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ECB QE Amount came Above Expectations with Low Risk Sharing and Legal Headwinds

The ECB unveiled a bigger than expected QE plan that will involve buying €60B a month including government bonds, covered bonds and ABS but excluding corporate bonds. The program scheme will begin in March and last until the end of September 2016; or “until the ECB sees a sustained adjustment in the path of inflation which is consistent with our aim of achieving inflation rates below, but close to, 2 per cent”. Therefore, it implies at least €1140B of purchases (19 x 60) so that the ECB balance sheet will exceed its 2012 top level in Sept. 2016 (previously than investors expected).

 

 

 

Assuming €10B a month of  ["covered bonds" + "ABS"] purchases, it implies €50B/ a month of sovereign bonds. In other words, in 2015, sovereign purchases should reach €500B which is almost 56% of Eurozone gross issuance and 2.3 times the net issuance. Through September 2016, the total amount of sovereign purchases would rise to €950B and will be based on the Eurosystem NCBs’ shares in the ECB’s capital key (and won’t exclude Greece).  Note that for Germany, the table shows that purchases through the end of 2015 will reach €129B which is more than 20 times the amount of the net issuance scheduled for 2015.

 

 

Moreover, the maturities of sovereign bonds purchased will range between two and 30 years and could offer negative yield.

 

However, after strong pressure from German and Dutch officials, national central banks will assume most of losses from any default or restructuring of their national debt, breaking with the tradition set by previous sovereign bond-buying schemes. There will be risk-sharing on only 20% of the assets, largely debt issued by European institutions bought by national central banks.

 

Finally, also on the negative side, the ECB QE is already facing legal headwinds in a context where the FT reported that:

 

Peter Gauweiler, a conservative MP who has launched multiple legal actions against the common currency, announced on Thursday that he had instructed a law professor to prepare a case against the QE programme.”

While government ministers refrained from comment, Werner Langen, a leading European Parliament member of Chancellor Angela Merkel’s conservative CDU, went on morning television to attack QE, saying: “This is wrong, it does not help, it is not the right instrument [ to aid economic recovery]. The ECB has reached the end with its monetary policy.”

 

Moreover, within minutes of Draghi’s announcement, deputy chancellor Hans Michelbach asserted that the ECB was “violating its mandate” while several hours later, Ifo economic institute President Hans-Werner Sinn says ECB’s bond-buying decision is “illegal and unsound state financing through the money-printing press.”

 

All in all, Draghi reassured investors by choosing both a monthly and a total amount above the consensus, including Greece and a large choice of maturities. Separately, in order to ease pressure from German and Dutch officials, he decided to cap risk-sharing on only 20% of the assets. However, it’s clear that it’s not sufficient and the QE is far from being implemented.

The ECB QE will be between €600B and €1.1T – Bloomberg, WSJ, FT

Several articles coming from Bloomberg, WSJ and FT unveiled details concerning the ECB QE announcement:

 

1/ According to the WSJ, the bond purchases would reach €50 billion per month that would last for a minimum of one year, which implies a total of €600B (lower bound):

 

A proposal from the European Central Bank’s Frankfurt-based executive board calls for bond purchases of roughly €50 billion ($58 billion) per month that would last for a minimum of one year, according to people familiar with the matter.
 
Still, the executive board’s proposal indicates that the ECB could move more aggressively than financial markets have expected. Forecasts among analysts have recently centered on a figure of around €500 billion or higher for a quantitative-easing program, but the executive board’s proposal suggests that bond purchases could amount to at least €600 billion.

 

2/ According to Bloomberg, ECB proposal circulated to Governing Council foresees asset purchases of €50 billion a month through the end of 2016. Purchases would not start before March which means that the higher bound would be €1.1 trillion:

 

The ECB president and his Executive Board recommended asset purchases of 50 billion euros a month until December 2016, according to two euro-area central-bank officials.
 
Purchases of sovereign debt or other assets in addition to the ECB’s existing covered-bond and asset-backed securities programs wouldn’t start before March 1, one of the people said. It hasn’t yet been decided if the target of 50 billion euros a month would include the existing programs, or how much of it would be sovereign debt.

 

3/ Finally, the FT confirmed the first headlines noting that the ECB is mulling buying around €50 billion-worth of government bonds a month for between one and two years as part of its quantitative easing programme set to be unveiled on Thursday.
 

The European Central Bank is mulling buying around €50bn-worth of government bonds a month for between one and two years as part of its quantitative easing programme set to be unveiled on Thursday.
 
The proposal implies the ECB will buy at least €600bn-worth of government bonds, and possibly as much as double that if it continues buying for two years.

ECB PREVIEW: Sovereign QE Imminent; Size, Risk-Sharing in Focus – Bloomberg

Bloomberg made a review of economists’ views ahead of the ECB meeting:

 

Morgan Stanley
- Expect ECB to embark on sovereign QE and announce government bond purchases of EU500b and private sector asset purchases of EU100b, economists including Elga Bartsch say in Jan. 19 note.
- A negative deposit rate makes it difficult for ECB to meet its target merely through funding facilities as it effectively introduces a tax on excess bank reserves.
- Difficult for ECB to raise deposit rate to zero without raising the refi rate at the same time
Workable compromise for ECB would be a hybrid program with a core component where financial risk is shared across Eurosystem and an optional component relating to national central bank risk.
- Remain skeptical on QE impact because of dissent inside the ECB, potential political backlash, legal uncertainties on government bond buying.
 

