The T Report: A Playbill for this Morning’s Central Bank Theater

Posted by on Jun 6, 2012 in The T-Report | No Comments

Expectations for the ECB meeting seem high with U.S. futures back to 1,298 recovering almost two thirds of Friday’s drop. The range of possible outcomes from the ECB meeting seems exceptionally high. Some ideas being bantered out seem unrealistic because it isn’t actually the ECB’s mandate. Others have so many possible variations that the mere headline won’t be enough to make an intelligent assessment of its value.

We will walk through a few of the possible outcomes and try and assess some measure of “risk on” or “risk off” to each.

Global Coordination

Any sign of global coordination will count for a lot. Any announcement about global swap lines is a +1. Unless they dramatically drop the rates or extend the maturity this is purely symbolic as the swap lines are already in place, but the confidence that yesterday’s G7 conference call was productive will increase on the back of any global coordination.

The BOE is expected to announce more QE so that won’t do much, but if China was to cut rates or reserve requirements that would be another +1.

ECB Rate Cut

This won’t do much since the good countries already trade tighter than the ECB’s overnight rate, and the weak countries don’t trade based on it either, so largely symbolic. It does help banks that rely on LTRO and other ECB funding programs as they would see the benefit. I think at this stage no rate cut is -1/2 and any rate cut is +1. I think a rate cut of 50 bps would initially spark a better rally, but concern of panic and running out of ammo would become a concern so think the net benefit is the same as a 25 bp cut, and that is what I would rather see.


I doubt we get a new LTRO program launched. No talk about LTRO is a -1 or possibly as much as a -2. Talk of another round of 3 year LTRO in the future is a wash. Everyone pretty much expects that. Further loosening of collateral requirements would be +1/2 as a lack of collateral is a growing concern, but a second order concern. An extended LTRO, such as a 5 year program would be a big change and take pressure off the entire front end of the curve for banks and would be +1 at least.

Secondary and Primary Market Purchases

My understanding is this responsibility has largely been passed to EFSF and ESM which may be why we haven’t seen any SMP. The ECB may be free to comment on this though as they would act as advisor to the EFSF and ESM and it is unclear, but they could possibly still initiate on their own. Any talk that this policy is on hold until politicians get their act together is a -1, reminder that it is one of their tools is a 0, and any talk that it will be resumed or the ECB will provide leverage to the EFSF to accomplish this task would be a +1. I don’t see the ECB doing direct purchases themselves given the mess their portfolio caused in the Greek restructuring negotiations.

Bank Recap, Bank Deposit Insurance, Bank Union

The ECB would have some involvement in these, but they are only a cog in the machine. Any negative comments would be a -1, but since I don’t see how they can actually implement anything, the best case, even if they come out aggressively supporting bank recap or bank union or deposit insurance is +1/2. The ECB just doesn’t have the power to accomplish this unilaterally. At this stage insurance wouldn’t cover currency conversion risk, which is a growing problem anyways.

Financing EFSF, ESM, EIB

Any aggressive action such as talk about a banking license or special facilities to finance bonds for these issuers would be a +1. The EFSF in particular doesn’t have the firepower without significant leverage from the ECB. The ESM isn’t up and running yet, but support from the ECB that it should get a banking license would be encouraging as they could do a lot more with their limited capital, assuming it is ever launched. The support of EIB would help ensure “project bonds” get done. I think this area has the least downside if not addressed, and has the potential to add to risk on if addressed as ECB has just enough power to help push it through.

Redemption Bonds, EuroBonds, Pixies

Any positive comments on these issues will be largely ignored as it is really outside of the scope of the ECB. So even if Draghi gets on his hands and knees and looks to the sky and says these are the best things ever and has his full support, it is a +0.00001. It just isn’t in his control. In spite of that fact, the market is looking to him, so saying nothing is -1/2 and being negative on the idea is -1.

Dumping it back on the politicians

Any comment that ultimately this has to be addressed by politicians is -1 as everyone knows how unlikely that is. If he takes no actions, is not dovish, and blames it all on the politicians than this is a -2 rather than just a -1. Any comments that the central bank will do what is necessary for the financial system in spite of politicians would be a +1 as at least the markets know someone has their back.

Update to follow actual announcements

Going into the various announcements and conferences this is my assessment of what could be done and what it would mean. I lean towards enough getting done that the risk on meter is at least high enough to support current levels and possibly enough to push it higher. Anything that adds up to risk off would lead to stocks breaking back down below Friday’s lows.


Twitter: @TFMkts