Markets are loving the new plan ECB president Mario Draghi laid out to rescue the eurozone yesterday.Nomura economists – not so much. A team led by Jacques Cailloux is out with one of the most bearish notes we’ve seen on the ECB and its plan since it was hinted at by Draghi back in July.
Under their “best case” scenario, the economists say the ECB will only be able to buy three more months of calm before markets really start unravelling again at year-end – and that’s only if the central bank really nails the implementation of its new rescue program.
Hence the title of the note, Policy response to buy 3 months at best—But countries likely to test market patience.
The big catch-22 Nomura is focused on is that as long as markets are heading higher, Spain and Italy will be less likely to request bailouts due to disappearing market pressures on government funding costs and the stigma of seeking financial assistance.
From the note:
We see no imminent intervention in either Spain or Italy (a change in view relative to last month). Indeed, improving market conditions should reduce the incentive for both Italy and Spain to call for help in the short term as they will try to exploit the threat of intervention to avoid falling into the “bailed out” camp. We believe that they will lose that game as we do not believe that markets have moved into a self-stabilising equilibrium.
The Nomura team then lays out the timeline for how events will likely play out through the end of the year:
We see the following timeline from here: we expect markets to wait until September 14th to see how imminent a deal with Spain is. Our baseline is that markets will be disappointed with no official call made at that time. From there on, market pressure on Spain is likely to build although the “intervention threat” might initially dampen some of the selling pressure. Tough negotiations around the conditionality are likely to destabilise markets further, eventually pushing Spain to call for help before the end of October, in our view.
So, once Spain requests a bailout following another deterioration in European markets, the ECB will step in with its new bond-buying plan and aim to keep sovereign bond yields down, which Nomura thinks could work for approximately three months before everything heads south.
This renewed period of calm could last for about three months in our view. Indeed, with little sign of economic and asset price stabilisation, markets are likely to continue questioning the viability of the banking rescue and thus the stability of the financial sector and the scale of the financial resources needed…Simply put it looks highly unlikely that the current programme can engineer an easing in financial conditions in Spain that would be sufficiently large to turn financial conditions accommodative in that economy.
That sums up what happens with Spain through the end of the year in Nomura’s view.
However, the real problem, the Nomura economists say, is what is transpiring in Italian markets right now, and how conditions could really devolve there over the next few months.
In the meantime, questions will arise around Italy. Here again, we believe that markets have only improved because they have priced in a very high probability of intervention in the Italian bond market. With heavy issuance ahead and no clear sign of a call for help, market conditions could deteriorate faster there than in Spain where the inevitability of the bailout is much clearer. The current backstop set up remains highly risky in the context of Italy given the very large funding needs of that sovereign in the next three years (around Eur550bn, ex banks). With the ECB having terminated the SMP, the only mechanism left is the under resourced, but senior ESM. This remains the biggest threat to the stability of the system, in our view. Event risks around Italy are disappointments around the economy, political risk and rising NPLs in the banking sector.
Nomura sums it up by opining that “Unfortunately, there is no longer any free lunch for those sovereigns that have abused of the ECB‟s goodwill in the past,” and that “in that context, one can easily understand Weidmann’s legitimate worry about the long term implications of the ECB becoming the institution that will decide on the fate of banks, sovereigns, governments and the monetary union itself.”
OTHER REACTIONS TO THE ECB’S NEW BOND-BUYING PLAN:
- CITI: How The ECB’s New Rescue Plan Could Go All Wrong >
- JP MORGAN: The ECB’s New Plan Will Change The Course Of The Euro Crisis >
- GOLDMAN: Spain Will Formally Request A Bailout Next Weekend >
- BofA: More Bad Than Good Came Out Of The Big ECB Announcement >
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