We will start with an appetizer of Liquidity Tenders and Securities Market Program Bond Purchases, move on to a plate of Emergency Liquidity Assistance, sample a pre-entre of Pro-Growth measures and ECB Covered Bond purchases, dive into an entre of Fed Swap Lines, medium rare, with a side of Emergency Liquidity Assistance, and finally unwind with a desert plate of Firewalls. To close we will dream of tomorrow' menu which some say may feature the mythical Eurobonds and even the, gasp, legendary Europan Bank Deposit Guarantee...
Please charge it all to the taxpayer, of course.
Now that a coordinated policy response is largely priced in (because if it wasn't, futures would be about 3% lower in just the past 2 trading days), the next question the market has to ask is just what form will this "response" come under. Courtesy of JPM, we have a full list of virtually every single probable, and less than probable, intervention technique in the central planner arsenal. Alas, a cursory glance of the entire response menu shows that there is too little, too late here: absent full blown printing of trillions by all central banks to mitigate the impact of the inevitable Greek exit, we may well be staring at the Nietzschean abyss.
Potential policy responses from Europe:
- ECB policy rates – the ECB’s rhetoric has shifted lately and officials have become less concerned about inflation and more worried about growth. Expectations are rising for the present 1% policy rate to be cut although it isn’t clear how good this will do for the current problems specifically.
- ECB SMP (Securities Market Program). This was introduced back in May 10 and while it has been dormant now for several weeks (it hasn’t been used since late Mar), in total there have been ~EU215B worth of sovereign bond purchases made via this facility. The SMP is a redirection of liquidity as all purchases are “sterilized” (this is a key difference between the SMP and the Fed’s QE – the Fed’s purchases are “unsterilized” and represent a net injection of liquidity). In theory, there is no limit to the SMP although in reality there are (due to political constraints but also b/c of sterilization limits – recall the ECB once last year failed during one of its sterilization attempts). Back in the summer/fall of 2011, the SMP nearly bought EU10-15B during some weeks (you can see the amounts under “ECBCSMPW Index” on Bloomberg) but it isn’t clear that purchases at those levels can be sustained for long (keep in mind that certain ECB officials, inc. former Bundesbank head Axel Weber, resigned over this program).
- ECB Liquidity tenders – the ECB currently conducts liquidity operations in 1-week (“MRO” or main refinancing operations) and 3-month intervals (“LTRO” or long-term refinancing operations). Europe’s banks can take eligible collateral to the ECB in unlimited amounts and borrow against it w/appropriate haircuts. Recall the ECB recently conducted two 36-month liquidity operations and in theory could launch tenders for any interval of time (6-month, 12-month, 24-month, etc). However, Europe’s banks may not have a ton of eligible collateral left, making future LTROs less effective than the ones from 2011. Keep in mind too ECB politics are a factor as these operations start to have longer maturities – recall that the ECB eased collateral standards for the second 36m operation but allowed each individual central bank to make the final determination (and some, like the Bundesbank, kept collateral standards unchanged). The next ECB meeting comes up June 6 and there has been some spec of them doing an LTRO less than 36m (something like ~12m).
- Don’t forget about subordination – the Greek PSI has set an important precedent that in some ways makes the SMP and liquidity operations counterproductive. The Greek haircuts were imposed only on debt held by private investors (it spared all the Greek debt owned in the SMP or used as collateral for operations). Therefore, as the ECB ramps up either of those facilities, it in effect subordinates private bond holders.
- ECB covered bond purchase program – the ECB has launched two covered bond purchase programs, the second of which was unveiled back in Nov ’11. However, these have had only a very mild impact on markets (the second covered bond purchase program had only ~EU11B outstanding as of May).
