It’s hard to fully assess at this point the relative importance for the reduction in Irish government bond spreads of the €750 billion bailout fund committed to by the EU and IMF versus the ECB’s decision to purchase sovereign bonds on the secondary market. However, the ECB’s presence or withdrawal from the secondary bond market may prove very important in relation to Ireland’s ability to keep issuing primary debt and staying out of the hands of an EU-IMF deal.
So, three weeks in, what do we know now about this program? A bit more than a few weeks ago but not as much as I’d like. This speech from President Trichet appears to be the most comprehensive discussion of the rationale for the program.
Trichet stresses that this program is being undertaken because it relates directly to the transmission of monetary policy in the Euro area. Some quotes:
We implement monetary policy by setting our key policy rates. Through this, we directly influence short-term interest rates in the money market. Financial markets transmit this impulse along the maturity spectrum, since term rates reflect current and expected future short-term rates as well as risk premia.
These rates, in turn, affect the costs of funding for households, for firms, and for governments. The resulting financing conditions affect economic activity and, in the end, prices.
The functioning of the market for government bonds is central to the transmission of the ECB’s policy rates …..
Because of these channels, severe tensions in the bond market hamper the monetary policy transmission mechanism. The relation between our key interest rates and the rates applicable in the real economy gets out of order, and our main tool for influencing refinancing conditions in the real economy does not work the way it should.
This is the situation that threatened us at the beginning of this month, so we saw the need to act quickly to re-establish a more normal functioning of our monetary policy transmission mechanism. The very rapid consolidation of that situation depends crucially on the effective implementation of the fiscal retrenchment programmes that have been decided in a number of countries.
In terms of the details of the ECB’s bond purchases, some information is released every Tuesday in the ECB’s Weekly Financial Statement. Consistent with Trichet’s characterisation of the program, it is known officially as the Securities Markets Programme (no mention of what type of securities are being purchased) and the purchases under this program are being listed under “Securities held of monetary policy purposes” and not under “General government debt denominated in euro.”
From these reports, we know that the ECB bought €16.3 billion during the week ended May 14, €10.4 billion during the week ended May 21, and €8.8 billion during the week ended May 28. No information has been revealed about the composition of these purchases in relation to whose debt has been purchased or which maturities.
A couple of observations on all this.
I don’t fully agree with Trichet’s characterisation of this program as one that is aimed at ensuring the reasonable functioning of the normal monetary transmission mechanism. That movements in short-term monetary policy rates transmit themselves across the yield curve for risk-free (or almost risk-free) debt is a standard part of the description of how monetary policy works. That other instruments are not seen as risk free and that are movements in the risk spreads on these other instruments is also standard.
The idea that spreads on certain instruments being higher than the central bank would like should prompt an intervention has not, until recently, been a standard monetary policy tool. And risk spreads being high is not usually seen as interfering with the “normal functioning of the monetary policy transmission mechanism.”
What is true, however, is that when monetary policy rates are close to zero central banks can choose to provide extra stimulus by purchasing bonds to reduce spreads on the key instruments. This has been the essence of quantitative easing as practised by the Fed and the ECB, with government bonds and mortgage-backed securities purchased in large quantities to get these rates down. Remember, though, the ECB has another point percentage point to cut should it choose to do so. You can argue that other forces, beyond those that motivated the Bank of England and Fed programs, have intervened here.
Trichet, of course, has been keen to point out that this is “not quantitative easing” because there are also some new operations to take in deposits from banks for a week, so this operation does not increase the stock of high powered money in the Euro area.
I’d disagree with this line of emphasis on a couple of counts.
First, the key aspect of quantitative easing in the UK and US over the past year has been targeted interventions in bond markets to get market interest rates down. This is what the ECB is now doing.
Second, the taking in of deposits under any new program is pretty irrelevant in the grand scheme of things. The ECB are still offering unlimited loans in their refinancing programs, so the sterilisation program is pretty irrelevant for thinking about the determinant of the money supply. And the money supply is far more irrelevant for macroeconomic outcomes than the ECB will admit.
Finally, to the extent that this program differs from quantitative easing as practised in the UK and US, it is that there are extra complications to the ECB program that did not apply in the UK or US and these complications mean that the program lacks transparency and is politically controversial.
Here are things we don’t know about the program:
(a) The composition of the debt securities the ECB is buying.
(b) The criteria being used to select bonds to purchase.
(c) The ECB’s bond purchase strategy during periods of primary issuance.
(d) How long the program is going to last and how much may be spent.
Think about this for a second. Suppose the Fed set up a program to buy municipal bonds but wouldn’t announce how much came from California or Florida or other states or cities. How long would this survive before members of Congress demanded a full explanation of the program? But that’s where we are right now in Euroland.
