After seemingly sending out trial balloons (via Bloomberg and Reuters simultaneously) on tapering last Thursday, which had almost zero impact (see “ECB Reportedly Considering Slashing QE in Half in January, EURUSD Shrugs), Draghi’s minions have been busy again.
“Central bank officials familiar with the matter” told Bloomberg that some - presumably quite hawkish - ECB policy makers “see room for little more than 200 billion euros ($235 billion) of purchases under the institution’s bond-buying program next year.” With said “officials” (who asked not to be named because the talks are not private anymore) seeing a limit to bond buying of 2.5 trillion euros under the current rules and purchases expected to reach 2.28 trillion by the end of 2017, we can do the calculation.
According to last week’s trial balloons, the ECB was looking at reducing its purchases from €60 billion euros to about €30 billion for at least nine months.
As we also explained in “How Will The ECB's QE Tapering Impact The Market? Here Are The Possible Scenarios”, the market neutral level of APP extension estimated by Citi appears to be around 250 billion Euros, or roughly €50 billion more than "some" ECB policymakers will permit. The three broadly market neutral scenarios laid out in Citi’s model were €20bn x 12mth, €30bn x 9mth and €40bn x 6mth as shown below.
For what it’s worth, Citi’s neutral scenario corresponded closely with a Reuters poll (from 11-14 September) which suggested the consensus amongst economists was for €40bn (range €30- 50bn) over 6mths (range 3-12mths).
And while we can argue about what the ECB should do to optimize conditions in the real economy, it now has a little problem vis-à-vis market expectations for the upcoming 26 October meeting. A 220 billion Euro extension is among the worst scenarios and, as Bloomberg confirmed “such a limit is at the lower end of volumes under discussion, setting the Governing Council up for a potentially difficult policy meeting.”
Citi previously noted that risks are skewed towards higher yields and bear-steepening due to issuer limit constraints. Following today’s trial balloon, HSBC commented that “The debate about the likely pace of QE continues to intensify in the run-up to the 26 October ECB meeting...If the ECB are correct then this would mean the pool of bonds would be used up beyond that point.”
Marc Ostwald, global strategist at ADM ISI in London, also commented on the ECB’s limited room to maneuver. “If they stick to the capital key, then there are only about 55 billion of Bunds that they could buy, which in turn caps what they can buy in total, especially with limits on what they can buy of smaller countries debt. However, they could reduce the relative proportion of govt bonds in a 30 billion euro per month QE pace to try and circumnavigate the problem…but even that will only be a marginal help.”
Bloomberg also notes that some policy makers are concerned about the reluctance of investors to sell their bonds “Reducing monthly buying to 25 billion Euros – which would total 225 billion euros over nine months – may address some of those concerns, the officials said.”
Perhaps the best tactic here is to release as many trial balloons beforehand, that 26 October becomes a non-event...