- European bank deposit guarantees – can a pan-European guarantor be introduced? No, not easily (this speculation is a bit more credible than the Eurobond dream but not by much) – right now each country has its own bank deposit guarantee fund and there is no pan-European FDIC-like structure. In theory, the individual country guarantee schemes can borrow from one another up to a certain limit (something talked about here http://bit.ly/Ki2aRD) but the creation of a single guarantor would likely take time and require parliamentary approval. Could the ESM lend money to a deposit guarantor? Possibly, but again the same problem exists whereby the ESM can only lend to governments (and the sovereign in turn would then have to redirect the money). So bottom line: like Eurobonds, a pan-European deposit fund would be great but doesn’t seem very likely in the near/intermediate-term.
- ELAs (emergency liquidity assistance) – an ELA is a facility introduced by the individual national central banks (only by ECB approval) designed to allow banks that would otherwise be locked out of normal ECB operations to secure liquidity. Ireland and Greece both have ELAs (although other CBs may have undeclared ELAs open too) and other countries could introduce these facilities. For the ELA, the national central bank is on the hook for any losses (vs. the overall ECB).
- Europe’s firewalls – back on Mar 30, Europe announced it would expand the size of their combined firewalls. What they really did however was decide not to count the existing EFSF bailout arrangements (which total ~EU200B for Ireland, Portugal, and Greece) against the prior total EFSF/ESM bailout cap of EU500B (http://bit.ly/KiMI7y). There has been speculation recently of using some of the EFSF money to provide capital into the Spanish banking system although as the structure is presently, this money would have to be channeled through a government (so Madrid would have to borrow and distribute the money to banks – banks can’t borrow directly). Some within Europe have called for allowing the EFSF/ESM to have banking licenses, effectively making them eligible to borrow from the ECB (although keep in mind Germany, and the ECB, have both been adamantly against this).
- New short sale restrictions – Europe has imposed short selling restrictions on several occasions throughout the crisis and could very well do so again. According to a recent press report, Spain’s banks are requesting a new short sale ban (per Bloomberg).
- Pro-growth measures – one of the immediate impacts from the Hollande presidency will likely be the adoption of pro-growth measures although it doesn’t seem like any will be all that material (the EIB could get a bit more money and certain fiscal targets may be softened but markets prob. won’t care much about either and actually could get more worried if countries are given more time to cut spending).
- “Eurobonds” – this is the holy grail of Eurozone crisis response tools but they seem extremely unlikely in the near-term.
- The IMF – according to the IMF’s latest update (http://bit.ly/KbEoqV), it has US$367B of Forward commitment capacity (FCC) but keep in mind this is for the whole world (not just Europe). Back in Apr the IMF said it received $430B in new commitments but it isn’t clear when/if this money will actually find its way into the organization’s coffers. The IMF would likely only participate in a broader liquidity package for a country that lost full access to private markets.
What about the Fed?
- The next Fed meeting is June 20 which means they will have the benefit of one more jobs report (June 1) between now and then. Based on where everything stands now (in terms of data), trends wouldn't support further easing (unless the June 1 BLS is a disaster). The Fed could justify something in light of Europe if there were severe stresses in credit markets but as of right now there aren't any. May 24 and June 1 will be important dates for eco data that will determine QE expectations (we get flash PMIs on May 24 and official PMIs and US jobs on June 1).
- If the Fed does decide to ease further, what could they do? For another "Twist", they don't have an unlimited capacity of stuff to sell. Also the Fed has spoken about how they don't want to become too large a portion of the Treasury market and they would be bumping up into some of those limits if they bought a lot more longer-duration TSYs. Another asset class could be targeted for purchase, like mortgages, but this could face resistance within the Fed. Keep in mind the WSJ article from several weeks ago that talked about how the Fed would look to potentially “sterilize” any further balance sheet expansion. Finally, recall that the whole point of QE is to lower Treasury yields but the market is doing that for them (10 yr yields are closing in on record lows).
- Swap lines - recall back in Nov ’11, the Fed announced it would cut the rate charged on dollar funding to foreign central banks (inc. the ECB). Those swap lines remain open (and charge a rate of OIS +50bp). The Fed could in theory come out and cut the rate charged on these swap lines although the present problem isn’t one of dollar funding (recall back in 2011 there were widespread reports of European banks having trouble securing funding for their dollar-denominated assets).