The euro staged a nice 100 plus point rally today as details of the ECB bond buying program emerged. The new ECB plan would be called "Monetary Outright Transactions." According to sources, the central bank would buy government bonds of up to three years maturity. The purpose of the bond purchases would be to reduce the interest rates in countries where the rate was high.
Spain and Italy were the immediate concerns, although other countries might be included. Countries would need to ask the ECB for help, and would agree to take the recommended reform and austerity measures. There would not be any interest rate targets, nor would there be limits on the size of the bond purchases. The ECB would not take a senior position ahead of other bank lenders.
Perhaps in deference to the apprehensive Bundesbank, the purchases of bonds by the ECB would be sterilized so as not to increase the money supply. Euros would be paid to those tendering paper to the ECB, and the ECB would subsequently drain an equal amount of what they claim is surplus liquidity from the banking system.
These details, probably intentionally leaked to the press, are of course denied by the ECB. They do not wish to comment on a program yet to be approved.
Should this plan be initiated, here are some observations. It would lessen the interest burden for the debt laden countries, but the offset would be austerity requirements that will cause a further contraction of the economy. Without a plan to stimulate the economy, the stern Teutonic cure would be as effective as human bloodletting was a few centuries ago. Other countries will suffer like Greece.
The sterilization would drain liquidity and crowd out the private sector. National banks' biggest function would be to finance the government. Lending activity would be compressed into the front end of the yield curve. Sovereign deficits are a product of the welfare state, which has promised more to their constituents than they can afford. This is a long-term commitment that cannot be financed with short-term borrowing. Once the ECB becomes government's main funder, when will it end.
We will see what the ECB reports tomorrow. There are rumors the bank rate will also be reduced .25% to .50%
There is increasing evidence the European recession is beginning to reach Germany. Was this a reason for the apparent Bundesbank cooperation with the new plan? It was reported today that German exports the past month dropped to the lowest monthly level since August 2009. A German paper said:
"Demand is sinking particularly in recession-plagued southern European countries, the survey of 500 German firms found, but even China is reportedly struggling against the worldwide economic downturn.
The survey reported that German exports to Portugal sank by 14.3 percent in the first half of this year, while exports to Greece and Spain sank by more than nine percent.
Orders for manufacturing machines, raw materials and other producer goods were particularly affected.
And there is little room for improvement, at least in the short term, the report found, as more and more German companies lay people off.
"Despite slowing the decline, German industry faces its worst quarter in more than three years this third quarter," Markit economist Tim Moore told Reuters news agency."
Elsewhere in Germany, there was a failed bond auction. The German Treasury held an auction to sell €5B of 1.5% 10-year bonds. It was able to sell only €3.61B directly to investors and had to retain 27.8% of the rest. Is this a precursor of other failed auctions should the ECB bail outs proceed?
Draghi, at the news conference tomorrow, will need to forcefully present a detailed plan. Failure to do so would result in a sell off tomorrow of both the euro and European securities.
Our preference is the sidelines until we see the US employment numbers on Friday. The markets have been anticipating the US Fed will commence a version of QE in the near future. We have been inclined to doubt such action because of the political risk the Fed would take should it embark on a new program during the election campaign.
If the unemployment is no worse, and the NFP comes in at 121K or higher, we will be looking to establish a short in the EURUSD (FXE, UUP, UDN) at current levels or higher. The ECB plan may hold the euro group together, but not as a happy family, and subject to a further economic slowdown.
As we have noted in our latest COT analysis, the USD has absorbed a large amount of spec selling, and for the first time in almost a year, specs are short the USD. Speculators have bought commodities and the commodity currencies, anticipating the Bernanke liquidity injection. The USD could benefit should commodities falter.