ECB's Latest Deja Vu Bluff: Rate Caps On Sovereign Bonds

Tyler Durden's picture

Just as Germany was warming its "Nein, Nein, Nein" machine, now that Merkel is solidly back from vacation and has caught up with all the desperation emails in the inbox, as reported yesterday, the ECB, in a furious attempt to preempt the unwind of every innuendo, speculation, "unsourced rumor", and everything else the ex-Goldman controlled printer of European currency (which however now and always is powerless without German support) has done in the past month to keep sovereign rates low, has just resorted to yet another deja vu preemption tactic: rate caps on sovereign bonds. Spiegel reports the based on unsourced data, "The European Central Bank (ECB) is considering to establish in its future bond purchases interest rate levels for each country. Thus, it would buy sovereign debt of the crisis countries whenever interest rates exceed a certain spread to German Bunds... At its next meeting in early September, the Governing Council will decide whether the interest rate target is actually installed." Which of course it won't for one simple reason: the same reason the ECB has done lots of talking in the past 3 months, and implemented absolutely nothing: the Bundesbank's Jens Weidmann, and the fact that as Danske (see below) and everyone else already explained when this idea was floated unsuccessfully the first few times, it would require an infinite balance sheet, something the ECB does not have, especially not when Germans are 'consulted.'

Furthermore, for the ECB to proceed with rate caps, it would need to trigger the "conditionality" phase of the crisis which as we have explained countless times, would require first Spain, and then Italy, to demand a bailout, which in turn would lead to political turmoil, coupled with a government turnover as well as ceding sovereignty to the Troika (explicitly) and Germany (implicitly).

Finally, to all those who are having a glitch in the matrix moment at this attempt to further jawbone rates lower without actually doing anything, the deja vu is indeed correct. Because as the following note from Danske from November (and countless other unsourced reports and articles from around the same time) confirm, the ECB was indeed considering rate caps at the most acute phase in the Euro crisis last year. And passed. In other words, the ECB very well may go ahead and implement a rate cap solution... after the periphery has demanded a bailout, and after both Spain and Italian 10 year notes are trading well above 8%. Until then, it will simply continue doing what it has been doing for the past 6 months. Talk, lie, and make empty promises.

From Danske, November 22, 2011: "ECB to defend an informal cap on rates"

  • The debt crisis is heading towards the end game. Mistrust has spread to Italy, Spain and beyond. In the absence of further policy action, interest rates spreads would probably continue to widen and the whole euro project could come to an end.
  • A number of feasible backstops are available, but face resistance. The German government as well as the Bundesbank is rejecting the use of the ECB as the lender of last resorts. It is also rejecting the idea that the ECB lends money to the IMF, which could then provide a temporary credit line for Italy. An increase in IMF quotas is an alternative approach, but this also faces resistance from, e.g. the US.
  • The two models for leveraging the EFSF presented at the euro summit a few weeks ago were designed to alleviate the debt crisis, but have attracted very little investor interest and seem unlikely to work unless they are made more attractive to investors.
  • Eurobonds that would allow government to raise funds up to a ceiling with collective guarantees could provide a much needed pause for governments. However, Eurobonds also face German resistance and would probably not be deployable as quickly as needed to combat the current debt crisis.
  • The ECB could provide a backstop by formally announcing a cap on individual countries’ yield spreads and saying that it stands ready to buy unlimited quantities of government bonds to defend this cap. However, the ECB and not least the Bundesbank, fear that this will remove incentives for structural reform. Therefore, in our opinion, the ECB is not going to make such a formal announcement unless the situation deteriorates significantly.
  • So, with no backstops immediately available will the debt crisis spiral completely out of control causing government defaults and possibly a euro break-up? We do not expect this to be the case. The ECB will not provide any formal guarantees to the market, but that does not mean that it will stop buying.
  • We believe that the ECB will defend an informal cap at possibly 7% interest rates on 10-year Italian and Spanish government bonds. The ECB will be averse to it, but do it nonetheless. This is due to the fact that until austerity measures succeed in  restoring confidence in Italy and Spain there are not many viable alternatives if the ECB wants the euro to survive.
  • The ECB has so far used its Securities Market Programme (SMP) to buy peripheral government bonds to the tune of as much as EUR200 bn. We would not be surprised to see them spend half a trillion or more before confidence is restored. It takes a lot of money to defend an informal cap.

And.... nothing. Why? One word - Germany.... and two more words "unlimited quantities" - good luck.

Full note below