What To Expect From The ECB

The ECB meets tomorrow. We do not attribute any significance to the fact that the meeting will be held in Cyprus. A couple times a year, the ECB meets outside of Frankfurt. 

There are three key elements of tomorrow’s meeting, none of which entail a change in policy. The ECB will provide some more details of its stepped up asset purchases plan that is expected to kick off as early as next week. The ECB staff will provide new inflation and growth forecasts.  Even if not in Draghi’s opening statement, we expect reporters will likely seek some insight into Greek developments.  

There are many technical and logistic challenges to the execution of the ECB’s new asset purchase scheme. The national central banks will be doing the bulk of the purchasing and the risk for most of the purchases will not be pooled. It is not clear whether the ECB or the national central banks will lend the bonds that are purchased back to the market, or the terms if it does. It is not yet clear precisely how the bonds will be purchased. The Federal Reserve did so through reverse auctions, but the Eurosystem appears to be more inclined to go directly to the trading platforms and market makers. However, the technical and logistic challenges seem to be modest compared to the operational risks.   

The operational risks are two-fold. First, the amount of sovereign bonds that it plans on buying may exceed net debt issuance for some countries, including Germany. This will displace existing investors. We suspect may types of investors will be reluctant to sell their sovereign bonds to the ECB. Banks, insurers, and pension funds are unlikely to be eager sellers. They will find it hard to replace the yields and incur tax event. Moreover, there has been regulatory pressure that has encouraged these investors to buy sovereign bonds. 

In the US experience, foreign banks appeared to have sold more Treasuries and Agencies to the Federal Reserve. If this experience is repeated, it would imply non-EMU owners could be the featured sellers. However, ex-EMU ownership appears to be concentrated in the core eurozone bonds (e.g. German and French) rather than the periphery (e.g. Spain, Italy, and Portugal). One group of investors that we would peg as more likely sellers of EMU bonds to the ECB would be foreign central banks. With negative yields and a depreciating euro, there already seems to be a move underway to unwind some of the diversification into the single currency.