How To Trade Tomorrow’s ECB Meeting
By Tyler Durden
The European Central Bank promised in January to “review and reconsider” its monetary stance this week. The question, as BloombergBriefs notes, is not if policy makers will ease but how. Haruhiko Kuroda's humbling in FX markets shows what Mario Draghi is up against tomorrow: namely, that even the most forceful policy decisions can be overwhelmed by events, positioning, or sentiment. Draghi has a number of options (some more and some less priced in) but most crucially there two large gaps to be filled in European Stock indices – the question is which is filled first?
To offset some of the pain for banks, the ECB might impose the most punitive rate on only a portion of banks’ reserves. Japan, Switzerland and Sweden already have such multi-tier systems. Another way to ease the pressure on banks could be to cut the ECB’s main interest rate to zero from 0.05%.
They could also expand quantitative easing.
The ECB is currently buying about €60 billion a month of mainly eurozone government bonds, as well as asset-backed securities and covered bonds. Economists expect the ECB to accelerate its purchases by at least €10 billion per month, to €70 billion, and perhaps extend their duration by six months, to September 2017.
Taken together, those two measures would boost the program by €540 billion to €2 trillion, or around 20% of eurozone gross domestic product, said Ken Wattret, an economist at BNP Paribas in London.
When the ECB first announced its bond buying program, European stocks rallied, and bond yields tumbled. A bigger than expected expansion could have this effect again, as the purchases raise the price of bonds and shift investors into other markets.
Part of any expansion could be a loosening the restrictions on QE.
There are five major constraints right now.
- Bonds are purchased in proportion to a country’s capital key, a measure of the size of each economy and population.
- The ECB won’t buy more than 33% of any individual bond issue.
- It won’t buy more than 33% from any individual issuer.
- The bonds purchased must mature in no less than two years, and no more than 30 years.
- And it won’t buy bonds that yield less than its deposit rate.
Dropping the latter requirement would be the least contentious tweak, economists say, and would greatly expand the pool of eligible assets, particularly of German bonds.
Cutting the deposit rate as expected would, of course, make more bonds with negative yields eligible for the bond buying program. However, yields are likely to fall in reaction to any rate cut too, making some bonds ineligible again.
The ECB could also buy other stuff.
The ECB could buy corporate or senior bank bonds. That would be a “highly effective signal” with powerful effects, but would likely encounter serious resistance from some council members, said Holger Schmieding, chief economist at …read more
Source: How To Trade Tomorrow’s ECB Meeting
