European Woes, but Euro Recovery

ECB’s Stark comments are more important today that increased speculation of a downgrade in Ireland and Spain. In an unusually revealing comment, the ECB’s Stark indicated that a number of the unconventional liquidity measures that are due to expire at the end of the year will in fact do so. This is unusual because it because such policy announcements are more commonly made by ECB President Trichet. It is also unusual in the sense too that it seems to pre-commit to a change in policy. Moreover, Stark’s comment seems to be largely based on one month’s numbers—August money supply and private lending figures.

Stark’s announcement comes on the heels of press reports suggesting that the long-term assets purchases that the consensus expects the Fed to announce as early as Nov may be smaller than the $500 bln-$1 trillion dollar program that many have envisioned. Some cited this as a factor behind the dollar recovery yesterday and today. However, a more incremental approach was anticipated to maximize the Fed’s flexibility so a “QEII-light” is not really new news.

With interest rates in the US already very low and mortgage rates very low, and with around $1 trillion in excess reserves, there has always been a question of the effectiveness of a QEII. A light version adds fodder to those arguments. Remember too that in recycling its mortgage proceeds, the Fed’s balance sheet may remain the same size, but may still support Treasury prices as they are projected to buy around $400 bln by the end of next year.

Meanwhile, Japan is taking the lead in the next round of government assistance. As noted yesterday, a supplemental budget is in the works and there is increasing speculation that the BOJ will take additional steps at its Oct 4-5 policy meeting. Most speculation has focused on increasing the fixed rate loan period to 6 months from 3 and increasing the rinban operations (JGB purchases).

There are heightened fears of rate action in Spain and Ireland today. Spanish bonds matching German bunds today, but a local paper is warning that Moody’s may cut Spain’s rating after tomorrow’s general strike. This is not as ominous as it may sound. For some inexplicable reason, Moody’s still has Spain rated AAA and we have expected them to cut it. Ireland is more problematic. Moody’s cut Anglo-Irish Bank’s unguaranteed senior debt three notches yesterday.

The Irish government is desperate to find closure here and tomorrow it is expected to unveil its latest estimate on the cost of supporting Anglo-Irish Bank. S&P says that cost may be in excess of 35 bln euros (~20% of GDP). The government’s most recent estimate is 22 bln euros. Splitting the difference would be around 29 bln euros, which is about what the Irish government has spent already on the banks. Also tomorrow, the Irish parliament needs to extend the Eligible Liabilities Guarantee program that is subject to review every six months and is currently set to expire at the end of the year.

Meanwhile there are reports that the government is squeezing current Anglo-Irish bond holders. The government appears to be seeking to buy back senior debt at a discount or offering to swap for equity in the new asset recovery bank being created out of parts of Anglo-Irish. There are also reports that it is offering the holders of subordinated debt holders (~2.4 bln euros) deep haircuts of as much as 90%.
European Woes, but Euro Recovery European Woes, but Euro Recovery Reviewed by Marc Chandler on September 28, 2010 Rating: 5
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