BofAML
- Expect ECB to announce government bond buying of between EU500b and EU700b over 18 months, analysts incl. Athanasios Vamvakidis, Gilles Moec, write in Jan. 16 client note.
- Program likely to include all investment grade govt bonds, with monthly or quarterly pace for purchases; mutualization likely, ECB would retain considerable discretion on details of purchases.
- Crucial issue is if ECB manages to create “open ended” feel; communication will be key for market reaction.

 

Barclays
- Expect ECB to announce expansion of asset-purchase program to include govt bonds this week: technicalities will likely be announced in March, strategists including Nikolaos Sgouropoulos say in client note dated Jan. 18.
- Central bank may signal program will stay open until CPI expectations are firmly re-anchored.
- Any QE without shared risk may be counter-productive, analysts including Giuseppe Maraffino write in separate note.
 

Deutsche Bank
- ECJ’s opinion on OMT last week makes it easier for ECB to act sooner and reduces risk of too much compromise on program’s design, economist Mark Wall write in client note dated Jan. 16.
- Even if central bank waits until March, Draghi has to send a clear signal on Jan. 22 of imminent QE; if vote on QE is in Jan., full details are only likely in March.
- Expect a broad-based asset purchase program encompassing investment grade corporate bonds as well as sovereign bonds, Wall writes in client note dated Jan. 9.
- No target size to be set for sovereign purchases; expects formal announcement of public QE from ECB on March 5.
 

Goldman Sachs
- Expect ECB to announce expansion of asset-purchase program on Thursday, with focus on sovereign debt and size of EU500b-EU1t, economist Dirk Schumacher writes in Jan. 13 note.
- Purchases to be mutualized and conducted according to capital key; degree of risk-sharing remains contested among GC members, so other modalities are possible.
 

JP Morgan
- ECB likely to announce EU500b sovereign-debt purchase plan, spread over coming year and with clear signal that it could be scaled up if needed, economist Greg Fuzesi writes in Jan. 16 note.
- Expect ECB to be pari passu to other bondholders and share credit risk on investment-grade bonds across national central banks; sub-IG risk to remain with national central banks.
- TLTROs to be made more attractive; ECB also likely to start buying non-financial corporate bonds.
 

HSBC
- ECB is likely to announce a broadening of asset purchase program to include corporate and government bonds, economist Janet Henry says in Jan. 16 note.
- ECB may not announce magnitude of purchases; may stick with previous statement that it intends to expand balance sheet back to early-2012 levels.
- If size of eventual purchases is capped or degree of risk-sharing by national central banks is very limited, announcement could disappoint market expectations.
 

Credit Suisse
- Attach 70% probability to QE in form of sovereign bond purchases this wk, economists including Christel Aranda-Hassel says in client note dated Jan. 16.
- Expect ECB’s QE announcement to be accompanied by broad guidelines rather than all details; bond-buying should start before mid-Feb.
Base-case scenario, to which CS attaches odds of 50%: ECB announces EU500b-EU750b of sovereign, investment-grade bond purchases.
- Expect ECB to unveil “hybrid” bond-buying program in which some risks are taken by national central banks, strategists incl. Helen Haworth, write in Jan. 15 note.
 

Citigroup
- Expect ECB to announce QE this week; decision will probably be taken with comfortable majority, economist Guillaume Menuet says in client note dated Jan. 15.
- To maximize effectiveness, QE would need to be open-ended, fully mutualized, encompass all sovereign debt issuers irrespective of credit ratings and include instruments such as supranational issuers and inflation-linked bonds.
- ECB will probably be conservative because of the likely reluctance to pre-commit.
- Suspect inflation generated by QE may be limited, probably leading to another program like QE2 or QE3, possibly by mid-2016.
 

UBS
- ECB is likely to announce this week purchases of EU1t including sovereign debt, possibly augmented by corporate and supranational debt, economists including Reinhard Cluse write in Jan. 19 note.
- ECB will leave door open to do more should inflation fail to move back toward target within acceptable period of time.
- Unlikely for program to include Greek debt just 3 days before Greek election (on Jan. 25)
EUR may fall toward 1.10 USD if ECB QE exceeds expectations.
 

BNP Paribas
- ECB likely to announce sovereign QE on Thursday, economists inc. Ken Wattret write in Jan. 13 note
Expect deposit rate to remain at -20bps.
- Size of sovereign bond program will probably be ~EU600b per annum, with assets of longer maturity than under OMT and purchases unsterilized.
- Look for conditions to be attached, ruling out participation of Greece.
 

RBS
- ECB is likely to announce EU650b of govt bond purchases; EU650b is a conservative assumption; size could easily be EU1t for sovereigns, head of European rates strategy Andrew Roberts says in client note dated Jan. 19.
- Expect ECB to announce QE this week; program to include corporate bonds and securities issued by EIB as well as sovereign bonds, economist Richard Barwell says in Jan. 19 note.
- Expects no change in ECB interest rates in Jan. meeting.
 

