Monday 2 February 2015

ECB Bond-Buying Plan Has Investors Questioning How It Works

(Bloomberg) -- Mario Draghi’s trillion-euro puzzle is missing some key pieces.
When the European Central Bank president announced a program on Jan. 22 to buy 60 billion euros ($68 billion) of assets a month for at least 19 months to avert deflation, he surprised investors with the size of the stimulus.
He also provided more details than anticipated. Yet analysts poring over the ECB’s statements are finding that several critical points remain unclear.
“The ECB had to present a lot of details right from the beginning as they wouldn’t have been credible without them,” said Johannes Gareis, an economist at Natixis in Frankfurt. “What is missing somewhat is the fine print, which might have quite an impact on the implementation.”
Here’s what the ECB has and hasn’t revealed about Europe-style quantitative easing.
What will the asset mix be?
The ECB’s monthly spending will include its existing programs to buy covered bonds and asset-backed securities. Of the added purchases, Draghi said 12 percent will be
debt issued by European Union institutions and agencies, and the rest will be government bonds.
The question is: how much does the ECB envisage spending on each type of asset?
Draghi also said officials will buy bonds with maturities from 2 years to 30 years, without specifying an average target that could affect yield curves and borrowing costs.
And while the central bank said eligible debt includes inflation-linked bonds, floating-rate notes and securities with a negative yield, it hasn’t given any indication of what the breakdown of purchases might be.
How transparent will the purchasing be?
The ECB hasn’t said much about the mechanics of QE. When it bought sovereign debt from 2010 to 2012 under its now-halted, and far smaller, Securities Markets Program, it dipped into the market without prior announcement. ABS and covered-bond purchases are carried out by external asset managers.
Those strategies contrast with the Federal Reserve, which issued a calendar for when it would make purchases under its QE programs and what type of securities it would buy.
A public calendar would “ensure greater transparency and minimize market distortion,” said Riccardo Barbieri Hermitte, chief European economist at Mizuho International Plc in London.
How transparent will reporting be?
The ECB said transactions “will be published in a weekly report which will list holdings at amortized cost by asset type.” That’s already the case for ABS and covered-bond buying.
For the sovereign debt and agency bonds bought under QE, the ECB will also release a monthly report with the amounts held and the weighted-average remaining maturity by issuer residence.
How will the ECB calculate its self-imposed limits?
The central bank plans to hold a maximum of 33 percent of any country’s outstanding debt and less than 25 percent of any specific bond issue. What’s not clear is how it’ll measure that.
One question is whether it’ll count the stock of short-term treasury bills as part of a country’s outstanding debt. If it does, that increases how much it can buy before it hits the 33 percent limit.
How will the ECB treat Greece?
Treasury bills are particularly important for Greece, where the ECB and euro-area central banks already own about 27 billion euros of the country’s bonds. That’s 40 percent of its outstanding debt excluding treasury bills, but only 33 percent if the short-term debt is included.
Which measure is chosen may be critical when SMP bonds mature this year, as it could allow the ECB to buy Greek debt and help reduce yields in the nation’s stressed economy.
Even so, this is highly dependent on how Greece’s newly elected government behaves. Prime Minister Alexis Tsipras won power on a platform that includes restructuring the nation’s debt and rolling back reforms linked to its bailout package.
Finance Minister Yanis Varoufakis said late Sunday in Paris that his country won’t take any more aid under its existing bailout agreement and wants a new deal with its official creditors. At the same time, the new government wants the ECB’s help to keep its banks afloat, he said, adding that he plans to travel to Frankfurt to meet with central bank officials.
How will the ECB use the capital key?
Bond purchases will be made in line with the ECB’s capital key, or roughly proportional to the size of each nation’s economy. That means the biggest share will be German debt, followed by French, then Italian, and so on.
What is unknown is whether the capital key will apply to each month, or over the lifetime of the plan. Might the ECB choose to front-load purchases toward particular countries and, if so, which ones?
In some nations, such as the Baltic countries, the stock of outstanding debt eligible for QE is small, meaning the national central bank might not be able to buy as much as the capital key allows. Will those countries be able to buy other national debt, or other asset classes such as covered bonds?
One consideration is whether the ECB will let national central banks buy more than their capital key suggests by transferring unused allowances from other countries.
“Much depends on how the ECB sees the use of capital keys as a flexible upper limit or as a fixed target,” said Lena Komileva, London-based chief economist at G Plus Economics Ltd.
How will QE be evaluated?
While Draghi said QE will run through September 2016, he also said it’ll last until the central bank sees “a sustained adjustment in the path of inflation” toward the ECB’s goal of just under 2 percent. The rate was minus 0.6 percent in January, matching the weakest level in the single currency’s history.
The day after the QE announcement, Executive Board member Benoit Coeure and Governing Council member Ignazio Visco said in Bloomberg Television interviews in Davos, Switzerland, that the program will be extended if the results aren’t adequate.
That begs the biggest questions of all: How will the ECB decide when enough is enough, and what will it do when that point is reached? The Fed ‘tapered’ its buying, reducing it over almost a year to ease out of QE as the U.S. economy improved.
“What matters are the criteria which will determine whether the ECB accelerates or tapers purchases and there is very little clarity about that,” said Richard Barwell, an economist at Royal Bank of Scotland Group Plc. “What was missing was the sense of urgency in Draghi’s personal pledge to bring inflation back to the target without delay.”

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