Via Peter Tchir of TF Market Advisors,
[ZH: While we do not agree that anything will happen on Wednesday (or pre-Greek-election to be more precise) - aside from perhaps a small bump in BoE LSAP, Peter Tchir provides a useful update to our original 'full central bank menu' two weeks ago.]
The ECB meeting on June the 6th seems key to me. Markets and economies are teetering across the globe. More and more people are coming to the conclusion that a Greek Exit would be catastrophic. Central banks won’t want to act as though they are panicking, but neither will they want to wait much longer to act. The regularly scheduled ECB meeting on the 6th is an ideal date for the first salvo to be fired.
Globally Coordinated Swap Lines
The easiest thing for central bankers to do in conjunction with the ECB would be to reduce the cost of the swap lines and once again extend their maturity and potential size. This is largely symbolic. The rate cut would help those that are using it, but 25 bps on that is not going to be a game changer for any bank in the near term. The lines are already in place, so any maturity extension or reiteration of commitment to swap lines is purely optics. On the other hand, it would show that once again all the major central banks are working together, are aware of the problems, and are committed to employing strategies to resolve it. It should calm growing chatter that the Eur/USD basis swap is trending weaker lately. An announcement like this is largely feel good, but since it costs next to nothing relative to what they are already doing, it is an easy step for central bankers to take and enhance any other policy announcements on that day.
ECB Rate Cut
The ECB should cut rates 25 bps on that morning. It would add to the “feel good” nature of yet another swap line announcement. The cut is unlikely to do much for sovereign debt yields. Unlike in the U.S. where treasury yields are sensitive to the Fed’s short term rate, the connection in Europe has long been broken. German and French yields trade far better than the ECB’s overnight rate and won’t move on the back of it. Italian and Spanish bonds yield far more than the overnight rate because of real credit and currency conversion risk. Spanish and Italian bond yields may improve on the announcement but it will be because of the “symbolism” of the cut and the ECB’s willingness to be aggressive.
The cut would also affect all the LTRO debt outstanding. Again, this is marginally better for banks as the weakest ones, that have relied on LTRO would see a funding reduction. Over time, this would become meaningful given the size of LTRO, but as we have seen time and again, carry takes time to work its magic and mark to market will play a far more significant role in the near term.
An ECB rate cut would be only slightly more useful from a practical sense than a renewed commitment to global swap lines, but combined they would send an indication that central banks are on top of the situation and should support risk assets.
The ECB could announce some new form of LTRO. They eased the collateral requirements on the last LTRO at one of these regularly scheduled meetings. If they are planning LTRO or something similar, this would be the day to do it. For any new LTRO to have meaningful impact for the market it probably needs to be at least 5 years in maturity. There is still enough unused LTRO money outstanding that just 3 years won’t excite the market much, but extending to 5 years could create some interest. If the ECB announces a new LTRO, look for them to emphasize that they will take corporate loans, EFSF bonds, and ESM bonds as collateral. If they do LTRO, they have to demonstrate it isn’t just so banks buy more of their own sovereign debt, but so that they can continue to lend to corporations or to load up on “safer” EFSF, EIB, and ESM bonds.
I think it is 50/50 whether get some new LTRO announcement. Without one, the support for risk assets will decrease. If we get one, and it has a longer maturity than existing ones, and the message is that banks can use it to fund things other than straight sovereign debt, it would be well received.
Pan-European Deposit Insurance
This could come up at the meeting. The ECB is clearly in favor of something like this and is likely to say positive things about the possibility but be careful. A program like this would take time to enact. This would be one of those cases where the bank would be saying what the market wants to hear, but limited probability of it ever occurring. Last year the markets would have responded well to a plan to plan a plan for an insurance plan. This year the market is likely to shrug off anything that doesn’t seem like a concrete proposal. This is especially true now that currency devaluation risk has been added to the solvency and liquidity mix.
Data out of China continues to be weak, not just by their standards, but in some cases, just plain weak. China seems the country most willing to make decisions away from scheduled meetings so they have the most flexibility in announcing something in conjunction with other central banks as early as this Wednesday. With commodity prices dropping like a stone, with the Baltic Dry index down almost 25% in less than a month, China has room to act. China, more than any other country, is in the position to actually provide real stimulus along with monetary stimulus. It certainly seems that China could use a dose of stimulus and that they can afford it and that they would be least sensitive to launching a program on a specific day. If they get comfort that other central banks will act, it wouldn’t surprise me to see them act first and aggressively. It would put pressure on commodity prices, which no one really wants to see, but would be very supportive for risk assets. I expect we get something out of China, though it take a bit longer than the 6th of June.
