Thursday, September 6, 2012

QE to infinity.. sort of.

Although the ECB did not reduce interest rates, citing increasing commodity costs, Draghi announced a sterilized bond buying program to back stop the interest costs of those European nations seeing stressed bond pricing. As you would expect, the bond prices in periphery Europe acted positively to the news.

Yields on Spanish 10-year yields have decreased more than 60bps over the last two days. Yields on Portuguese bonds fell by almost 100bps while Italian 10-year bond yields fell almost 50 bps over the same time frame. 




I included some of the key takeaways from the Draghi's press statement below. If you want to take a look at it in its entirety, the materials can be found here. 

 - we decided to keep the key ECB interest rates unchanged. Owing to high energy prices and increases in indirect taxes in some euro area countries, inflation rates are expected to remain above 2% throughout 2012,

-the Governing Council today decided on the modalities for undertaking Outright Monetary Transactions (OMTs) in secondary markets for sovereign bonds in the euro area. As we said a month ago, we need to be in the position to safeguard the monetary policy transmission mechanism in all countries of the euro area. We aim to preserve the singleness of our monetary policy and to ensure the proper transmission of our policy stance to the real economy throughout the area.

-policy-makers in the euro area need to push ahead with great determination with fiscal consolidation, (My comment- does this suggest the loss of European sovereignty?) structural reforms to enhance competitiveness and European institution-building.

- Looking ahead, it is essential for banks to continue to strengthen their resilience where this is needed. The soundness of banks’ balance sheets will be a key factor in facilitating both an appropriate provision of credit to the economy and the normalisation of all funding channels.

Even more details on the bond buying program are found here and here. Essentially, this program is open-ended with no set buying limits. In addition, it is fully sterilized, and all purchases of sovereign nation X's bonds will drain money and resources from some other sector. The purchases will be focused on the lower end of the curve (3-years and under), essentially providing a backstop against near-term maturities and debt rollovers. However, this does nothing to address long-term structural issues. I would expect this program to expand to the long-end of curve at some point. More importantly and what appears to be an under reported item, the ECB has suspended its credit rating threshold requirements for collateral while also allowing non-Euro denominated collateral. In my mind, this is a key change in the ECB's announcement and will serve to laden the ECB with lower-quality assets.

Now we wait for the Federal Reserve's announcement. Will they or won't they move? Well, today's ADP report may throw cold water on those thinking it will, with some details found here.



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