Draghi forceful; market response predictably erratic

European Central Bank President Mario Draghi was very honest that current extensive measures were not an overnight Eurozone growth panacea. And that explains a lot about seemingly erratic market responses which were in fact wholly predictable.

There is quite a lot to be said for the creative structure of the latest ECB stimulus program. Given the major differences of its multinational composition compared with other major central banks, this was a requirement. In the first instance there is no single national government bond market, and in any event major purchases of those bonds would fly in the face of the rightful Teutonic proscription on ‘monetary financing’ of government debt. And in the second case, the problem is not with rates that are generally too high, but rather with encouraging lending to the corporate sector; especially in the still weak economies on the periphery of the Euro-zone.

And in that regard the various policies initiated today appear to be quite useful in addressing the specific issues that continue to restrain the Euro-zone economy. While it was only hinted at previous, there are direct incentives in a couple of the key initiatives that may well encourage the activity the ECB wants to see. And yet, Signore Draghi was very honest in allowing that efforts of this type take some time to have an impact. In response to a key question on economic developments from the measures instituted today, he allowed it might take three or four quarters. That additional bit of candor explains a lot about the actual market response in various asset classes.

The requirements for development of the ABS (Asset Backed Securities) market that the ECB is encouraging seemed pretty sensible. In the context of the ECB's limited ability to buy government bonds, the lack of a more extensive ABS market in Europe is a real impediment to the ECB's efforts to stimulate more corporate lending. However, the last thing they want is a pre-crisis free-for-all that saw the development of highly exotic, hard to value securities.

As President Draghi noted during the Q&A, there are three primary requirements for any Asset Backed Securities developed in the Euro-zone. They must be simple (no CDO’s or other exotic animals), real (as in based on actual loans), and transparent, so that the true nature of the underlying instruments will be very clear to investors, traders and the ECB.

And the new TLTRO ("Targeted" Long Term Refinancing Operation) program also makes sense. Those loans will be low-cost and have a longer-term (four years) than the original LTRO program. Use of the funds must obviously also avoid the sovereign bonds that the ECB and others feel are already over weighted in various banks’ balance sheets at present, as well as not providing financing to any sectors that are deemed possibly to either be in, or just coming out of, an asset valuation bubble.

The main thrust is as he stated in the press conference. The ECB has wanted to find a way to encourage more legitimate lending to the corporate sector on the periphery of Europe for some time now. It has had a major focus on the divergence in economic activity and lending rates between core and peripheral Europe.

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