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• Large holdings could result in large losses and recapitalising the ECB could increase political influence and threaten ECB independence. In any case, the ECB would be more politicised by the move; and • Once you’ve started this, where do you stop? How to do it Should the ECB opt to embark on some forms of quantitative easing, an important issue would be the purchase allocation in terms of maturity and across countries. Should it be short or long-term debt? One constraint for the ECB would be to minimize possible distortion which suggests buying across the whole curve. That said, two considerations suggest short-term debt might be preferable. First, it would help ease immediate funding pressures reducing therefore the liquidity risk for many issuers. Moreover, it would facilitate the ‘exit strategy’, a consideration that the ECB gave priority to when designing the liquidity injections. Short-term debt would not need to be sold back to the market but it could simply be held until expiration. The allocation by country would pose another significant challenge. A pro-rata allocation (either linked to GDP or to contributions to ECB capital) would help communication. It would be easy in this case to sell the decision as a purely monetary policy action, motivated for example by increasing risks of deflation rather than an attempt to bail out this or that country. On the other hand, it would dramatically increase the size of total purchases needed in order to make a material difference for the countries which are currently under pressure. The alternative would be to focus on the sovereign debt of those countries under most stress, justifying the choice with the ‘cheap’ price they offer under the assumption that no country within the eurozone will ever be allowed to default. An obvious drawback would be the implied ‘moral hazard’ not to mention the inconsistency with the ‘no-bailout’ clause of the EU Treaty. Of course, all these relate to long-term problems that could result from short-term event-driven actions intended with the best will in the world to avoid problems today. We see an increasing risk that the ECB does end up buying government debt, but we would expect it to try to enhance liquidity first so that it is private banks not the ECB that buy government debt. The trouble with such an approach is that many banks already feel themselves to be overexposed to risky governments. Increasing liquidity might not work. The chances of outright ECB purchases are increasing. They would support markets directly, help to put a floor under bond prices and increase money market liquidity at the same time. We can envisage circumstances where they look like the least worst option. The risk is, as so often in this crisis, too little, too late. Macro picture Macroeconomic developments are obviously playing second fiddle at present when it comes to listening to what the ECB has to say. The assessment at this month’s press conference was broadly similar to its predecessor which was no surprise. There were a few changes, however, which merit comment. One was a reference to near-term risks to inflation being “somewhat tilted to the upside”. The upside risks relate specifically to external factors, however, including higher oil prices and strong growth in other parts of the world. The medium-term assessment of inflation was as before, i.e. pressures are low. The key to this is that domestic wage and cost pressures remain contained. The differentiation between the internal and external influences on inflation we see as significant. It tells us that the ECB will look through upward pressure on inflation generated by factors beyond their control and focus instead on domestic pressures which are going to remain subdued. The tone of Mr Trichet’s comments on growth was a bit more positive than previously. Specifically, there was a reference to the “strengthening” of the upturn in activity during the spring. But in bigger picture terms, the outlook was much as before. Growth rates will remain moderate and the recovery uneven. More flexibility A new phrase was also slipped into the statement: "Monetary policy will do all that is necessary to maintain price stability in the euro area over the medium term." We see this as a way of giving the ECB more room for manoeuvre should they need it in future - in both directions. This is just the kind of phrase which could be used in future should the ECB opt for the 'nuclear option' of buying government bonds. Such action would then be linked explicitly to the downside risks to price stability. Alternatively it could be deployed should, perish the thought, a surge in inflation and upward pressure on inflation expectations necessitate a rate hike despite economic and financial stress a la summer 2008. The latter we continue to believe is a much lower probability than the former. Paul Mortimer-Lee/Ken Wattret 7 May 2010 Market Mover 6 www.GlobalMarkets.bnpparibas.com
