Update (8:40am ET): Some three hours after it started, the ECB emergency meeting concluded, and the world's largest hedge fund (although it may drop below the Fed once the EUR hits parity with the USD at which point the ECB's AUM will drop below the Fed's), instructed committees to "create a new tool to combat unwarranted jumps in euro-area bond yields" as markets strain at the prospect of the first interest-rate increases in more than a decade.
Well… there is a tool, and it's called QE, but naturally the panicking ECB can't admit it is forced to revert to square one just days after it solemnly vowed that QE is ending, in the process sending European bond yields soaring (and having to hold today's meeting as a result).
“The pandemic has left lasting vulnerabilities in the euro-area economy which are indeed contributing to the uneven transmission of the normalization of our monetary policy across jurisdictions,” the ECB said in a statement.
Following an emergency meeting Wednesday, convened after Italian yields surged to the highest since Europe’s sovereign-debt crisis, Bloomberg reports that the Governing Council also said it will apply flexibility in reinvesting redemptions coming due in its pandemic portfolio, with a view to preserving the functioning of the monetary policy transmission mechanism.
“Based on this assessment, the Governing Council decided that it will apply flexibility in reinvesting redemptions coming due in the PEPP portfolio, with a view to preserving the functioning of the monetary policy transmission mechanism, a precondition for the ECB to be able to deliver on its price stability mandate. In addition, the Governing Council decided to mandate the relevant Eurosystem Committees together with the ECB services to accelerate the completion of the design of a new anti-fragmentation instrument for consideration by the Governing Council.”
This, as Bloomberg's Ven Ram correctly observed, was overly long on words and short on action and has left markets scratching their heads why the ECB held today's meeting if it failed to deliver anything credible.
Needless to say, the market was disappointed with the meeting which only cemented the collapse in ECB credibility: “I see today’s statement as the bare minimum of what could be expected, but also the most realistic outcome,” said Piet Christiansen, chief strategist at Danske Bank. “With ECB tasking the committees they have sent a signal that they have fully committed to ensure the functioning of the monetary policy transmission. However, they have also bought themselves some time. We will likely only hear from the committees at the July or September meeting.”
Sure enough, Italian yields are already paring back their sharp drop, realizing that nothing the ECB can come up with – short of more QE – will help.
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Last week, shortly after the ECB's latest meeting disappointed markets and concluded without a discussion of Europe's growing bond market fragmentation (which is to be expected since QE – the glue that held the Euro area's bond market together – is ending) and which has since sent Italian bond yields soaring above 4%, we joked that "at this rate the ECB would make an emergency rate cut" just hours after announcing an end to QT and guiding to a July rate hike.
At the rate European bonds are imploding, the ECB will make an emergency rate cut by 4pm
— zerohedge (@zerohedge) June 9, 2022
Once again, our "joke" was spot on because on Wednesday morning, just hours before the Fed's first 75bps rate hike sine 1994, and with Italian bonds in freefall, European Central Bank "unexpectedly" announced it would hold an emergency, ad hoc meeting of its rate-setters starting 11am CET in which it would “discuss current market conditions." It wasn't immediately clear if a statement would be published after the confab.
The meeting, which comes less than a week after the rate-setting governing council’s last vote, raised investor expectations that the central bank is preparing to announce a policy instrument to stave-off another debt crisis in the region, which can only come in the form of more QE… which is ironic at a time when the ECB just announced it was phasing out all QE!
Italian government bonds rallied in price following news of the planned meeting, reversing some of the recent sell-off that analysts said brought the country’s borrowing costs towards the “danger zone”. Gilles Moec, chief economist at Axa, an insurer, said the “stakes are high” for the ECB “now that everyone is dusting off their debt sustainability spreadsheets for Italy, they probably need to go up an extra notch”.
Commenting on the move, SocGen's Kit Juckes writes that "the ECB's carefully-communicated strategy was to end asset purchases, then raise rates, starting in small increments and accelerating if needed. That would allow an escape from the current extraordinary policy regime. This strategy is in all sorts of trouble today as the ECB meet to discuss their anti-fragmentation policy and tools."
He added that while "the euro likes the news, because BTPs like it and as peripheral spreads narrow, the euro can bounce." But the need to prepare the ground to defend the Eurozone bond market highlights the ECB's dilemma: "How can you use monetary policy both to target inflation and to target bond market stability? And how can you stave off fragmentation without easing monetary conditions through additional bond purchases? If the stability of the bond market is more important than the ECB's inflation mandate, it can stymie monetary policy normalisation, until there's a fiscal, as opposed to a monetary solution to the euro's Achilles Heel."
Indeed, as we have been joking for months, for the ECB this boils down to a choice between fighting inflation and keeping the Eurozone from disintegrating.
ECB WILL DISCUSS CRISIS STRATEGY AS WELL AS PEPP REINVESTMENTS
Translation: ECB will discuss how to raise rates while boosting QE. Coming to every central bank near you
— zerohedge (@zerohedge) June 15, 2022
The 10-year yield on Italian government bonds fell about 0.2 percentage points in choppy early trading on Wednesday to about 3.87 per cent, according to Tradeweb data. It had risen to almost 4.2% in the previous session from just over 1 per cent at the end of 2021.
'Italeave' risks remain extremely elevated relative to post-crisis history…
Breathing a sigh of relief that the ECB won't let the eurozone implode, the euro reversed some of its losses, rising 0.6% against the dollar to $1.047 early on Wednesday after the ECB statement was reported by newswires. European bank shares also rose on Wednesday. The Euro Stoxx Banks index gained 3.7 per cent with big Italian lenders UniCredit and Intesa Sanpaolo jumping more than 6 per cent.
ECB executive board member Isabel Schnabel indicated in a speech on Tuesday evening that the central bank was getting closer to the point where it would intervene in bond markets, saying “some borrowers have seen significantly larger changes in financing conditions than others since the start of the year”.
She added: “Such changes in financing conditions may constitute an impairment in the transmission of monetary policy that requires close monitoring.”
Schnabel, the ECB executive who oversees its market operations and one of the most influential voices on its board, said the central bank’s commitment to the euro had no limits. “And our track record of stepping in when needed backs up this commitment,” she added.
But wait, this means… more QE at a time when the ECB just vowed… less QE!!??
And while we wait for the dazed and confused ECB to announce its decision which is due any minute, we can't help but agree with Bloomberg which notes that "the risk for markets is that the central bank over-delivers. The sources stories we have seen this morning, plus the comments from Wunsch, suggest that this may end up being something of a damp squib. Italy’s 10-year yield is currently trading just below 4%, and is still 60 bps above Thursday’s pre-decision level. If markets have this right and there’s not much new coming today, then there has to be questions asked about why the meeting is being held at all. An emergency meeting that amounts to little more than re-reading from last week’s press conference would only further damage the central bank’s already creaking credibility. Presuming that the governing council members know this, they also know that they are in a position where over-delivering is the only way to maintain credibility."
We don't know about any of that, we just know that the central bank is trapped, and that any further push to contain inflation will mean the continent's bonds will only accelerate their free fall; alternatively if the ECB – like the BOJ – picks bond market stability, it can kiss its inflation mandate goodbye, as the world reverts to a reality where much higher structural inflation is the norm.