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.
Of the existing stock of ABS securities, Netherlands
accounts for a little more than a quarter. Italy and Spain together account for
about a third, which is evenly divided between the two. It falls considerably
after these three. Belgium accounts for about 8% and Germany 6%.
Ireland is just shy of 4%, and France’s share is a tad lower, just below
3.5%.
There are three elements that investors want to know from
Draghi: the size, components, and duration of the ECB’s purchase plan,
which will be conducted by an asset management firm. Reuters reported recently that the initial
plan for the ABS (and covered bond) purchase program anticipated up 500 bln
euros. This suggests that the TLTROs
were anticipated to expand the balance sheet by another 500 bln euros).
The risk is that the ECB does not announce the size of its program. This
preserves the most about of flexibility by not doing so.
By telling the market the components of its ABS purchases,
investors can quick estimate the maximum the ECB could purchase of the existing
stock, and make judgments accordingly. There are several other moving
parts here. For example, it is not yet clear what Draghi meant by
“simple and transparent” ABS that the ECB would purchase. The
ECB could also lower the rating of ABS that is is willing to accept. This
would boost the securities available, of course, and assist the peripheral
banks more.
Under QE3+, the Federal Reserve told the amount it would
buy of long-term securities, but left the duration of the program open-ended. The ECB could turn this formulation
on its head. It could indicate that it would make monthly ABS purchases
for the next two years. This would encourage banks to
“manufacture” the securities the ECB will purchase, the same way they
are manufacturing the collateral the ECB was willing to accept.
If the ECB limits itself to new securities only, the impact
will likely be small. There was an estimated 240 bln euros
in ABS issued in 2013 and about 150 bln euros in H1 2014. Much of this
may already sit with the ECB in the form of collateral. Buying old
issuance may not offer a power incentive to increase current and future
lending, though it does help banks de-leverage.
If the ECB wants a large program, it needs to provide banks
incentives to create more. This implies a slow start. If
the ECB wants to start quickly, it may find that its program will be small. It
may adopt other technical polici
es that will help augment the purchase program,
including collateral and credit rules.
While the ECB meeting dominates
the agenda, it is, of course, not the only event of the week. A second highlight is the US jobs
data. The market expects a large bounce back after the surprisingly weak August
non-farm payroll increase of 142k. We
expect that the US economy loses some momentum seen in the middle two quarter
of he year. Q2 GDP was revised to 4.6%
last week and Q3 appears to be tracking something a bit north of 3%. Expectations will be fine tuned after this
week’s personal expenditure, construction spending, and trade balance reports.
We suspect Q3 is ending on a
soft note and that payback will be seen in Q4.
It is difficult to
envision US auto sales building on the strong 17.45 mln pace. That said, GM, Ford and Chrysler likely
picked up market share.
Weekly initial jobless claims
bottomed in mid-July, and although they have not deteriorated, the improvement
has stalled. Republicans
appear to have a strong chance to capture the Senate from the Democrats in November.
This may freeze some private sector decision making
in anticipation of better legislative climate, including corporate tax
reform.
The market may get the 215k
increase in non-farm payrolls the Bloomberg consensus shows. However,
it may not be in quite the form it would like.
Given historical patterns the August series is likely to be revised
higher.
We do not expect this week’s
data in the US, Europe or Japan to influence the outlook for policy. It
would be only mildly encouraging to see, for example, a tick up in the euro area
flash September CPI. It is too early to
see expect the impact from the euro’s decline.
The euro area PMIs will be interesting only for mapping relative
movement of the core and periphery.
The UK’s three PMIs are unlikely
to alter the view of a BOE rate hike in Q1 15.
The readings may be consistent with a moderation of activity, but they
are expected remain at elevated levels.
Japan’s Tankan survey is
expected to show that corporate Japan is a bit less optimistic on balance. The
sales tax increase is have a greater and longer impact than the government had
expected, and recently the government has downgraded its assessment. It is little wonder that businesses do also
downgrade their assessment. We suggest
the focus of the policy response will be on a supplemental budget rather than
the expanding the BOJ’s asset purchase program.
We anticipate the the yen’s recent sharp decline will boost inflation in
the coming period.
via Zero Hedge http://ift.tt/YxfOgR Marc To Market