I fully expect the Fed, BOJ, and BOE to take aggressive stances and to announce either new QE programs, or to publicly recommit to existing ones. Too often the central banks have waited until the markets are in true crisis mode to act. When that happens, their policies do help the markets but do little for the economy. Acting sooner may allow some of their policy actions to actually trickle into the real economy. Bernanke probably faces the most opposition to another round of QE, but frankly he doesn’t seem to care. He “wrote the book” on what to do, and since it is his book he will follow what it says – as much money as fast as possible.
I expect the June 20th meeting to be the official launch of a new mortgage based QE program that creates new money (rather than being sterilized ala operation twist). There is no need to launch it on the 6th, but he will signal his support with swap lines and then follow up with very dovish testimony on the 7th.
The ECB can only do so much on this front. This will require additional EU policy makers, but the ECB can highlight that this is the priority it should be. If Europe has any hope of turning the corner (or at least mitigating the damage) they have to get serious about finally getting bank recapitalizations done. They can no longer worry about the dilution for existing shareholders in weak banks. This has to be a priority. I don’t think the ECB has much real authority in this, but look for comments that point to progress and high prioritization on this front. If there signs that no progress is being made on this front, that is very bad, no matter what other policies they put in place.
If the EIB is going to go down this path, it might as well announce some deals now. These will eventually get issued so might as well do it now. The size of the projects won’t be enough to change anything in Europe but once again the “feel good” factor will be high and it will encourage all of those who are championing European “growth”. Although they won’t be game changers, they are easy enough to push through and the “morale” benefit would be best if some started to get issued in conjunction with other policy initiatives. The “shock and awe” theory.
EFSF Intervention in Primary and Secondary Markets
The EFSF and ultimately the ESM are supposed to assume these roles from the ECB. It would not surprise me to hear that the ECB is ready to perform their role as agent on behalf of the EFSF for these purposes. Bond markets are so thin, that just the hint of renewed intervention in the secondary market, could cause Spanish and Italian bond prices to gap higher. This would affect the long end of the curve more than the short end since this would be more of a short covering rally than any real belief that the EFSF has the firepower to buy too much debt. The threat to intervene in the primary market is just that, a threat. The EFSF, as currently structured cannot get big enough to be meaningful. The ESM, especially with a bank license, could get big enough.
ESM as A Bank
I think the ECB will mention that they will take ESM debt as collateral, but don’t think they will be able to give it a bank license at this stage. Germany has been opposed to that. Germany cannot stop the ECB from taking ESM bonds as collateral and providing banks with a lot of leverage, but they can stop the ESM from becoming a bank in its own right. Any sign that ESM will be getting a bank license would be a big deal.
If this is all they come up with, run. EuroBonds are a long way from being reality. The countries all have such divergent policies it would take years to create true EuroBonds if the economies were doing well, let alone when they are struggling. Germany is opposed and should be. Not only are they not going to get done anytime soon, I haven’t actually seen a credible plan of how to implement them without causing disruptions in this market. The dispersion between the different economies makes any form of implementation almost impossible. If the ECB takes a lot of other actions, then take some infinitesimal comfort from talk about Eurobonds. If the ECB does nothing but announce plans to work on EuroBonds, be extremely afraid.
Troika Debt Restructuring
Far less likely, but still a possibility is some form of announcement that the Troika is renegotiating their existing debt to reduce coupons or extend maturities. I don’t see this getting done yet, but possibly after the Greek elections, something along these lines could be announced. Whether countries are running primary deficits or not, a reduction in current interest expenses would be meaningful. I don’t see this happening now, but is worth keeping an eye on.
How to Play It
Look for action on the 6th. Be extremely disappointed if nothing happens and expect markets to decline rapidly. If central bankers do take some policy actions, it is key to figure out which ones are practical, which are merely symbolic, and which are just a dream and not an action. Who says what is just as important in some cases as what they say. When Merkel says something, we all need to listen. When anyone from the EU in Brussels says something, it will be the same thing they have said over and over and is completely self-serving and should be ignored. Anything Draghi and Bernanke might say is critical to listen to, because in this weird world, they have the most power to do something meaningful in a short period of time.