Of course, part of the reason we don’t have an answer to part (d) above is that there are clearly internal disagreements within the ECB Governing Council on this issue. Trichet conceded in an interview with Le Monde that the decision to undertake the program was not unanimous. He said the decision was taken with “an overwhelming majority”. Well, these are normally a “unanimous decision” kind of crowd so this is an important sign of internal divisions.
Axel Weber and Mario Draghi, heads of the Bundesbank and the Banca d’Italia are already publicly calling for a quick end to the bond purchase program. Draghi pinpoints the moment for withdrawal as when “the markets spontaneously resume trading of the securities of the countries involved.” What Draghi proposes to do if the markets are trading these securities but only because the ECB stays in the secondary markets is unclear. What’s worrying is that there is no clear indication as to how this important program is going to develop over the coming months.
21 replies on “ECB Sovereign Bond Purchase Program”
@ Karl
“No information has been revealed about the composition of these purchases in relation to whose debt has been purchased or which maturities.”
No official figures correct, but anecdotally we are hearing its almost 75% Greek debt purchases, with Portugal and then Ireland being the next biggest beneficiaries, and some smaller Spain and Italy purchases thereafter, though this mix would no doubt change as market perception of who is “weak” changes. Focus has been on the shorter end of the curve, 2y-5y maturities, and while initial bids were designed to push the price way back up, ECB bids are now seen more ‘just under’ the market prices, though in allegedly massive size (ie purely as a hypotethical example, Greek bond trades two way 95-97 in 10mio, and ECB is on the bid for 100mio at 94). They seem to have been a lot less active this week though, so will be interesting to see the new figures that come out on Monday or Tuesday.
I think the basic principle seems to be (a) get spreads down and (b) wipe out any shorting interest for a long long time.
Some elements of your stylised anecdote, Eoin, would surprise me. And even if you see some of the flow, you can never be sure what is going on elsewhere. And that takes us back to Karl’s point – we don’t know that much, and the impact on confidence is at best mixed.
It is vital of course that market issuance continues for sovereigns other than Greece. So far so good. Yet 10-year BTP Bund spreads are at or close to year high (now 160bp, 150bp when the SMP was first announced, then falling to a low as 90bp a fortnight ago). So the effectiveness of the SMP programme in stemming fear has yet to be proven.
I think it is very surprising that there would be buying of Greek debt (and some central bankers are shocked too). Greece is already bailed out. Greece doesn’t have to issue anymore. Greece doesn’t have to worry now where its secondary market spreads trade. So it is missing that very important discipline, substituted for by the “will of the Troika”, to use the term now commonplace in the Greek press.
All this looks like throwing yet more good money after bad.
If the only bone of contention among the authorities was the SMP, matters wouldn’t be so bad. But there is now a debate raging about the design of 2011 budgets (in much of the rest of Europe . .. if not Ireland yet, as I see or hear nothing in the press for now).
Commissioner Olli Rehn called yesterday for “smart” deficit cuts, saying the overall fiscal stance should not become “restrictive” until the economic recovery takes hold next year, says a newswire.
All this is a recipe for further disaster. A bit like the doctor allowing the alcoholic to live it up, on fear of the withdrawal symptoms, while a number of doctors disagree vehemently, and none of them have any way to restrain the drunkard. I’ve no idea what Rehn’s “smart” means. Seems like a euphemism for “small”. Rehn also emphasised “coordinated” fiscal policies, aka Germany should not cut its deficit. Hmm. To be followed.
@ Ciaran
well i can only tell you what im hearing and seeing. It’d be great if you could provide additional or counter information from your viewpoint (accepting of course that you’re not anonymous like me), rather than just saying that mine “surprises” you. Of course so much is going on it is very hard to get a full and true picture of what is going on, so the more info out in the open, the better. For instance, me noting that the ECB is less active makes sense with your note about the BTP (Italy) spreads going back out to their highs. Sharing is caring Ciaran.
It is clear, if Eoin is right, why the ECB is coy about identifying which debt is being bought -it is mostly Greek! The condition of the secondary market in Greek debt does not matter for the next three years, since there will be no primary issuance.
The only impact of secondary market support to Greek bond prices is to help banks which hold them and must mark to market. I fail to see what this has to do with M. Trichet’s ‘transmission of monetary policy’.
@Colm
If true and we do not know if it is, it boosts the solvency of the core banks most exposed to the Greek market. These would be the French who could (just) withstand the hit to capital and the German landesbanks who could not. So effectively it would be an ECB bail out of the German banks plus Societe General & Credit Agricole.
