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Will ECB Follow the Tactics of SNB?

Last updated 11/14/2011 3:08 AM ET (GMT -5) 2 Comments

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Boris Schlossberg

Director of Currency Research, GFT

With new technocratic governments taking the reigns of leadership in both Italy and Greece the EUR/USD was higher at the start of week’s trade as markets speculated that both Mr. Papandremous and Mr. Monti would begin to institute proper budgetary reforms to pacify the credit markets. However, any type of fiscal reforms are likely to take some time to put in place and may face very stiff opposition from populations that are already suffering from serious economic hardship.  That’s why many market analysts believe that the ECB is the only institution in Europe that can stabilize  region's credit markets in the short term.

The latest idea in the market is that the ECB would announce explicit ceilings on peripheral debt yields (say 200bp premium for Italian BTPs to German bunds) that would effectively put an end to further deterioration in credit prices allowing the governments of those countries to refinance their debt at reasonable rates for the foreseeable future.  Having seen the recent success of the SNB at keeping the exchange rate of the EUR/CHF  above the 1.2000 mark  for more than two months, many market analysts believe that similarly explicit intervention tactics by the ECB  would put an end to the daily short selling assaults on EZ periphery bonds.

It is clear from the Swiss experience that monetary authorities achieve much greater respect from  the markets and produce much more efficacious  results  when they communicate specific target levels rather than simply providing ad-hoc support. Few speculators are willing to challenge the unlimited buying power of the central banks, and the mere threat of such endless liquidity would  prevent the market from testing the resolve of the authorities especially since short positions in peripheral debt bonds carry a stiff daily penalty of negative interest costs and are predicated on the quick collapse in values of the instruments.

Unlike Greece which is in need of true structural reform,  the crisis in Italian bond market is more of a crisis of confidence rather than fundamentals. The Italian fiscal budget picture is much more sound then that of Greece with only a minor deficit this year and if the ECB can break the will of the shorts it can prevent the contagion in the EZ credit market from hitting France.

Will this strategy work? In the short run  the answer is likely to be yes, as few market players will be willing to absorb such a sustained short squeeze.  However, if the EZ core economies fall into a deep recession in 2012,  the fiscal budget dynamics  could deteriorate to such a degree that even the  ECB will not be able to   prop up the market for long. Meanwhile, many analysts believe that this is the best chance for European policymakers to avoid the death of a thousand cuts as they try to stabilize the region’s financial markets.

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Comments (2)

Darkdoji

November 14, 2011 at 03:48 AM ET

The EFSF remains an illusion, Germany will not allow the ECB be what it should be in the situation the EU finds itself and analysts speak of technocratic non-elected leadership in two very poorly countries as if they know what they are talking about. Who is fooling whom? I would stay on the sidelines just now - trusting no one. If the ECB positions to break the logjam - fine, then I would trust risk on any subsequent trip up. If not I suspect the fickle markets will cry to mama sometime midweek and the center will not hold. Meanwhile, no one is talking about the ruse that has become the EFSF which was supposed to underpin the "famous" Euro rescue plan. Yet the truth remains so clear - it is comatose or am I missing something everybody else knows?

bschlossberg

November 14, 2011 at 04:39 AM ET

Agreed. EFSF is a mess which why ECB is the last hope. Staying on sideline not a bad idea until/unless they act

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About The Author

Boris Schlossberg began his Wall Street trading career more than 20 years ago at Drexel Burhnam Lambert. There, he traded nearly every type of financial product on the market in the U.S., from equities and options to stock index futures and foreign exchange. His innate ability to analyze market information and use it to trade has helped him become an industry-recognized, “go to” trading professional.

These days, whenever the markets move, many organizations turn to Schlossberg for his take on the situation. He is a weekly contributor to CNBC's Squawk Box and a regular commentator for Bloomberg radio and television. His daily currency research is widely quoted by Reuters, Dow Jones and Agence France Presse newswires and appears in numerous newspapers worldwide. Schlossberg has written for publications like SFO magazine, Active Trader and Technical Analysis of Stocks and Commodities. He is also the author of Technical Analysis of the Currency Market and the co-author of Millionaire Traders: How Everyday People Are Beating Wall Street at Its Own Game with Kathy Lien. He joined GFT in 2008.