Societe Generale
- Expects ECB to announce a new purchase program including corporates bonds, EU agencies and government bonds this week, economist Michel Martinez says in client note dated Jan. 16.
- Package will eventually include EU400b of private assets and EU500b-EU600b of sovereign bonds.
- A hybrid system could be contemplated, including part-mutualization based on capital key but with most purchases undertaken by NCBs at their own risk.
- Legal and political hurdles to risk-sharing will remain significant in coming months.
 

Nomura
- ECB will probably announce on Thursday a large-scale asset purchase program, including govt bonds, economist Nick Matthews writes in Jan. 19 note.
- Expects ECB to broaden existing ABS and covered bond asset purchases to include corporate bonds, supras and agencies.
- ECB will probably detail monthly flow of public and private sector asset purchases of at least EU40b per month, for as long as necessary, conditional upon inflation outlook.
 

Credit Agricole
- Easiest way to surprise markets would be with a flexible program of at least EU500b, with more to come if needed, economist Frederik Ducrozet writes in client note dated Jan. 19.
- Expects ECB to commit to monthly pace of EU40b-EU50b of sovereign-bond purchases over 12 to 18 months, or an implied total amount of EU500b-EU700b.
- Sees combination of capital keys and caps on individual bond holdings, with an attempt to keep credit risk at national level.
- EU1t balance-sheet-expansion strategy could be boosted later this year should CPI outlook fail to improve.
 

ABN Amro
- Draghi will probably announce that ECB will embark on large-scale asset purchase program, mainly consisting of sovereign bonds, head of macro research Nick Kounis writes in Jan. 16 note.
- Program could also include other securities such as non-financial corporate bonds and agency debt.
- Purchases likely to be allocated according to capital key.
 

Commerzbank
- ECB likely to announce broad-based sovereign QE on Thursday, economist Michael Schubert writes in Jan. 16 note.
- National central banks will likely have to buy up own countries’ bonds at own risk; this should ensure that new Greek govt would be cautious about advocating debt forgiveness, and could also result in greater support across Governing Council.
- Purchases likely to be in line with capital key; ECB likely to buy floaters and linkers to avoid market distortions; purchases probably won’t be limited to particular maturities.
 

ING
- European Court of Justice aide’s opinion on legality of OMT program removed last roadblock to QE, economists inc. James Knightley write in Jan. 16 note.
- Central bank probably won’t present all details of likely program, postponing them to March meeting.
 

UniCredit
- ECB probably has QE package in pipeline that includes at least EU500b of govt bonds and up to EU250b of non-financial corporate and agency/supranational debt, economist Marco Valli writes in Jan. 15 note.
- Timing a close call; plan could be ready on Thursday, as suggested by recent comments from officials.
- There will be probably be some limit to risk-sharing, with national central banks retaining some or all risk.
 

Market Securities
- ECB likely to announce corporate and sovereign bond purchases on Thursday, economist Christophe Barraud writes in Jan. 19 note.
- Looks for hybrid approach involving risk-sharing across euro-area, limited to a maximum of 50% of total program, and separate purchases by national central banks.
- ECB may not detail specific amount, could give a range; likely to reiterate commitment to expand balance sheet by almost EU1t.
 

Four Different Scenarios For ECB Sovereign QE: Credit Suisse

Ahead of the ECB meeting, Credit Suisse published a very interesting preview concerning the four most likely soevereign QE scenarios:

 

We consider four potential scenarios for ECB sovereign bond purchases depending on 1) the degree of risk sharing and 2) the size the ECB announces. We believe the market reaction to an announcement of QE is likely to be very different depending on these two factors.

 

 

4 scenarios:

 

1) Small size and low risk sharing: The first scenario is a purchase programme that is below €500bn and has risk sharing below 50% of the total programme. We believe the market reaction would very negative for risky assets in general and the periphery in particular. We believe this scenario remains bullish core rates driven by the likely riskoff moves in risky assets and removal of any debt mutualisation.
 
2) Large size and low risk sharing: The second scenario is a purchase programme with a size closer to €1 trillion but risk sharing of the overall purchase programme still limited to a maximum of 50% of the total programme. We believe such a programme would be bullish risky assets and core rates given the upside surprise in the size. We expect a similar move in core rates as in the Japanese QQE, where the flow of purchases will trump any change in inflation expectations.
 
3) Large size and large risk sharing: The third scenario is identical to the second scenario in terms of size but risk sharing will be above 50% of the programme. We expect such a programme to very bullish risky assets and, in particular, leading to a strong rally in peripheral bond markets. Given the high degree of European debt mutualisation in this scenario, we expect core rates to sell off.
 
4) Small size but large risk sharing: The fourth scenario is equal to the first scenario in terms of size and equal to the third scenario in terms of risk sharing. We believe the market reaction in such a scenario would be bearish risky assets but peripheral markets should fare well given the higher degree of mutualisation relative to market expectations.