@ Colm,
The linked article below suggests a little French conspiracy
http://www.spiegel.de/international/europe/0,1518,697680,00.html
“By buying up Greek debt, the ECB keeps the prices of the bonds artificially high. French banks, in particular, benefit from this policy because it enables them to sell their Greek bonds to the ECB, as an inexpensive way of cleaning up their balance sheets. France’s banks and insurance companies have a total of about €80 billion in Greek government bonds on their books.
German banks, on the other hand, are not potential sellers, because they have made a voluntary commitment to Finance Minister Wolfgang Schäuble to hold their Greek bonds until May 2013.”
@CmcC
Another impact could potentially be to reduce borrowing rates for the Greek private sector – in other words to transmit monetary policy to Greece
More Hotel California policy. An exit? The light-bulb in the sign seems to be broken. I agree that the intentions are to bail out banks (and not just banks) and governments (to support issuance). What I don’t see is how, once started, it can stop?
We have already crashed into zero interest rates with no likelihood of escape in the neat term (at least not without serious consequence). We have already abandoned Maastrict deficit and debt guidelines (for all eurozone states it would appear). Yet we still have deflation or near deflationary conditions. How can this be if we are not stuck in debt deflation?
Somebody somewhere is going to have to take a loss on the mountains of public and private debt that exist. It’s the who and where that are unclear at the moment!
There are some good ideas in the Spiegel article – notably in highlighting that the SMP is not a panacea. However I’m always wary of journalistic articles that can’t get the vocabulary and some of the facts right – it is the ESCB that is doing the buying, so that means that the central banks in Eurosystem are mandated to out and deal with their commercial banks. The risk is then put on the balance sheet of the national central banks.
I’m also wary of conspiracy stories. Even investors love whodunits. But that credits Europe’s policymakers with more cunning and know-how than I’ve seen up until now. If they were so clever, we probably wouldn’t be in the mess we find ourselves in. Aid to Greece and others is chasing investors away. Alternate policies of responsibiling governments (or facing the music) have been shunned. Shades of Ireland in protecting its own banking system in its entirity.
@ Colm
while as you rightly note, secondary market prices don’t directly affect the Greek state right now, headlines like “Greek debt hits 15%” are not particularly helpful when the ECB and EU is trying to calm the markets. Aggressively buying Greek debt (a) kills those who were shorting Greek debt and (b) gets rid of those headlines about crazy high yields. Its an effective, if expensive, way for the ECB to get some manner of control on the story and buy some breathing space for the moment. The effect on Irish and Portugese secondary market rates however WILL help with actual issuing yields when they return to the markets. It could also be argued, less conclusively though, that the ECB quasi-QE is driving down interest rate swaps and increasing liquidity, which will ultimately have some affect on the rate that Greece pays for its EU/IMF bailout, although this isn’t a particularly effective or significant factor so far.
@ Eoin
The yield on Greek debt reflects the probability that it will be restructured i.e. defaulted on. Whether this happens or not should not really be the ECB’s business. “Getting control of the Greek story” is not a Euro area monetary policy concern any more than “Getting control of the California story” is an issue for the Fed.
But, as a point that could be put forward in favour of your assessment, the ECB are certainly talking in public as though it’s their business. Look at this speech by Executive Board member Lorenzo Bini-Smaghi
http://www.ecb.int/press/key/date/2010/html/sp100528.en.html
He accuses people who say Greece will default of not looking properly at the issue by, for instance, reading the IMF’s report on GreeceL
“To summarise, I wonder which analysis is more serious and credible: the many one-pagers, very well publicised – I must admit – which probably aim to influence the rest of the market; or the IMF’s 120 pages of rather tedious analysis describing the contents of the programme, together with its risks.”
The funny thing is, I have read the long IMF report. I came away from it thinking that avoiding default was a long shot.
I think the ECB are straying into very dangerous territory here.
@ Karl
listen, i think a Greek default is a done deal, its a question of how and when. I think this is the point behind the ECB action. At no stage up until the bond buyback was announced did either Greece, the EU or the ECB have a handle on this problem, it was being chased away from them by the markets, and it was completely out of their control, and both an imminent and near total Greek collapse was in the offing, as well as the very real threat of contagion. The buy back at least allows a situation where they can take a look at the Greek finances (as well as the rest of the PIIGS), come up with a plan to reduce the deficit, and make an eventual restructure as ‘fair’ to all parties as possible, whilst also giving the markets time to get a grip on what a large right down will mean for most holders. The German unilateral decision, stupid as it is, also seems to have this end in mind. Remember, for all the large scale of the Greek bond buybacks, its likely only going to amount to a fraction of their total outstanding debt of 300bn.
