Disclaimer. After nearly 40 years managing money for some of the largest life offices and investment managers in the world, I think I have something to offer. These days I'm retired, and I can't by law give you advice. While I do make mistakes, I try hard to do my analysis thoroughly, and to make sure my data are correct (old habits die hard!) Also, don't ask me why I called it "Volewica". It's too late, now.

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Wednesday, January 25, 2012

Draghi not a drag

The new head of the ECB, Mario Draghi, has moved decisively to short-circuit the debt-refinancing crisis in the euro area.  Unlike Trichet, the previous head, Draghi is an economist, and he clearly understands feedback loops.  The ECB last month lent banks an unprecedented E489 billion (US$ 606 billion) at a low interest rate for three years, and the banks promptly used the funds to buy the national government's government stock.  Yields on 2 year Spanish government paper have fallen 180 basis points (1.8%) to 3.14%; yields on Italian 2 year bonds fell 2.7% to 3.54%.  The impact on 10 year bonds has been smaller, but still material (see chart)
Source: Bloomberg

Since it was high interest rates on the government bonds which were causing government deficits to blow out, this was a decisive circuit breaker, and was seen as such by the markets, with big name borrowers (RaboBank Nederland and Nordea Bank, for example) able to raise E19.5 billion in new senior unsecured debt, which had been impossible before.

There is to be a second bidding for loans at the end of next month, and the ECB will ease the rules on what constitutes acceptable collateral.  This will give another fillip to confidence.  Meanwhile, the negotiations on a sensible debt restructure for Greece are close to completion, with only an argument about precisely what rates the new 30-year paper is to pay.

The good news lies more in the clear signal the ECB has given:  it's prepared to use very unconventional means to prevent the euro and the European economy melting down.  Yes, the pollies are still squabbling like cockies looking for an evening roost.  Yes, longer-term austerity will still be needed as budgets move towards balance.  And yes, the level of debt is still high.  But if the ECB has at last started behaving like a real Central Bank we can realistically hope that a 1930s-type collapse has been averted.

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