Draghi Delivers & Drags Euro Lower

The Decision

  • The ECB is to expand asset purchases as expected. Under the programme, combined purchases will be €60 billion per month until the end of September 2016 or until the inflation outlook has improved sufficiently.
  • This is a higher figure than the one leaked in press reports. Purchases will include sovereign debt, but also supra-national agencies. Purchases will be conducted according to capital.
  • There will be partial loss-sharing. The ECB also removes the 10bp spread for coming T-LTRO operations.
  • Overall, the programme is probably more aggressive than expected owing to a) the partial risk-sharing and b) the potential open-endedness of the program.

The Nuts & Bolts

Size: President Draghi confirms that the cumulative impact is in the ‘ballgame’ of the existing balance sheet intention.

Flow: The combined monthly purchases of public and private sector securities including the existing CBPP3 and ABSPP will amount to €60 billion per month.

What: Purchases of securities issued by euro area governments and agencies and European institutions. Inflation linked and floating rate securities issued by central governments will qualify.

Duration/Open-ended: Purchases are intended to be carried out until end-September 2016. However, purchases will be conducted until the Council sees a sustained adjustment in inflation, consistent with the Council’s mandate – that is, inflation rates below, but close to, 2% over the medium term.

When do purchases start: Purchases under the new programme will begin in March 2015.

Country split: The purchases of securities issued by euro area governments and agencies will be based on the capital key.

Control: Governing Council retains control over all the design features of the programme and will coordinate the purchases (‘safeguarding the singleness of the Eurosystem’s monetary policy’).

Ratings threshold: There is an investment grade threshold but the eligibility criteria can be relaxed for countries under an EU/IMF adjustment programme, although the issuer constraint is an additional constraint here.

Negative yield: As expected, the ECB can buy bonds with negative yield.

Maturity: Purchases will range across maturities stretching from two to thirty years.

Size limits: The programmes are subject to two constraints: an issuer limit of no more than 33%, and an issue limit of 25%, in order that the ECB does not form a blocking minority in collective action clauses in order to pari passu; these constraints include bonds purchased under the SMP.

Risk sharing: An 80: 20 split in the burden of risk, with the risks entailed in the purchases of securities issued by European institutions (which will be 12% of the additional asset purchases), and 8% of the additional asset purchases sitting with the ECB.

TLTRO tweak: The 10 basis point fee attached to the TLTRO will be removed, and that decision will be applied retrospectively to the stock operations.

Support for the decisions: unanimity that asset purchases are a legitimate monetary tool, a larger majority (so large that no vote was required) supported the decision and nobody disagreed with the risk-sharing split (although not everyone supported it)

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The Euro Trade

  • The market went into the announcement looking for ways to poke holes into whatever plan the ECB announced, but that is precisely the reason that we are now 300 pips lower than yesterday’s high.
  • Market players have missed a lot of the move this year and have been waiting for a meaningful bounce to sell. First that level was 1.20, then 1.18, and now its 1.15.
  • Rallies will be short lived and the move could go a lot further than most expect. In fact, it already has.
  • Going forward, the first level of meaningful resistance is 1.1400, followed by 1.1460. Support levels are few and far between, but 1.10 is the medium term target for now.
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