Event Risks In The Week Ahead

The key event in the week ahead is the ECB meeting.  The ECB surprised many in early September by cutting key interest rates. We had anticipated it because although Draghi had indicated their rate policy had been exhausted, he acknowledged there some still scope for technical adjustments.  We had thought it bolstered the chances of a successful TLTRO, as with a five bp repo rate there could be little hope in lower rates later.

Although many think that there can be no further interest rate cuts, Draghi did point to the possibility of some adjustment in the rate corridor. For example, it is conceivable that the ECB could cut the lending rate, which is the top of the corridor.  Still, it is unreasonable to expect a change in the rate corridor this week.  Instead, the focus is on the “modalities” or terms of the asset-backed purchase facility that Draghi in early September.  

After the low takedown at the initial TLTRO, market participants are anxious for details about the ABS and covered bond purchase plans.  The idea being that the low TLTRO borrowing points to a more aggressive asset purchase program.  The key is boosting the ECB’s balance sheet, as Draghi indicated, back to levels in mid-2012, which is about one trillion euros from current levels.  

The problem is the that the ABS market is relatively small.  The outstanding ABS at the end of the 2013 was roughly one trillion euros.  Of this amount, only about half is estimated to be in the market. The other half is being used for collateral for funding at the ECB.   This is an important point about the potential for the ABS purchase program, but also about the ECB’s experience in assessing the risk and pricing such securities.  

There are four components to the ABS universe that is relevant here.  The single biggest part by far in the assets back by real estate mortgages.  That is roughly 60% of the ABS market in Europe. The size of the remaining components shrink dramatically. Traditional ABS, backed by car loans, leases and that sort of activity, is about 15% of the outstanding market.  Another 10% of the market are ABS backed by loans to small businesses.  ABS backed by loans in the form of collateralized debt obligations account for roughly the same amount.