2.0

The main focus of this Thursday’s press conference will be a clarification of the modalities under which the ECB would be willing to intervene again in short-dated sovereign debt markets. In August the Governing Council declared that it “may undertake outright open market operations of a size adequate to reach its objective.” As we have explained in more detail here there are different degrees of market interventions that are in principle consistent with this announcement. Outright caps of yields or spreads would be obviously at one of the spectrum, while occasional interventions to dent spikes would be at the other end.

Several statements from Governing Council members over the last couple of weeks, in particular a very critical interview from Bundesbank head Weidmann, have shown that there is no consensus within the Governing Council what the appropriate degree of intervention is. While the decision itself is a simply majority vote we doubt that, at least at this stage, the concerns of those that are more sceptical on renewed interventions, will be simply ignored.

We therefore foresee a “compromise” in the form of a statement that the ECB will intervene, unlimited if needed, in markets in order to keep yields in a range that is deemed as consistent with fundamentals and that, in particular no longer reflects “risk premia that are related to fears of the reversibility of the euro”. The exact range, we think, will not be announced in order to give the ECB a high degree of freedom in its interventions. This freedom is also needed given the conditionality under which these interventions are taking place. Note in that respect, such intervention could also take place in countries already under a programme such as Portugal and Ireland (for more see here).

One important aspect for market participants is the question of a possibility seniority of the ECB relative to private investors. President Draghi declared in August that ”the concerns of private investors about seniority will be addressed”. One complicating factor thereby is that the ECB cannot simply participate in voluntary debt restructuring schemes as this could be seen as a form of direct government financing (losses incurred as a result of a default are a different matter). Guarantees for the ECB via EFSF/ESM would be one possibility to overcome this problem, though given the financial limits of these facilities, investors could doubt how credible these guarantees are once the ECB were to start buying significant amounts of sovereign debt. We see no easy way out of this problem and expect for the time being simply a declaration saying that the ECB will be pari passu leaving open the question what would happen in case of a “voluntary” debt restructuring.

Further non-standard measures

Beyond the clarification (to some degree at least) of the new bond purchasing program we also expect the Governing Council to announce other non-standard measures as already indicated at the August meeting (“Furthermore, the Governing Council may consider undertaking further non-standard monetary policy measures according to what is required to repair monetary policy transmission”).

In reaction to its review of the Eurosystem collateral framework, we expect the Governing Council to announce measures that it will (1) address the availability of collateral; and (2) reduce haircuts. In the case of sovereign debt, we see it as likely that the ECB will abolish the rating requirement from CRAs altogether, favouring an internal rating process so as to eliminate the ‘cliff risk’ and pro-cyclicality created by prospective downgrades.

A reduction in haircuts would specifically help peripheral banks that are dependent on ECB funding and for which the existing haircuts make it economically difficult to refinance some of their less liquid assets sitting on their balance sheet. The next natural step in that direction would be the outright purchase of bank debt. This would, depending on the size of the program, allow peripheral banks to tap the market for unsecured debt again. While we do not expect any specific announcement this Thursday on this front, we see the possibility that the Governing Council will give hints that it is contemplating this option and/or of buying corporate debt outright.

 

Source: Goldman Sachs