Goldman Interprets Draghi

Wondering what Draghi really meant this morning when he spoke at an informal Investment Conference? Apparently nothing just as we said first thing this morning: IMF SAYS DRAGHI'S REMARKS ARE A WELCOME REITERATION OF ECB'S WELL-KNOWN COMMITMENT TO DO WHAT IS NECESSARY. So now the talking down of expectations, or in this case today's iteration of "baffle with bullshit" begins. Yet surely there is some additional agenda. For the best interpretation of what the ECB head said, we go to his former employer, Goldman Sachs, which is always ready to tell its clients to do the opposite of what its own prop desk is doing.

From Goldman's Dirk Schumacher

Strong signal for ECB intervention from Draghi, though timing and instrument yet to be determined


Speaking at a conference today, ECB President Draghi pledged: “Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough." This statement from Draghi comes after an interview published in Le Monde last Friday (July 20) in which he said that “the euro is irrevocable”.


We have been of the view for a long time that the ECB is ultimately the only institution that can credibly backstop Italy and Spain should these countries no longer be able to refinance themselves in private markets. The existing bail-out funds are not large enough to cover both countries and any other form of debt mutualisation (Euro bonds, for example) that would provide relief for either Spain or Italy are not feasible any time soon.


Mr Draghi’s comments, in our view, signal very clearly the ECB’s determination to use the ECB’s balance sheet in one form or another to support the Euro. While we think that the ECB wants first to see a similar commitment from governments - and the use of the existing tools as signalled by his comments - before it springs into action, we would not rule out that some action will be taken at short notice in order to dent the sharp rise in Spanish and Italian yields.


As we wrote in last week’s European Economics Analyst, the ECB still has a broad range of non-standard measures it can use. A reactivation of the SMP would be one possibility to change, at least temporarily, market sentiment. But another 3-year LTRO would be another possible short-term reaction to the latest market moves. Both measures can be implemented rapidly and the chances of this happening have increased after Mr Draghi’s comments today. The reference of Mr Draghi to the malfunctioning monetary policy transmission mechanism could be seen as a preference for a re-activation of the SMP. However, it is noteworthy that a damaged transmission mechanism has been the justification for all non-standard measures the ECB has taken.


In any case, such measures would probably provide only short-term relief and a firmer commitment would be needed to have a lasting effect on peripheral bond markets. Some form of refinancing of the EFSF/ESM through the ECB would be a lasting solution, although there is some legal uncertainty about whether this is feasible.