Eurozone Periphery: Compare and Contrast • The Greek crisis is spreading to other socalled peripheral countries. Chart 1: 10yr Spreads to Bund • It is important to highlight significant differences between these economies. • These include differences in the size of deficits & debts, liquidity risks, contingent liabilities, fiscal credibility and social tolerance. • But we should also recognise that there are similarities which make them vulnerable to further market tensions. • Portugal shares Greece’s low saving ratio. • Spain’s problem is an excess of private debt with possible fallout on the financial sector. • Ireland’s fiscal reform to date has been impressive but sovereign risk is tied up with the banking system, making the recent widening of spreads a reason for concern. • Italy’s imbalances are less worrying than in other economies, but its high debt-to-GDP ratio makes it vulnerable to an interest rate shock. Source: Reuters EcoWin Pro 18 16 14 12 10 8 Chart 2: Age-Related Expenditure (Change 2010-2060, % of GDP) 6 4 The agreement of eurozone finance ministers over the weekend to provide EUR 110bn worth of financial support to Greece has failed in its objective of calming markets and preventing risk aversion from increasing. The crisis is now spreading to other socalled peripheral countries. Portugal is leading the way but sovereign spreads have significantly widened in Spain, Ireland and Italy, highlighting the risks of an indiscriminate contagion effect. From a macro perspective, it is important to highlight that these economies are heterogeneous and differ significantly from Greece. At the same time, they share a number of structural weaknesses and imbalances which, in the absence of a prompt and decisive response from the eurozone authorities, make them vulnerable to further market tensions. Greece versus other peripherals Greece’ situation differs significantly from that of other peripheral countries on a number of counts: • First, the level of the public deficit and debt. At 13.6% of GDP in 2009, the Greek public deficit was second only to Ireland’s (14.3% of GDP). Greek public debt as a share of GDP (115.1%) is similar to Italy’s (115.8%) but significantly higher 2 0 Belgium Germany Ireland Greece Spain France Source: EU Commission Italy Cyprus Malta Netherlands than those of Portugal (76.8%) and Spain (53.2%). Ireland’s debt-to-GDP ratio can be relatively low (64%) or high (around 100%) depending on whether you choose to include all its interventions in the banking sector; • Second, liquidity risk. Greek redemptions this year are relatively high this year, about twice those of Spain and Portugal in relation to GDP. Moreover, Greece’s refunding tends to be heavily concentrated during certain months of the year – increasing rollover risk; • Third, contingent liabilities. In the absence of a reform of the pension system, age-related spending would increase by a massive 16% of GDP in Greece between 2010 and 2060 according to EU Commission estimates (Chart 2). This is about double the estimates for Spain (8.3% of GDP) and much higher than the anticipated rises in Portugal and Italy, where past reforms should bear fruit over the following years; Austria Portugal Slovenia Slovakia Finland UK Eurozone Luigi Speranza / Eoin O’Callaghan 7 May 2010 Market Mover 7 www.GlobalMarkets.bnpparibas.com
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Page 3 and 4: UK: all eyes on the election US: re
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Page 11 and 12: Market Stress Charts • Signs of s
Page 13 and 14: Chart 7: Greek Bank CDS* 900 Greece
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Page 29 and 30: BNP Paribas Surprise Indicator •
Page 31 and 32: UK headline After surprising to the
Page 33 and 34: US: Supply Could Affect Swap Spread
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Page 37 and 38: decline. We continue to maintain ou
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Page 41 and 42: the gamma sector for some time now.
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Page 49 and 50: Table 1: BNP Paribas' Inflation For
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Page 53 and 54: Table 1: BNP Paribas Carry Analysis
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Update on FIN SEN and FIN SUB 5/10y
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Germany 10y: Within MT falling wedg
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Judging Currencies by Liquidity •
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type of regulation would reduce mon
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Euro Dives • The euro is collapsi
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Currency Spot Trade Recommendations
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Economic Calendar: 7 - 14 May (cont
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Key Data Preview Chart 1: US Payrol
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Key Data Preview Chart 5: UK Manufa
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Key Data Preview Chart 9: French GD
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Key Data Preview Chart 13: US Indus
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Treasury and SAS Issuance Calendar
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Central Bank Watch Interest Rate EU
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FX Forecasts* USD Bloc Q2 '10 Q3 '1
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RESEARCH DISCLAIMERS: IMPORTANT DIS
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