ECB bond buying plan: S.M.P to O.M.T... easy as 1.2.3

As Mario Draghi took centre stage yesterday I got a sense that a number of market participants were hoping for disappointment, hoping for a bond buying plan that fell short of the mark and thus triggered the start of the next leg of the EUR down move. In reality, however, what we got, was confirmation that the details of the plan that had been leaked from the European Parliament on Wednesday and saw the whites of Draghi’s eyes as he delivered the plan to the on-looking world in a confident determined manner following a vote which he referred to as “almost unanimous” despite the dissention from the German contingent of the ECB governing council.

The plan itself is by no means a panacea; it does not solve the divergence in the euro area’s competitiveness, or facilitate the required structural reform; it does not improve the deficits or debts of its member states; however, it does provide what Draghi referred to as a “fully effective backstop” to troubled Eurozone states; it gives troubled Eurozone member states the breathing space to enact reform without the negative feedback loop of higher yields pushing up indebtedness, pushing up yields. From Draghi’s perspective the rationale is even simpler; bond buying via OMT is a means by which the ECB can maintain the transmission mechanism for monetary policy and “recreate the singleness of the currency area” under a ‘one size fits all’ monetary mandate.   

S.M.P replaced by the O.M.T
In essence the ECB is replacing the ‘Securities Market Programme’ (SMP), (which was the medium through which the bonds of countries formally under a full macro adjustment programme (Greece,Ireland, andPortugal) were purchased) by conducting ‘Outright Monetary Transactions’ (OMT). The ECB will conduct OMT to provide the effective backstop on the short term financing costs of a member state, only after the national government has sought assistance and the ECB (seeking assistance from the IMF) attach strict and effective conditionality.        

Three C’s and one S
The size of the bond purchases under the OMT are to be unlimited in size, and perhaps in a moderate compromise to the German opposition to the principle of centralised bond purchases. The OMT will have four key attributes:

• Conditionality. Bond buying transactions will have strict conditionality attached. The ECB and IMF will need to be satisfied, on an ongoing basis, that the national government seeking assistance has a plan for the required structural reform and deficit reduction and is implementing the plan.
• Coverage. The bonds purchased will be those in the 1 – 3 year maturity bracket. This is the area of the curve that the ECB feel best fulfils the requirement to mend the transmission mechanism for monetary policy and is consistent with the maturities of other non-standard measures such as the LTRO’s.
• Creditor Treatment. As Draghi suggested at the end of July, purchases under the new bond plan will be pari pasu in terms of seniority with bonds bought by the private sector. ECB seniority or preferred status under the SMP was seen as detrimental to private demand due to the fact that private investors would be at the back of the queue in the event of default.
• Sterilisation. While the OMT will be unlimited in size, the purchases will be sterilised (deposits taken in to offset the value of bonds purchased) in order prevent an expansion of the money supply, or in effect Quantitative Easing.

Easy as … 123
The contention about bond buying by the ECB, at least from the German contingent, was the question mark over whether it constituted ‘monetary financing’. Draghi was resolute in his testimony in that Article 123 of the EU treaty prohibited the purchase of sovereign bonds in the primary market but that secondary market purchases under the imposed conditionality of the ECB (with the assistance of the IMF) and the support of the national government, in ex-ante unlimited quantities, does not violate article 123… Easy!

So where does this leave us?
As I suggested above the actions of the ECB are far from panacea to the woes of the indebted union. In fact, during the press conference, the ECB announced its lowered expectations and official forecasts for growth over this year and next, in conjunction with a slightly higher than expected inflation trajectory and the headwinds to growth from austerity, structural reform, deleveraging and a slowing global economy, the prospects for the Eurozone and for the EUR in the medium term are far from rosy.

NFP
For today, the fortunes of the EUR and other risk correlated assets will be dominated by this afternoon's US employment report. The implications of a better or worse release are not explicitly clear as there is some contradictory influences on sentiment. A very weak number may be seen as a USD positive (EUR negative) on the basis of risk appetite, but a USD negative on the basis that it raises the chances of a further expansion of the US money supply via QE. A very strong number would have the opposite conundrum. My central expectation is that the release comes in moderately higher than expectations and that the environment remains supportive of risk assets, EUR (perhaps more efficiently GBP) and while in the longer term I am bearish for the EUR, its day in the sun may be longer than you might have expected.