Two weeks ago, the Fed roiled bond markets by signalling it would start to purchase Treasury bonds with printed money – the very definition of inflation.
Now, its the ECB’s turn to show it can inflate with the best of them. They have adopted extraordinary measures despite the view of many that they have not inflated. But, the ECB has certainly not been nearly as aggressive as the Fed. Are they all-in now too?
Marc Chandler from Brown Brothers Harriman gives his view.
After the March 18th decision by the Federal Reserve to increase its purchases of we argued that contrary to what many pundits were saying, the Fed was not “all in” and there were and continue to be a number of additional steps the Fed could take.
The focus this week is on the ECB meeting. What can it do ? We highlight a number of things in today’s North American daily, pull them together for convenience here. The first thing to note, however, is that through its unlimited supply of liquidity and liberal collateral rules, the ECB has already engaged in what ECB President Trichet calls “non-standard” operations. Second, the previous policy maker and market focus on the refi rate is not longer applicable. The 150 bp policy rate is not the key operational rate. The market rate is closer to 100 bp and the deposit rate, which is what the ECB pays on reserves, is at 50 bp. Moreover, there is not much difference between libor rates. Consider June 09 Euribor implies a yield of 1.3%, while June 09 Eurodollar implies a yield of 1.14%. Dec Euribor 09 implies a yield of 1.46%, while Dec 09 Eurodollar implies a yield of 1.29%.
There are a range of options that the ECB can still chose from:
- Extend existing efforts
- lengthen duration of unlimited liquidity provisions
- reduce “haircuts”, allowing greater loans for same collateral
- accept lower quality collateral
- New Efforts
- purchase commercial paper
- purchase long term corporate bonds
- purchase long-term sovereign bonds
Our contacts and public commentary makes it appear that a majority of the ECB may not yet be ready to initiate new efforts. Expanding existing programs seems to be the more likely scenario, coupled with a modest rate adjustment. The ECB may also narrow the gap between the refi rate and the deposit rate which is now 100 bp wide. The deposit rate acts as the floor for short-term rates. The ECB could cut this to zero, but that also seems unlikely at this juncture. A 50 bp cut in the refi rate, and 25 off the deposit rate coupled with some tweaking of its current liquidity provisions seems more likely.
The euro’s response is not immediately evident. As pressure on the ECB has increased in recent days, the euro has weakened. It is possible that a “sell the rumor, buy the fact” type of trading materialize, keeping the euro weak ahead of Thurs ECB meeting. The following day is the US jobs data and another dismal report is expected. However, the weak jobs data has not meant a stronger euro (only 2 of the past six months has the euro finished higher on non-farm payrolls release days).
A break of $1.2950-80 support area for the euro would have ominous signs and point to a retest on the year’s low set on March 4 near $1.2460.