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Comments made by ECB President Mario Draghi at his August 2 press conference have given European markets a major lift, while reducing borrowing costs in Spain and Italy.It took a while for the market to come to a conclusion on what Draghi’s message was, but by the following day, the gist was basically this: If countries in Europe make a commitment to reform, the ECB will commit to reducing borrowing costs.
For the first time, the ECB hinted it would use its unlimited balance sheet to intervene in a meaningful way to stem the crisis.
Bank of America FX strategist Athanasios Vamvakidis is out with a new note titled Wishful Thinking Supports EUR.
He argues that investors are over-optimistic about what the ECB will do to protect the euro, and that they’re projecting their wishes and wants onto Mario Draghi, while not listening to what he actually said, which in Vamvakidis’ view is not very much.
In Vamvakidis’ view, here’s what Draghi said at his August 2 press conference:
- ECB interventions will be conditional on countries making requests for EFSF/ESM help. Furthermore, the ECB intervention is not unlimited.
- The ECB still does not know how it’s going to deal with the matter of ECB bond holdings being senior to private creditors.
- The ECB will not give a banking licence to the ESM.
Then according to Vamvakidis, this is what the markets heard:
- The ECB will give up its seniority.
- Countries will come in with unlimited firepower.
- This big aid offer will encourage Spain and Italy to ask for aid.
So there’s a big gap in what Draghi said and what the reality is.
Furthermore, he writes:
— The ECB’s commitment to save the euro does not set the bar very high. First, it has always been implicit. Second, between addressing the crisis and a breakup of the eurozone there is a large range of outcomes, for which there is no commitment on what the ECB will do.
— The ECB has committed not to “blink” first by intervening when sovereign yields rise to levels that threaten macroeconomic stability. If this framework was in place earlier, the ECB would have not intervened in the periphery. Although such interventions turned out to have a temporary impact, this impact was positive, buying time and supporting the euro. Moreover, expecting such interventions was providing an implicit backstop – markets were considering 10-year sovereign yields of around 7.5% as a level close to which the ECB would intervene.
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