This Thursday brings the announcement that European Central Bank President Mario Draghi has confirmed that the ECB will purchase an unlimited number of bonds to support Spain, Italy and other troubled European Member State issuers, providing that Member States play by the right rules. Meanwhile, the Fed looks close to launching QE3. We provide some commentary of our own and from other news sources.
The ECB:
– Market response. In the momentum see-saw that is the markets today, the ECB’s announcement of its bond buying program sent Treasuries lower and stocks around the world higher (except for in Japan for other reasons). We are thinking that the high repo rates we’ve seen lately will taper off as European debt looks less risky. Hopefully the new program will keep the top earners and the professional class in Spain, Greece and Italy instead of seeing both themselves and their assets flee for more stable shores.
– “More Europe, Not Less”. According to the BBC, “Mr Draghi said the ECB would engage in outright monetary transactions, or OMTs, to address “severe distortions” in government bond markets based on “unfounded fears”. He insisted that the ECB was “strictly within our mandate” of maintaining financial stability, but reiterated the need for governments to continue with their deficit reduction plans and labour market reforms.” We fully expect this move to be part of “More Europe, Not Less,” and will come with significant strings attached for countries that accept the ECB’s bond buying program assistance. With some luck, more stability in the Eurozone will mean that price discovery gets set by fundamentals and not macro politics and politically-driven decision making. This will help the securities lending market (so long as lenders can still find a market or two in Europe that a) allows shorting and b) hasn’t scared off short sellers by mandating greater transparency).
The Fed:
– IOER. The Fed announced yesterday that the interest rate paid on Interest on Excess Reserves remains at 25 bps. This is getting to be a waiting game of when that rate will drop, as we have argued that it should in order to get market forces back into balance on the Fed Funds rate.
– QE3. The Fed’s not-hoped-for-but-expected-anyway QE3 is seen likely to reduce interest rates for consumers and maybe, according to Fed Chairman Bernanke, make US taxpayers some money. Money managers seem to take the news with a yawn, according to a Pensions and Investments article out last week. Meanwhile, a new Fed working paper suggest that the Fed is likely to hold large balances of securities for years to come. According to the paper, The Federal Reserve’s Balance Sheet: A Primer and Projections, “Our baseline projection suggests that market participants likely do not expect the Federal Reserve’s portfolio to return to a more normal size until August 2017, and its composition to return to normal until September 2018. Overall, this suggests that market participants believe that unconventional monetary policy will be in place for some time, likely depressing longer-term interest rates for a number of years.”