In our concluding comments on the ECB's disjointed message yesterday, in which Draghi feebly tried to talk down the EUR while talking up the European economy, and also hinting at the start of policy normalization but without actually doing so, in the process sending the EUR shooting higher, we said "And now that the market is supremely confused, we expect the ECB to lob the next Reuters trial balloon any moment to punish all those who keep buying the EUR."
Less than one day later, this is precisely what happened because just before 5am ET on Friday, the ECB's "sources" struck again through, guess whom Reuters which reported that contrary to Draghi's responses during yesterday's Q&A, the European central bank had discussed four QE scenarios in detail and agreed that the next step is to cut stimulus, to wit:
- ECB POLICY-MAKERS DISCUSSED 4 QE SCENARIOS ON THURSDAY AGREED NEXT STEP IS TO CUT STIMULUS & SHOULD BE DONE WITH BROADEST POSSIBLE CONSENSUS
- ECB QE OPTIONS INCLUDED BUYS AT 40 BILLION EUROS OR 20 BILLION A MONTH; EXTENSION OPTIONS INCLUDE 6 MONTHS OR 9 MONTHS - SOURCES
Ironically, however, the Reuters "post-script" ended up confirming what the EUR bulls knew all too well: the ECB has no choice but to taper QE, and soon, in the process pushing the EUR even higher.
As the ECB's favorite FX trading news service Reuters details further, "ECB policymakers meeting on Thursday were in broad agreement that their next step will be reducing their bond purchases and discussed four options, two sources with direct knowledge of the discussion said. Possibilities discussed by the ECB included - but are not limited to - cutting assets buys to 40 billion euros a month or 20 billion euros, with extension options including 6 months or 9 months."
Per the details, the ECB is merely trying to apply the Fed's own normalization template to its gargantuan balance sheet:
Although the scenarios included specific monthly volumes and extensions, much of the focus of the discussion was on the overall amount of the purchases. This includes the reinvestment of proceeds from maturing bonds, which will slowly rise towards 15 billion euros per month next year, the sources said.
Policymakers also agreed that interest rates will not be raised before the asset buys end, the sources said, indicating by default that any extension of the program would also push out the first rate hike.
Why wait one whole day before unveiling this addendum to Draghi's press conference? It appears the ECB wanted to see which way the market will turn and how Mario's words would be digested by the market. Furthermore, the ECB hopes to telegraph a "broad consensus", which ironically needs a pre-release from a wire service to gauge investor sentiment.
Worried about the euro’s strength, the bank stayed pat on Thursday, honing in on October for the key decision after more than 2 trillion of euros worth of asset buys.
The cautious approach raises the chances that the ECB will opt to phase out quantitative easing, designed to boost growth and inflation, only very slowly next year, despite solid economic growth in the euro zone and worries about real estate bubbles in richer countries such as Germany.
Furthermore, as Draghi hinted during the press conference, Reuters "sources" added that the so-called issuer limit, which caps any ECB buying to a third of a country’s outstanding debt, is not up for discussion because it would open the program, already under review by the European Court of Justice, for a legal challenge.
But maintaining the cap and the program’s other self-imposed constraints would limit the purchases as the ECB is already approaching its limit in several countries - notably Germany, the euro zone’s biggest economy and the ECB’s top critic.
And while all of the above was largely expected, if not at all mentioned by Draghi , who was too scared to discuss it during yesterday's announcement, purchases what is most notably was the ECB's confirmation that if QE purchases are left unchanged, "Germany could hit the limit in the first half of 2018." At least it's good to know that simple math still works at the ECB.
Finally, in terms of market response, judging by the EURUSD, which moved up all of 20 pips on the "news", the ECB should have just avoided this latest PR fiasco. The reaction was more notable among Bunds, where futures fell, reversing their earlier advance as German debt had opened higher, tracking gains in Treasuries.