Positions in Europe: Long German Bunds (BUNL)
As we’ve noted in recent research notes, Draghi primed the market for great expectations leading into today’s ECB decision with his statement last Thursday (7/26) that “within our mandate, the ECB is ready to do whatever it takes to preserve the euro,” adding , “believe me, it will be enough.”
Well, Draghi certainly under-delivered today and the market is selling off hard since the ECB’s 8:30am EST conference call. And we aren’t surprised. As recently as 7/27 in response to Draghi’s “whatever” comment we wrote:
“The issue here, though, is that Draghi hints at possessing some bazooka that he’s been concealing for all this time. We frankly don’t think there is one, particularly because we can’t envision what one grand bazooka would look like. “
In today’s conference call Draghi left rates unchanged (main refinancing operations at 0.75%, marginal lending facility at 1.50% and deposit facility at 0.00%) and signaled no further plans of a LTRO. Unlike previous calls, he directly addressed yields across the periphery, saying:
“Exceptionally high risk premia are observed in government bond prices in several countries and financial fragmentation hinders the effective working of monetary policy. Risk premia that are related to fears of the reversibility of the euro are unacceptable, and they need to be addressed in a fundamental manner. The euro is irreversible.”
To address these rising yields (Spain and Italy, without being named) Draghi announced that the ECB “may undertake” non-standard measures, hinting at a reactivation of the SMP to namely buy bonds on the secondary market and areengagement of the EFSF to buy bonds on the primary market, with focus on the short end of the yield curve. No target size of buying was mentioned beyond “size adequate to reach its objective”.
Questions about the seniority of these bond purchases were not addressed by Draghi. He deflected them saying that the details will be worked out in the coming months.
Also note that Germany and the Bundesbank under Jens Weidmann remain firmly against ECB bond buying. This rub will continue to contribute to European market volatility.
What this spells is further artificial hand holding in the Italian and Spanish bond markets. Ultimately, the ECB must buy time until 1.) the 12th of September when the German Constitutional court votes on the constitutionality of the ESM and fiscal compact and 2.) more clarity on a banking license for the ESM, assuming that the Germans sign off on it. And remember, numerous Eurocrats are on vacation in August.
You can find Mario Draghi’s full Introductory Statements to the press conference here.