Friday, August 3, 2012

Uh, So, Maybe Draghi Meant Something Different

The markets seem to be rethinking yesterday's message. This is Olaf Storbeck of Handelsblatt via FT Alphaville:


Between the lines the message was perfectly clear. The Bundesbank might not like it, but the ECB will intervene in the bond markets in the foreseeable future. And big time.
From my perspective, the most important piece of the speech was Draghi’s implicit acknowledgement that the ECB has a target rate for bond yields. Draghi described the current yields as unacceptable and he stressed that the ECB “may undertake outright open market operations of a size adequate to reach its objective”.
He did not reveal where the ECB’s pain barrier is. However, the mere acknowledgement that the ECB has a certain threshold in mind is quite something. If Draghi means what he says, it follows that the bank is ready to buy bonds without any limits.
So, bottom line: Spanish yields will be allowed to rise only so high. We won't tell you how high, but somewhere around the level reached last week. This means investing in Spanish debt is "safe" (with an implicit ECB guaranteed floor price), so if you can borrow at a low rate, say around 2%, and earn a spread of 4.5 to 5% investing in Italy or Spain, you've got a nice carry trade. But you have a couple of downside risks: the ECB guarantee stays in place only as long as the peripheral governments play ball, that is, toe the austerity line; and if the continued squeeze makes people desperate enough to topple one of these governments, or even force an existing government off the ECB line, you can lose your shirt. How will the big investors perceive this offer from the ECB? They are desperate for yield, but these risks are not small.

1 comment:

bert said...

"... the ECB will intervene in the bond markets in the foreseeable future. And big time."

Agree with everything but the last three words, on which I don't think there are any grounds for certainty right now. Draghi may be squaring up for a rerun of September '92, with sovereign yields rather than exchange rate bands the line in the sand. Good luck to him. But Handelsblatt also reports that seven ECB board members started out unconvinced about bond purchases. He managed to talk six of them round, apparently. Guess who the holdout was.

Art, you've read the commentary, as we all have. You can pay your money and take your reading of choice. The range of readings out there suggest one clear conclusion: over the past week, ECB communications have sucked, and market expectations have been badly mismanaged.

[NYT]: “From a communication point of view, he misguided the markets,” said Jörg Krämer, chief economist at Commerzbank in Frankfurt. “He raised expectations which he could not fulfill.” ... In fairness to Mr. Draghi, markets may have attached too much importance to his “do whatever it takes” oath, spoken at an investment conference in London last week. To those who questioned whether perhaps he regretted getting ahead of himself, Mr. Draghi insisted Thursday that the remark had been planned and intentional. And yet, a close look at the transcript, which includes an analogy between the euro zone and a bumblebee, suggests that he was at least partly speaking off the cuff.

It'd be interesting to know what really happened. I doubt we ever will.