Now here’s a bravely contrarian Goldman Sachs research headline:
The European Rescue: Stability and sanity restored!
Which comes from the bank’s chief European economist Erik Nielsen.
As European markets end their first week of life under the Great Rescue Package, Nielsen argues that the bailout’s risks will be far outweighed by the benefits.
Starting with the ECB’s sovereign bond-buying, which has been guessed at around €10-€20bn so far:
The move by the ECB is clearly controversial, and it has indeed been criticised in many quarters. We disagree with the criticism heard so far…
Naturally, Nielsen is keen to cite the yield-smashing in Greek and Portuguese bonds (among others) at the start of the week. Fair enough — the yield spread on 10-year Greek and German debt has more than halved since Monday.
Spreads widened on Friday amid reports of central banks leaving the market, though. Nielsen seems to have anticipated this, and isn’t too worried:
As the ECB steps away, markets might test their resolve by pushing spreads wider again. If that were to happen, we would expect the ECB to let it run for a bit, only to return to punish the shorts. In the final analysis, markets cannot fight central banks when they have unlimited resources, but an interesting issue will emerge as the sovereigns return to the market and banks do not know how much of the present market price is generated by central bank demand, which – ultimately – will be there only temporarily.
And, he adds, the ECB would have plenty of room for manoeuvre:
Suppose that the Eurosystem ends up buying ten times more than what the press has guessed that they have done so far, i.e. about €150bn worth of assets, and that they’ll end up taking a 50% haircut on all these assets (in our view, a true tail end risk). This would imply a relatively modest loss of 3.8% of the Eurosystem’s balance sheet. Do we really believe in such a stable money demand function to think this is inflationary?
Well, do we? See chart below — click to enlarge:
To close, here’s a more glum reflection on the week — from Monument Securities’ Stephen Lewis:
The EU/IMF proposals were, illogically, greeted with enthusiasm in the markets for high-risk assets. A more reasoned analysis is now gaining the upper hand over sentiment in these markets. If the proposals are to work at all in maintaining stability, it will only be through restraining economic growth for years to come over large swathes of the euro zone. This will not be a benign environment for companies with business in that region. If, on the other hand, the proposals prove impracticable, the EU authorities appear to have no more shots in their locker. The result, therefore, could be catastrophic for the euro as a currency. That would hardly be a situation where investors’ appetite for risk would be sustained.
In Europa we trust, or not?
Related links:
A short history of European liquidity – FT Alphaville
Behold — the dollar swaps – FT Alphaville
Ackermann’s curious Greek-speak – FT Alphaville