All the unknowns behind the EBC's Quantitative Easing
Yesterday Mario Draghi launched his public and private bond acquisition program worth 1,080 billion euro. But there are many risks involved. The most worrying? That the nation states won't stick to their side of the bargain.
- Tuesday, 10 March 2015
The most incomprehensible thing is that it is comprehensible at all. That's how, in Albert Einstein's words, we might define the European Central Bank's (ECB) Quantitative Easing (QE) program, launched yesterday. There are, as it turns out, perhaps too many unknowns behind the treasury and corporate bond acquisition program that was presented by the ECB president Mario Draghi last January and now comes into its own.
All the details are known. We know how the ECB will enter the secondary market and why, seeing as article 21 of the ECB statute rightly forbidscash funding of member states.
Therefore no acquisitions on the primary market, the auctions conducted by individual national treasuries. We know how much it will purchase, 50 billion euro's worth of government bonds and 10 million in corporate bonds a month. We know for how long, until September 2016. We know what it will buy, seeing as the acquisitions will be conducted based on the participation of the individual national banks in the ECB capital. Therefore, there will be a prevalence of German, French, Italian and Spanish securities. Of the 850 billion euro, 76%, approximately 723 billion of the bonds purchased will come from these countries. And we also know who will handle the acquisitions, seeing as the coordination will be assigned to the team headed by Ulrich Bindseil and Roberto Schiavi, of the EBC's Directorate General for Market Operations. Finally, we know what Mario Draghi'stwo-fold objective is. Getting the inflation rate back to around 2% and increasing the ECB budget by around 1,000 billion euro.
In actual fact, we should be surprised by all we know, because what we're overlooking is that we don't know the most important aspects of the deal. That is to say, what impact the QE will have on the financial environment. The ECB has already done much to alleviate the suffering of the Eurozone on bond markets. Initially by introducing the Long-term refinancing operation (LTRO), between December 2011 and February 2012, to enable states under pressure, mainly Italy and Spain, to avoid losing access to the bond market. This was achieved by means of long term loans to euro area banks, which were thus in a position to continue backing the states in the auctions. Then came the Outright monetary transactions (OMT), the conditional government bond acquisition program that provided a safety net for all those member states whose bond market situation was becoming unmanageable. Finally, Draghi launched a complete package. He carried out the most thorough budget assessment in the history of the euro, the Comprehensive Assessment. He launched a new round of long term bank loans. He started purchasing corporate securities, such as Asset-Backed Securities (ABS), Residential mortgage-backed securities (RMBS) and covered bonds. He started buying treasury bonds.
And now? Now all we can do is wait and hope that the EBC's forecast's weren't wrong. The expectation is that inflation will rise up to 1.8% in 2017, but a number of obstacles will have to be negotiated if this is to be achieved. The first is the impact the QE will have on a world where the problem is no lack of cash, but its allocation. The asymmetries in the macro-economic areas, due to the crisis, are increasingly apparent. On the one hand there's the Eurozone that is still having to come to grips with the fear of deflation and century long stagnation, incapable of innovating and uniting, other than on an economic level. On the other's there's Asia which continues to grow and generate interesting returns for investors, despite China's structural problems and the limited effectiveness of the Bank of Japan quantitative easing. The United States stand somewhere in the middle. It has just bid goodbye to the Federal Reserve's QE but can rely on a capacity for innovation that has no equal in the euro zone.
The ECB's QE comes into play in a context that is even rosier than expected. All the actions taken by the ECB since 2011 have reduced the yield differential between the government bonds of the various countries. But what is this if not a distortion? Why are the top brass of the International Monetary Fund (IMF) and the European Commission still calling for the full adoption by member states of the structural reformspromised in recent years? A look at the bond markets would not seem to warrant all this urgency. Anything but. There are two possible answers here: either the market are lying or the institutions are. In this particular instance the first hypothesis is the correct one. The more yields are cut, the lower the sense of urgency and the worse the situation gets that was by no means rosy at the outset. In other words, we're wasting time. And to think that the ECB has a solution for all problems is not only wrong, it's downright foolhardy.
International investors are fully aware that without the QE the Federal Reserve will have to find other sources of earnings. And this is unlikely to be the Eurozone bonds, seeing as yields are at their lowest since the introduction of the euro in most member states, Italy included. Better turn towards more remunerative asset classes, such as shares or derivatives. But will the ECB be capable of managing any bubbles that may form around a some of its assets? As things stand, no one knows, seeing as each bubble is unique, and different from the previous ones. There may be similarities, but they are not sufficient to manage the scenario without the risk of damage.
In a world that is flying on the wings of easy cash, what can the euro area do? It certainly can't wait to be picked back up by the ECB once again. This is the last opportunity to show that the last six years of crisis have helped the Eurozone to mature, to raise it up to another level where concerted action, rather than individual efforts, runs the show. Once again, it's only a question of time. The faster the states take action and secure market trust once more, the more useful and effective the ECB's QE will be.