Mutiny At The ECB?
A lot of desk chatter about this move in risk-assets - and the entire reversion to red on the day in EURUSD - as a WSJ report now circulating suggests that ECB members are not backing reported proposals by President Draghi. Specifically, the statement referenced is the following: "Many ECB Members Surprised By Draghi's Comments Suggesting New Bond Buys, Source Tells WSJ". The bottom line here is that Draghi most likely pulled a Mario Monti (and his hanger on Mariano Rajoy), and spoke up before pre-clearing with Buba's Weidmann. Draghi thinks that, like Monti with Merkel at the June 29 summit, he can bluff the Bundesbank into submission, and Germany will agree to monetization, especially if markets have risen enough where nothing out of the ECB next week leads to a market plunge (as the WSJ explains below). The problem is that as we patiently explained, Monti got absolutely no concessions our of Merkel, as was seen in the bond yields of Spain after the June 29 summit, which hit record wides a few weeks later. Expect the same this time around too: i.e., Germany will hardly cave in to the European beggars.
From the WSJ:
Of course, the markets may have simply over-reacted to Mr. Draghi’s speech in London, or he may not have intended to give the impression he did. But either way, Italian and Spanish sovereign bond yields crept back up again before easing as the French newspaper Le Monde suggested the ECB is indeed preparing to buy Spanish and Italian debt in co-operation with euro-zone governments. Stocks and the euro moved up, down and then back up again. If this sounds chaotic, it is. But one thing is sure. If the ECB does nothing next week, the markets will tumble.
Further, from Citi's European GC desk:
Mr.Draghi surprise outburst to defend EUR and possibly the government bond yields took many off guard yesterday. The knee jerk risk on move suffice to say has helped to pull peripheral bonds well below its highs with Spain now yielding ~6.6% in 10yr, off the highs of ~7.5%. We doubt the rally will last as a long term trend for number of reasons despite Mr. Draghi’s comment that “IF PREMIA ON GOVT BORROWING HURT MONETARY POLICY TRANSMISION, THEY COME WITHIN OUR MANDATE”.
First, even if Mr. Draghi manages to wiggle out the SMP from the locked box, it won’t change reality in the long run as we have seen last year when yields continued to increase during sporadic bond purchases. Instead they only provide opportunity for the market to sell their holdings and reduce the liquidity available for certain bonds, as well as increase both the specialness of the bond and the fails rate. There are talks of alternatives, i.e. reducing the haircut of the existing haircuts on collateral which would boost amount of cash to the banks or widening collateral eligibility etc. But none of them address the underlying problem of the Euro. In some perspectives a large consistent SMP buying would bring down the yields and give more time for Spain, albeit their unemployment rate was rising again to 24.6% in the second quarter vs. 24.4% in the prior 3 months. Labour reform anybody? Spanish competitiveness? How to fix this staggering figure is more important.
Source: Citi FX
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