Btw, on a complete tangent, anyone see Sean Quinn on PrimeTime? Slightly surreal interview. Living in a parrallel universe in terms of how he viewed that the regulator was “technically” right that Quinn Insurance did not meet the solvency requirements. Basically felt that because he (SQ) that that QI was solvent enough then it was ok. Truley strange. As someone just texted me, “car crash tv – no offence or pun intended on the guy who was paralysed”.
After the initial tightening of spreads on the ECB announcement, widening has been the order of the day. Eurozone bond yields are beginning to look like Seanad mileage bands – Germany is band 1; France, Netherlands and Finland are band 2; Austria is on its own in band 3; Belgium is being split from the herd in band 4; band 5 comprises Spain and Italy; band 7 Ireland and Portugal: and Greece is on its erratic own in band 8 (not yet dubbed Kilcrohane by*shudder* market wags).
While the ECB action has stemmed panic selling as existed in early May, anecdotal evidence (and unfortunately there’s no better available) suggests that the sales to the ECB have come from what the markets call “real money”, i.e. long-term or natural-home investors such as pension funds, life companies, and general insurers.
Leaving aside the return effects of short-term price moves, it’s worrying that such funds (if the anecdotal evidence is true) are shunning the enhancement of returns over either money rates, or those available on the German yield curve, at any point one cares to pick.
@ Karl (and others)
maybe i missed it (quite possibly), but where do you guys stand on the issue of whether the ECB should be doing QE (regardless of whether this ultimately constitutes QE or not) – for or against, reasons etc? Its obviously a controversial subject that throws up very differing arguments.
The ECB is being forced to undertake responsibilities for which it was neither designed nor formally mandated to rescue a failing political programme driven through by the EU elite. I’m inclined to agree with Eoin’s view that this is a holding operation to establish a basis for some sort of orderly debt restructuring. Popular support for the EU’s institutions in the core EU members has been fraying for some time and this crisis is stretching the fabric to breaking point.
Having driven through the Euro primarily as a political project in pursuit of “ever closer union” – though not without significant economic benefits to the core members, but without securing explicit popular consent, the EU’s leading politicians (and the top Eurocrats behind them) are finding it very difficult to explain to their voters, in particular German voters, that it is their banks and pensions that are being bailed out in the first instance – and not exclusively the PIIGS (who, effectively, have ceded economic and fiscal sovereignty and are experiencing severe fiscal adjustments).
A bit more honesty all round – and less concern about factional advantage – is needed to shore up popular support for the major adjustments required. But when did we ever get honesty from politicians?
Karl
You are clearly interested in the minutiae. Eoin is to be thanked for his info.
The net news is that fiat currencies are devaluing competitively, no surprise. The ECB has options. Wise. Best to move slowly in order to increase the devaluation.
Who will pay? Those who pay taxes in the EU, bank in the EU and who have funds in EU FIRE sector. For the next ten years, minimum. Given the lack of the Wizard of Oz, the money making machine, the economy from which payments are to be made and repayments of priciple of past debt will more than make up for the so called benefits from the borrowing and consequent malinvestments. Volatility is high and will get higher, as capital seeks a safe haven.
Japan shows what is likely to happen. Except the Japanese consider living and dying elsewhere than in Nippon, to be a shame. So they can afford to carry a debt of 200% GNP. At less than 1% interest rate. What happens when that goes up?
Massive frauds have still to be revealed …..derivatives can postpone the evil day for a while, but as the volatility goes logarithmic, there is going to be a CRASH! Argentina defaulted and confiscated large sums on deposit in banks ……… Cash in hand, anyone? Having the ability to live in another hemisphere might also be handy.
Don’t forget to vote in the next election and show your pleasure at how the economy is performing.
[…] Eoin asks a good question “Should the ECB be doing quantitative easing?” My thoughts are as […]
By the by, ECB back on the bid this morning. One can only but assume that they have been reading this blog and noticed our nervousness about the PIIGS spreads moving back out. Good work to all who have helped to alert them to this.
One reason the ECB cannot use for their bond purchase program is that they do it to hurt short-sellers. As long as short-selling is legal, the markets should have to deal with the existence of short-selling.
The mission creep into ECB doing something to damage investors engaged in currently legal activities is step too far. Hopefully this reason is only used for PR reasons.
Wall Street Journal, not citing sources
The European Central Bank’s emergency bond-buying program may be creating its own distortions. While the ECB has calmed some segments of the market by buying Greek, Portuguese and Irish bonds, investors don’t know how far the central bank will go with its purchases, making it hard to participate in the market.
Some of the Fed’s recent bailouts have been just as opaque as this, for example AIG Schedule A. The money went to banks rather than to state or local governments but that doesn’t make the secrecy any easier to accept.