ECB Rate Cut

Posted by on Nov 3, 2011 in Uncategorized | No Comments

The ECB finally came through with a rate cut. We have been expecting one as it is the last chance to keep yields down on sovereign debt in Europe. I wouldn’t be surprised if the failed EFSF auction yesterday influenced the timing. Maybe cutting the ECB rates will cause a shift in the curve, making EFSF bond yields lower? I am actually surprised it is only 25 bps. I would have expected 50 or even 75 bps.

What is the impact?

German 2 year Bunds already yield only 0.4%. ECB rate cuts aren’t going to change German rates much.

French 2 year bonds are more interesting. They are yielding 1.05%. They went from 1.15% to 1.03% but are giving up some of those games. It looks like very little of the rate cut has been transferred into French bond yields.

The Italian 2 year bond yield did move by 25 bps. It went from 5.35% to 5.10%. That is a positive development and is good to see so much of the cut transfer through. They the ECB may be buying Italian bonds and the yield is still almost 50 bps higher than where it started the week.

Spanish 2 year bonds went from 4.14% to 3.98% so about 16 bps.

I would think the market would want to see a move of 25 bps, or close in French, Spanish, and Italian 2 year bonds. If the rate cut doesn’t help at the 2 year point of the curve, what benefit is there? So far I think the grade is about a B. We will see how it plays out throughout the day, but it is critical that this cut works on sovereign yields, or it will be another part of the “grand plan” that doesn’t live up to expectations.

The EU and EFSF need low absolute rates to have much of an impact. So far, the initial reaction was decent, but where it is settling in, looks like the cut was largely a fail in the bond markets. Great for stocks I guess, but the problem isn’t short-term rates, it is longer term rates.

I guess this will encourage banks to borrow from the ECB to buy bonds of the countries that back the ECB. At least it is consistent with the “all-in” strategy the EU seems hell-bent on pursuing. Ultimately it seems that it has to end with ECB printing money.