I expect the June 20th meeting to be the official launch of a new mortgage based QE program that creates new money (rather than being sterilized ala operation twist). There is no need to launch it on the 6th, but he will signal his support with swap lines and then follow up with very dovish testimony on the 7th.
Bank Recapitalizations
The ECB can only do so much on this front. This will require additional EU policy makers, but the ECB can highlight that this is the priority it should be. If Europe has any hope of turning the corner (or at least mitigating the damage) they have to get serious about finally getting bank recapitalizations done. They can no longer worry about the dilution for existing shareholders in weak banks. This has to be a priority. I donât think the ECB has much real authority in this, but look for comments that point to progress and high prioritization on this front. If there signs that no progress is being made on this front, that is very bad, no matter what other policies they put in place.
Project Bonds
If the EIB is going to go down this path, it might as well announce some deals now. These will eventually get issued so might as well do it now. The size of the projects wonât be enough to change anything in Europe but once again the âfeel goodâ factor will be high and it will encourage all of those who are championing European âgrowthâ. Although they wonât be game changers, they are easy enough to push through and the âmoraleâ benefit would be best if some started to get issued in conjunction with other policy initiatives. The âshock and aweâ theory.
EFSF Intervention in Primary and Secondary Markets
The EFSF and ultimately the ESM are supposed to assume these roles from the ECB. It would not surprise me to hear that the ECB is ready to perform their role as agent on behalf of the EFSF for these purposes. Bond markets are so thin, that just the hint of renewed intervention in the secondary market, could cause Spanish and Italian bond prices to gap higher. This would affect the long end of the curve more than the short end since this would be more of a short covering rally than any real belief that the EFSF has the firepower to buy too much debt. The threat to intervene in the primary market is just that, a threat. The EFSF, as currently structured cannot get big enough to be meaningful. The ESM, especially with a bank license, could get big enough.
ESM as A Bank
I think the ECB will mention that they will take ESM debt as collateral, but donât think they will be able to give it a bank license at this stage. Germany has been opposed to that. Germany cannot stop the ECB from taking ESM bonds as collateral and providing banks with a lot of leverage, but they can stop the ESM from becoming a bank in its own right. Any sign that ESM will be getting a bank license would be a big deal.
EuroBonds
If this is all they come up with, run. EuroBonds are a long way from being reality. The countries all have such divergent policies it would take years to create true EuroBonds if the economies were doing well, let alone when they are struggling. Germany is opposed and should be. Not only are they not going to get done anytime soon, I havenât actually seen a credible plan of how to implement them without causing disruptions in this market. The dispersion between the different economies makes any form of implementation almost impossible. If the ECB takes a lot of other actions, then take some infinitesimal comfort from talk about Eurobonds. If the ECB does nothing but announce plans to work on EuroBonds, be extremely afraid.
Troika Debt Restructuring
Far less likely, but still a possibility is some form of announcement that the Troika is renegotiating their existing debt to reduce coupons or extend maturities. I donât see this getting done yet, but possibly after the Greek elections, something along these lines could be announced. Whether countries are running primary deficits or not, a reduction in current interest expenses would be meaningful. I donât see this happening now, but is worth keeping an eye on.
How to Play It
Look for action on the 6th. Be extremely disappointed if nothing happens and expect markets to decline rapidly. If central bankers do take some policy actions, it is key to figure out which ones are practical, which are merely symbolic, and which are just a dream and not an action. Who says what is just as important in some cases as what they say. When Merkel says something, we all need to listen. When anyone from the EU in Brussels says something, it will be the same thing they have said over and over and is completely self-serving and should be ignored. Anything Draghi and Bernanke might say is critical to listen to, because in this weird world, they have the most power to do something meaningful in a short period of time.
E-mail: tchir@tfmarketadvisors.com
Twitter: @TFMkts
