It seems that not everyone was left woozy and starstruck by Monsieur Trichet’s delphic purrings.
Despite Thursday’s European Central Bank bond purchases and the announced extension to April of its liquidity function, BNP Paribas’ Paul Mortimer-Lee thinks it’s inevitable that much more will be needed, and soon.
A mere extension of the European Financial Stability Mechanism, however, is not the answer:
The EFSF has turned out to be a destabilising not a stabilising force, because it has allowed the ECB to retreat to the sidelines.
Market expectations about long run prices of peripheral debt are volatile and unstable. Taking another country into the EFSF will not improve that, rather the opposite.
As FT Alphaville noted earlier, the ECB needs to find a way of clarifying longer run expectations of bond prices and of ensuring that foreign investors come back and stay in the periphery.
Mortimer-Lee argues that the ECB will be cutting its liquidity nose to spite its solvency face if it continues its piecemeal approach:
The ECB’s chances of success are maximised if it encourages the private sector to work with it. That means buying well before the bond spread enters the “death zone” of around 500bp or so above the benchmark. (Note the LCH circular of 5 October that clearly set out 450bp as being in the danger zone for additional margin calls on sovereign debt http://www.lchclearnet.com/member_notices/circulars /2010-10-05.asp.)
After all, it’s better to prevent the patient having a heart attack than wait until after it has happened. To me, working with the grain of the market means buying where the marginal impact of purchases will have the maximum impact on the price. Buying the worst sovereign credit that is not yet in a programme risks giving investors an easy exit.
In terms of moral hazard, what could be better than letting potential shorts know that there will be no ECB buying until spreads get really wide? Or that the longs will be left out to dry? To stabilise the market, you have to make shorting painful and being long profitable (or less unprofitable and less risky).
The objective of the SMP should be to stabilise expectations about where the price of a sovereign’s bond will go. Waiting until the sovereign is “gone” and virtually cannot issue is to wait way too long. By then, real money investors will have decided to vastly reduce their exposure and will not come in again. The objective is to keep people in.
Therefore, we need good ol’ bit of shock ‘n’ awe:
So I would recommend buying no Greece or Ireland, and would suggest not buying a lot of Portugal either, except to the extent that doing so would defend the citadel. The citadel is Spain. If Spain’s spread moves in that will help Portugal. Putting Portugal in EFSF will not help Spain much.
What seems sensible is for the ECB to buy a lot of Spain. Moreover, the ECB governors need to use moral suasion with Spanish and other banks to make sure they do the same at the same time. Seeing China buy Spain virtually simultaneously would do no harm (given the RMB’s link to the USD, China cannot be overjoyed by the EUR’s weakness).
Of course, Spain will be reluctant to see the ECB buy its bonds. And the ECB will be reluctant to do so for a whole variety of reasons. One reason they will have in common is to maintain the “Spain is not Portugal, Portugal is not Ireland, Ireland is not Greece” line of argument. Sorry, but that tactic looks a bit hollow by now and it is time for a different tack.
In short, take one for the team, Zapatero.
Related link:
If not the ECB, whom? – FT Alphaville