Take two

"Proviamo questo nuovo, eh?"  Macro Man can only assume that thought will be the first thing that pops into Mario Draghi's head when he wakes up this morning.  Having made a hash of their previous easing in December, given recent developments the ECB will no doubt be keen to get back on the front foot.  Putting aside the ongoing issues with the banking system, on a more prosaic basis CPI has dipped back below zero (from 0.1% at the time of the December meeting.)  While we can have our debates about tilting at windmills and the impotence of isolated monetary authorities to combat secular disinflation, from the ECB's perspective this unwelcome development deserves and demands action.

So what are the options?  Let's examine a few in turn.

*Deposit rate cut.  The easiest and most obvious option, and also one that was apparently confirmed by recent "sources" stories.  There is a very legitimate concern that in many ways deposit rates do more harm than good at these levels, for reasons that Macro Man discussed in the posts linked above.  Nevertheless, why let empiricism get in the way of a good model, so a depo rate cut is almost certainly forthcoming.  As far as Macro Man can make out, markets are priced for roughly 12.5 bps of depo cut (judging by the spread between spot EONIA and 1m1m); that's somewhat less than the 16 bps priced just before the December meeting.  Still, a cut of 0.10% will be seen as a disappointment (unless you own Eurozone bank shares.)

* Increase in Asset Purchase Program size.  Adjusting the APP is the obvious next port of call for the ECB.   It's somewhat difficult to quantify how much is in the price, but the very minimum quantum of increase to register would be EUR 10 billion per month, and even that would probably be seen as a disappointment.  Still, it's probably the most likely outcome, at least for government bond purchases.

* Increase in APP maturity.   Another six months seems like an easy call here.   They may try to extend further to get ahead of the market; one thing they could do that would surprise might be to introduce an Evans rule-type threshold, i.e. asset purchases will continue until CPI is 1.9% (given that the target is "close to, but under 2%" and the Germans would never countenance further easing with inflation above target.)

* Broaden assets being purchased.  When asked about a potential broadening of the assets to fall under the APP's remit, Draghi has been remarkably coy, refusing to rule anything out.   It seems ludicrous to think that they would buy equities, and frankly Macro Man cannot see it without a number of intermediate steps in between.   High-quality corporate bonds would be an obvious avenue to explore, though ultimately that would just channel more credit to those that can already access it.  Hoping for the portfolio balance channel to work would seem a little optimistic from where Macro Man sits.   Really, the best thing that they could do on this front would be to mitigate the negative impact of NIRP on the banking system, perhaps by purchasing bank debt (especially Cocos!)  It's hard to see it happening, but if they did manage to help banks it would be seen as a huge positive.  Generally, however, high quality corporates would appear to be the most likely outcome, and one that is probably halfway in the price already.

* Allowing larger purchases of bonds currently in the portfolio.  The ECB currently faces some difficulties in executing its program, insofar as there are limits on percentage of each individual bond that the ECB can hold.   Moreover, the  ECB cannot currently purchase bonds with yields below the deposit rate.  It certainly looks like something along these lines is being priced; the margin of Schatz yields below the depo rate is the largest since the ECB's ill-fated tightening campaign of 2011.   Moreover, even Bobl yields are trading on a par with spot EONIA, below the current deposit rate.

* Another LTRO.   Sure, why not?  It's worked in the past, right?   On the other hand, excess liquidity in the Eurosystem is more than ample at EUR 691 billion, and peripheral spreads are no longer a problem and probably aren't getting any tighter.

It's not like EONIA is exactly mispriced against the depo rate, either.

So in many ways, it's difficult to see what the point of another LTRO might be.   Why would banks borrow more cash when their primary options for it are negative carry from the deposit facility or negative carry from government bonds?

Of course, the ECB could be cute and dangle a carrot or two.   Preferential borrowing rates can be offered for banks that demonstrate loan growth beyond a certain threshold, thus offering them the prospect of positive carry.   Of course, with both the regulators and the market telling these same banks to de-lever, it's hard to see how such an enticement will have much of an impact.   Just look at the BOE's Funding for Lending scheme, which was an abject failure.

Still, old horses like to drink from the same well, so an LTRO could well be in the offing.  It's hard to see why the market should shed tears if one is not, however.

* Tiered deposit rates.  With excess liquidity rising inexorably thanks to the APP, the ECB could well introduce a tiered deposit rate system.  This could be something fairly innocuous, like the Japanese system whereby only marginal increases in the deposit facility would be impacted by the (more) punitive depo rate, or something sexy like tying the level of loan growth to the level of the deposit rate.  Macro Man even heard one suggestion that the ECB should allow some multiple of any new LTRO takeup to be deposited at the ECB at zero rates.   While this would certainly help the banks and encourage a bigger LTRO take up, it may be a little too radical and/or complicated.  While tiering may not be a base case option, it remains a possibility.  Market reaction may be dictated by whether it helps or hurts the banking system.

* Helicopter money.  In such a program, Eurozone banks would credit each account by say EUR2000 and create an offsetting asset that could then be sold to the ECB for the same amount.  Voila! Everyone's richer!   Macro Man would ordinarily say that the chances of this are as remote as some relegation fodder 2500/1 outsider winning a major football league, but on recent evidence they're much more remote than that.  

Obviously, the more of the above boxes get ticked, the happier the market will be.   While it seems clear that the market expects at least a few of these options to be employed today, unlike in December Macro Man does not have a sense of foreboding that that street is all one way.   Having been burned so badly three months ago, how could it be?  While it's true that EUR/USD has sagged recently, the magnitude of the move is nothing like that preceding December's meeting...and there's even been a squeeze the last few days.

While the IMM is hardly the end all and be all of EUR positioning, given how the whippy market has turned lots of punters into momentum traders it's probably not a bad proxy at the moment.  The message there is pretty healthy, actually....the EUR short was recently smaller than at any point last year.

On a broad basis, the EUR TWI is closer to its highs than its lows of the last year...unlike in December, when it was near the latter.

Given economic and market developments over the past three months, the current set-up looks more favourable in many ways than it did in December.   Macro Man can't see much of a high quality trade being long rates at these levels, but the currency set-up looks a bit more favourable.  Perhaps shorting both the euro and Schatz/Bobls makes some sense, as to a degree it takes getting the ECB right out of the equation, and the latter seems to have quite a bit more priced than the former.

Macro Man cannot shake the thought, however, that Draghi must look wistfully at countries like New Zealand, where the central bank still has the opportunity to deliver a genuine shock to markets by cutting a positive nominal interest rate.   And just look at the effect it's had...you reckon Mario would accept a similar shellacking of the euro when all is said and done?

 (As aside, Macro Man reckons it's probably time to take a little profit in this one if you've been long for the last 5-6%.)