Mario sprinkles the market with golden mushrooms, urges you to take a bite

Today the ECB’s governing council unveiled an expanded plan for asset purchases. Also known as Quantitative Easing (QE), the ECB’s program consists of:

  • A total of 1.1 trillion euro’s for expanded asset purchases of eligible securities
  • $45 billion euros in monthly purchases of sovereign debt
  • $5 billion euros of institutional and agency bonds
  • $10 billion euros of existing asset purchase programs

The ECB’s program is different than the FOMC’s past QE owing to the ECB’s unique structure. The ECB is composed of individual National Central Banks (NCB’s). Under the new QE program, the ECB will only share risk in 20% of the asset purchases. The remaining 80% of the risk will be born collectively by the NCB’s.

It is likely that this risk sharing system was created to assuage German fears that QE purchases could be used as a source of funding from profligate eurozone governments. Placing the NCB’s at risk is meant to force them to exercise prudence and not be pressured by their national governments to finance their deficits.

The ECB also announced a change in the pricing structure of their TLTRO program, bringing down the refinancing rate to match that of the existing MRO facilities. This removes a 10 bp premium over the MRO rate.

Mario Draghi also mentioned that under the proposed QE program, the ECB would limit its purchases to:

  • no more than 25% of each bond issue and
  • no more than 33% of each issuer’s total bond issuance

This contrasts with the FOMC’s QE programs, where at one point the Fed owned over 40% of treasuries over 5 year maturity and up to 2/3 of some individual bond issues.

German Bund Futures exploded after the announcement

German Bund Futures exploded after the announcement

Predictably, the QE announcement sent European bonds to the moon and cratered the EURUSD exchange rate, with futures finishing the day around 1.1368:

Euro FX Futures

Euro FX Futures

Categories: Monetary Policy

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3 replies »

    • As long as we have the combo of ECB stimulus while the FOMC chants a mantra of a lift-off mid 2015, there will be pressure on the value of the euro vs other currencies. The last big buyer (the swiss nat bank) is gone.

      Polar opposite monetary policies have some precedent, but they were generally characterized by massive FX volatility and the need for govt intervention in the market.

      The question becomes how long the twin stock and bond bubbles can persist side by side. Our guess is the QE add’s a cushion to every decline in these assets that would otherwise not be there. Strong dollar will certainly give a tail wind to any dollar-denominated asset

      The risk to bonds is if the US economy doing too well moving ahead rate liftoff expectations. As we talked about in the “why traders fail” post, sometimes when people announce their intentions in advance, they feel like they have to go through with the decision, even if evidence hints otherwise.

      We believe central banks increased transparency magnifies this psychological risk that the FOMC may feel locked in to an action because they warned the market so thoroughly and they don’t want to shock the markets (unlike the swiss).


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