Macro Outlook
“When you reach the end of your rope, tie a knot in it and hang on.”
– Attributed as a American West proverb in a 1946 article California Folklore Quarterly
Mr. Draghi has now left no doubt. Taking the ceremonial plunge of an additional 0.1% just to prove the point that there is no more room for conventional monetary measures. Early reads by a range of market watchers took it for what is was – a “do nothing” in real impact but a clear signal. When conventional measures have reached the end of their rope, it’s time to try something different. The real message from the meeting this week did not come until the prepared remarks and the Q&A. In this portion, the ECB President announced that new programs of purchases of asset-backed securities (ABS) and covered bonds will commence in October. This is in addition to the targeted long-term refinancing operations (TLTROs) that were announced earlier this year and are set to begin in earnest around the same time. While being bold in addressing topics that frankly will still face resistance from the likes of Germany, Draghi was still true to form in being short on the details. For example, no size of a program was announced. Only an inference that the intent is to bring the ECB balance sheet back to levels consistent with early 2012 – roughly €2.7-3.0trln or almost €1trln higher than today. It was simply said that more details of the program will be announced October 2nd. Given that any new action from this meeting was a surprise, the direction of the market’s reaction is understandable (equity up, euro down) but the magnitude still shows that investors want to know the details before getting overly excited (roughly 1% for both). Again, talk is cheap. The market watchers are quick to point out that the current issuance outstanding in the ABS and covered bond markets are small. In addition, the tranches that the ECB would buy (senior) are held by lower risk investors unlikely to send the cash into more risky investments. We continue to think that the market watchers lack creativity. Banks hold the most non-financial loans out there. Banks are in need of capital. We have not done the math, but what if the ECB facilitates the bank securitization of these loans identified via the Asset Quality Review process and where the ECB takes the a significant senior piece and the bank keeps the junior (first loss) pieces. Are you better as a bank to have a €100 non-financial loan, €15 in the junior tranche of an ABS issuance and €85 in cold hard cash. Either way, we must not forget that a devaluation of the euro is clearly one of the goals. So if the plans announced by Draghi do not lead to further weakness in the exchange rate and thus improving the competitiveness in the region (and an increase in business confidence for eventual refresh of aging equipment and hiring as topline demand gets a bit better), our guess is there might be more tricks up the sleeve. We are not getting too excited in the near-term however. We expect the process to proceed as it has for a while now – slow.