Something Brewing?
Three UK newspapers – the Guardian, the Telegraph and the Financial Times – all suggested that Germany is now less opposed to using the EFSF and its successor (the ESM) to purchase Spanish and Italian sovereign bonds in the secondary market. We note that the EFSF already has the authority to do so in principle, and the ESM’s design also allows for this. However, whether this authority is ever exercised is another matter. Fundamentally though, whether the ECB buys bonds via the SMP, or whether this new approach is used, the seniority problem would remain. Simply put, the more sovereign bonds are bought by official sources, the more the private sector holders who remain are subordinated and – taken to extremes – an aggressive official bond buying program could eventually do more harm than good. Also, although the ECB’s firepower is theoretically infinite, a bond-buying campaign executed through the EFSF/ESM would need to be funded and would have finite resources at its disposal. Finally, capacity diverted to bond buying would reduce the pool of resources available to fund the more traditional bailout agenda where cash is provided directly to fund governments who have lost market access, by-passing the bond market entirely in the process. The G20 meeting concluded and a vague communiqué praised Europe’s “intention to consider concrete steps towards a more integrated financial architecture, encompassing banking supervision, resolution and recapitalization, and deposit insurance”. This fits with our view that a Big-Bang policy announcement encompassing a roadmap for debt mutualisation seems unlikely to emerge at the upcoming EU Summit. Instead the thrust of the meeting seems likely to focus on the concept of a so-called “banking union”. Meanwhile, market expectations continue to build that Wednesday’s FOMC meeting may produce yet another round of balance sheet expansion, boosting risk currencies like AUD and NZD to unsustainable levels. Our US economics team are sceptical and do not expect any further money creation, although they do expect the policy language to change to indicate the Fed’s greater readiness to ease in future if required, especially given the increased risks to the outlook arising from the Eurozone crisis. A temporary extension of Operation Twist cannot be excluded either. If that is all the Fed delivers, we would expect the US dollar to clawback much of the losses seen over the past 24 hours. As far as the sequencing is concerned, the policy statement is scheduled to be released first, followed by forecast revisions 90 minutes later, and rounded off by Fed Chair Bernanke’s press conference which begins 15 minutes after that.
Click here to read the full report: UBS Morning Adviser Europe
UBS Investment Bank