Busch: The Bazooka Shot Heard Around the World
Twenty-seven European nations and the IMF agreed to a mammoth E750 billion planto stabilize the financial markets.
Sixteen Euro area governments were joined by 11 European Union governments in meetings over the weekend to create the plan and commit to E440 billion. The European Union budget is going to contribute E60 billion. The IMF is going to contribute E250 billion. The UK abstained from contributing to the plan.
The European Central Bank is participating by agreeing to provide Euro liquidity and US dollar liquidity.
Here are the four measuresthey’ve agreed to do to address the tensions in the financial markets:
1. To conduct interventions in the euro area public and private debt securities markets (Securities Markets Programme) to ensure depth and liquidity in those market segments which are dysfunctional. The objective of this programme is to address the malfunctioning of securities markets and restore an appropriate monetary policy transmission mechanism. The scope of the interventions will be determined by the Governing Council. In making this decision we have taken note of the statement of the euro area governments that they “will take all measures needed to meet [their] fiscal targets this year and the years ahead in line with excessive deficit procedures” and of the precise additional commitments taken by some euro area governments to accelerate fiscal consolidation and ensure the sustainability of their public finances. In order to sterilize the impact of the above interventions, specific operations will be conducted to re-absorb the liquidity injected through the Securities Markets Programme. This will ensure that the monetary policy stance will not be affected.
2. To adopt a fixed-rate tender procedure with full allotment in the regular 3-month longer-term refinancing operations (LTROs) to be allotted on 26 May and on 30 June 2010.
3. To conduct a 6-month LTRO with full allotment on 12 May 2010, at a rate which will be fixed at the average minimum bid rate of the main refinancing operations (MROs) over the life of this operation.
4. To reactivate, in coordination with other central banks, the temporary liquidity swap lines with the Federal Reserve, and resume US dollar liquidity-providing operations at terms of 7 and 84 days. These operations will take the form of repurchase operations against ECB-eligible collateral and will be carried out as fixed rate tenders with full allotment. The first operation will be carried out on 11 May 2010.
Translation: the ECB is going to increase liquidity for Euros and for US dollars to calm down markets and reduce interest rates in the LIBOR markets. The Nuclear option on buying government bonds is put into place, but will be sterilized to minimize longer term inflation risks. It’s clear by this that the ECB doesn’t like doing this but will be active. Today, the Bundesbank, the Bank de France, and the Bank of Italy all bought sovereign debt to begin the process of lowering interest rates for European countries.
Stating the obvious, this is the European Bazooka and it is having the desired affect.
CDS and bond yields for Greece, Portugal, Spain, and Italy have all dropped significantly. Equities have rallied across the world. The Euro has rallied over 4% on the news. Last week, I kept asking where the ECB is and doing a poor imitation of Jim Cramer’s “They Have No Idea” rant with Jim Cramer on CNBC during the Thursday stock meltdown. I wrote,“Given that the ECB didn’t move today on rates, I believe they could be waiting for this vote to take action in the markets.”
This is exactly what happened.
Here are the salient remaining areas of major concern:
- The Euro area needs to amend/change their structure to enforce their rules of 3% deficit to GDP.
- We need to learn what are the rules/austerity measures for funding from the European stabilization package.
- We need to learn if Greece and Portugal are going to follow these rules.
- We need to learn how the IMF is going to fund their portion of the plan. Last time I checked, I thought they only had $268 billion in the fund.
- We need to learn if this is going to be the defining moment for the European Union in its path towards federalism. Will Germany get veto power?
In the meantime, here’s a point to remember: the passage of TARP didn’t stop the markets from declining. It was only after it was implemented and the US Federal Reserve engaged in quantitative easing did the markets finally stabilize. Fortunately, the starting point in the global economy today is vastly better than it was in 2007.
This should mean that the European debt package and ECB liquidity provision will have a better chance to stabilize the crisis sooner than the 6 months it took from September 2008 to the trough in March of 2009.
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Andrew B. BuschDirector, Global Currency and Public Policy Strategist at BMO Capital Markets, a recognized expert on the world financial markets and how these markets are impacted by political events, and a frequent CNBC contributor. You can comment on his piece and reach him hereand you can follow him on Twitter at http://twitter.com/abusch.