Is June 6th D-Day Once Again? (Tchir)

by Peter Tchir, TF Market Advisors

The ECB meeting on June the 6^th seems key to me. Markets and economies are teetering across the globe. More and more people are coming to the conclusion that a Greek Exit would be catastrophic. Central banks won’t want to act as though they are panicking, but neither will they want to wait much longer to act. The regularly scheduled ECB meeting on the 6^th is an ideal date for the first salvo to be fired.

Globally Coordinated Swap Lines

The easiest thing for central bankers to do in conjunction with the ECB would be to reduce the cost of the swap lines and once again extend their maturity and potential size. This is largely symbolic. The rate cut would help those that are using it, but 25 bps on that is not going to be a game changer for any bank in the near term. The lines are already in place, so any maturity extension or reiteration of commitment to swap lines is purely optics. On the other hand, it would show that once again all the major central banks are working together, are aware of the problems, and are committed to employing strategies to resolve it. It should calm growing chatter that the Eur/USD basis swap is trending weaker lately. An announcement like this is largely feel good, but since it costs next to nothing relative to what they are already doing, it is an easy step for central bankers to take and enhance any other policy announcements on that day.

ECB Rate Cut

The ECB should cut rates 25 bps on that morning. It would add to the “feel good” nature of yet another swap line announcement. The cut is unlikely to do much for sovereign debt yields. Unlike in the U.S. where treasury yields are sensitive to the Fed’s short term rate, the connection in Europe has long been broken. German and French yields trade far better than the ECB’s overnight rate and won’t move on the back of it. Italian and Spanish bonds yield far more than the overnight rate because of real credit and currency conversion risk. Spanish and Italian bond yields may improve on the announcement but it will be because of the “symbolism” of the cut and the ECB’s willingness to be aggressive.

The cut would also affect all the LTRO debt outstanding. Again, this is marginally better for banks as the weakest ones, that have relied on LTRO would see a funding reduction. Over time, this would become meaningful given the size of LTRO, but as we have seen time and again, carry takes time to work its magic and mark to market will play a far more significant role in the near term.

An ECB rate cut would be only slightly more useful from a practical sense than a renewed commitment to global swap lines, but combined they would send an indication that central banks are on top of the situation and should support risk assets.

New LTRO

The ECB could announce some new form of LTRO. They eased the collateral requirements on the last LTRO at one of these regularly scheduled meetings. If they are planning LTRO or something similar, this would be the day to do it. For any new LTRO to have meaningful impact for the market it probably needs to be at least 5 years in maturity. There is still enough unused LTRO money outstanding that just 3 years won’t excite the market much, but extending to 5 years could create some interest. If the ECB announces a new LTRO, look for them to emphasize that they will take corporate loans, EFSF bonds, and ESM bonds as collateral. If they do LTRO, they have to demonstrate it isn’t just so banks buy more of their own sovereign debt, but so that they can continue to lend to corporations or to load up on “safer” EFSF, EIB, and ESM bonds.

I think it is 50/50 whether get some new LTRO announcement. Without one, the support for risk assets will decrease. If we get one, and it has a longer maturity than existing ones, and the message is that banks can use it to fund things other than straight sovereign debt, it would be well received.

Pan-European Deposit Insurance

This could come up at the meeting. The ECB is clearly in favor of something like this and is likely to say positive things about the possibility but be careful. A program like this would take time to enact. This would be one of those cases where the bank would be saying what the market wants to hear, but limited probability of it ever occurring. Last year the markets would have responded well to a plan to plan a plan for an insurance plan. This year the market is likely to shrug off anything that doesn’t seem like a concrete proposal. This is especially true now that currency devaluation risk has been added to the solvency and liquidity mix.

China Stimulus

Data out of China continues to be weak, not just by their standards, but in some cases, just plain weak. China seems the country most willing to make decisions away from scheduled meetings so they have the most flexibility in announcing something in conjunction with other central banks as early as this Wednesday. With commodity prices dropping like a stone, with the Baltic Dry index down almost 25% in less than a month, China has room to act. China, more than any other country, is in the position to actually provide real stimulus along with monetary stimulus. It certainly seems that China could use a dose of stimulus and that they can afford it and that they would be least sensitive to launching a program on a specific day. If they get comfort that other central banks will act, it wouldn’t surprise me to see them act first and aggressively. It would put pressure on commodity prices, which no one really wants to see, but would be very supportive for risk assets. I expect we get something out of China, though it take a bit longer than the 6^th of June.

Global QE

I fully expect the Fed, BOJ, and BOE to take aggressive stances and to announce either new QE programs, or to publicly recommit to existing ones. Too often the central banks have waited until the markets are in true crisis mode to act. When that happens, their policies do help the markets but do little for the economy. Acting sooner may allow some of their policy actions to actually trickle into the real economy. Bernanke probably faces the most opposition to another round of QE, but frankly he doesn’t seem to care. He “wrote the book” on what to do, and since it is his book he will follow what it says – as much money as fast as possible.