Daily: ECB penalty rates for sovereign debt as conditionality
I am a bit pressed for time, so the like will be short today. The key issue is the ECB’s bond buying. I wrote up the key variables in the weekly earlier but here are some general thoughts. The IMF says that Spain and Italy’s bonds have traded 200bps wide of what fundaments would suggest. The IMF wrote that fundamentals call for 200bps to Bunds. But Spain and Italy averaged about 400bps in the first of half of 2012. They are trading even wider now with Italy at 439bps and Spain at 509bps. That’s actually down from a July high of 536bps and 638bps respectively.
Influential ECB board member Joerg Asmussen has suggested this is completely due to redenomination or convertibility risk, meaning that the parabolic move is not default related but euro breakup related. His conclusion is that the ECB must intervene to eliminate convertibility risk where appropriate (read Spain and Germany).
The problem is that the ECB’s likely way of intervening – with only ex-post asset purchase communication and no explicit target in exchange for fiscal conditionality – is a very politicized way of offering banks liquidity. Remember, the ECB is a bank lender of last resort, not a sovereign lender of last resort. So the point is to make an orderly market in sovereigns for banks – and to do so at a reasonable or even penalty rate of interest. Adding fiscal conditionality is a fiscal role for the ECB tat is forbidden under its mandate as an institution.
In any event, this is where we are headed. So the point for investors is that buying Italian bonds at 439bps is a good deal if the ECB’s bogey for unlimited purchases is 200bps. Now clearly, we are talking about the short end of the curve, so the spreads I am using are not specifically applicable to where the ECB is likely to intervene. But do note that the 300-350 numbers I talked about in the Bagehot Rule policy are actually 100-150 basis points of penalty compared to where the IMF says Spain and Italy should be – and without fiscal conditionality. The only implicit conditionality is the penalty rate.
ECB bond buying: what to look out for in the detail | Money Supply
“It is unclear how large Mr Draghi and other members of the governing council think these convertibility premia are. The International Monetary Fund thinks Spanish and Italian 10-year yields were about 2 percentage points higher than justified by economic fundamentals in the first half of this year. But in his August presser, Mr Draghi refused to be drawn on this matter.”
Summer boost may be short-lived for Spain – FT.com
Remember how I put it in the Bagehot Rule post: the spread would be 300-350 on a Bagehot Rule principle. Here you can see that is a penalty rate.
“According to the International Monetary Fund, spreads between Spain’s and Italy’s 10-year bond yields and Germany’s in the first half of 2012 were about 200 basis points higher than justified by economic fundamentals.
Given spreads for both countries averaged about 400 basis points, the IMF seemed to be suggesting a 200bp spread would be more reasonable – quite a bit lower than currently.”
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The deposit flight in Spain continued in July. Statistics from Spain show a monthly decline equivalent to 4.6% of total deposits or 74.2 billion euros. That’s just one month of capital flight.
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“Post-mortem examinations revealed that most of the 34 victims of the police action on August 16 were shot in the back while a smaller number were shot while facing forward, Johannesburg’s Star newspaper reported citing sources close to the investigation.
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“Had the graph compared apples to apples, there would have been a huge increase last year balanced by an equal decrease this year. If you’re not going to do that, then you have to wait to see how the entire third quarter plays out – which would deprive you of the trashy sexy graph of DOOM!
So here’s the moral of the story of the alleged trash indicator: garbage in, garbage out.”
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