ECB offers liquidity tweaks, but patient wants stronger medicine

More John J Hardy, 2 days ago08 December 2011 Non-Independent Investment Research The ECB announced a number of measures aimed at enhancing Euro Zone liquidity, but nothing yet points in the direction of more explicit monetization. The market is not happy – what about tomorrow’s EU summit?

ECB
Our Macro Mads out with a more thorough list of the ECB announcements, but I also list most of the key points below: 

The ECB cut the rate 25 bps as expected, bringing the rate to 1.00%. At the press conference, Draghi outlined a number of new initiatives that were largely anticipated (in spirit if not in all of the details):
New 3-year LTRO’s with the option of pre-payment after the first year Lowered requirements for collateral quality Reduction in reserve ratio to 1% from 2% to free up collateral and support money market activity Halting “fine tuning operations” related to money market activity, which was said to a be a “technical measure”.As for the outlook going forward, pessimism expressed on the economy “from financial market tensions” (what about austerity, Mr. Draghi). Inflation risks are “broadly balanced”.

Importantly, in the question and answer session, Draghi indicated that his comments from last week had been misinterpreted and that they didn’t signal an expansion of bond purchases, which quickly took the air out of the initial expression of enthusiasm on the announcement. 

It is important to note that the measures announced by Draghi today were largely expected and are not game changers, merely all about “liquidity enhancement”. With no indication of stronger move toward monetization, it is hard to see how the market will get much traction on risk from today’s meeting alone. A half hour after the meeting, Euro basis swaps were off several ticks and peripheral debt yields had jumped back higher. 

Chart: EURUSD
EURUSD not thrilled with Draghi’s fairly direct language on bond purchases and lack of any change of tack beyond the announced liquidity enhancements. The trendline is important beyond tomorrow’s EU summit. Expression of downside fear levels in the options market (risk reversals) has declined to the lowest level in about four months.