Market commentary: The ECB showdown

On Wednesday, the markets performed relatively well with both Europe and US closing in positive territory, while overnight all the major Asian markets also posted gains ahead of today’s important ECB press conference.

The main topic on the agenda is obviously the game-changer ECB Monetary Policy Meeting started yesterday and scheduled to end today with the usual press conference held by the President and Vice President of the EU Central Bank.

Yesterday, sources from inside the ECB confirmed that the Policy Meeting started with the assessment of an initial QE proposal put forward by Mario Draghi and his executive board. The proposal calls for a FED-like QE approach focused on monthly sizable installments rather than a huge one-off liquidity injection.

The same sources also stated that the proposal intends to push for a sizable balance sheet growth, bringing it back to its 2012’s size of around € 3 trillion. Sources are saying that Draghi is considering a monthly bond purchases of €50 billion starting from next March toward the end of 2016, to be mainly directed towards non-performing government bonds and asset-backed securities instruments.

So far so good, however, most analysts believe that this proposal will still have to go through major discussions today in order to accommodate all parties involved. On one hand there are almost no objections from Council Members on the need of QE and on its potential size, but on the other hand, there still quite a divergence on how to implement this program, and how to structure and manage the risk involved in the whole operation.

The ECB is still juggling between Members that are calling for a full and proportional risk sharing, and Members that are asking the ECB to take up as little real risk as possible. At this stage, the most accredited version sees the ECB passing onto each Member State’s Central Bank the task to purchase and hold the designated securities, and in so doing, shifting back the majority of the risk to each Member State.

This approach would favour the side led by Germany that does not want a full risk sharing and the holding of the purchased securities at ECB level, leading to the stronger states bearing the majority of default risk.

This solution could also leave an open door for EU policy makers to discuss future exits of extremely weak states, an option that was rumoured to be under discussion in the case the anti-austerity party should win the Greek elections next weekend, although the Syriza party has recently muted rumours of their intention to leave the Eurozone should they win this election.

Another crucial point under discussion verts around a potential, and experts believe probable, transfer of wealth from stronger and richer states such as Germany and the Scandinavian States towards weaker and highly inefficient countries such as Greece, Portugal and Italy.

This is a delicate and contentious matter that is seen by many as the major potential driver for citizens of stronger countries to shift their voting preference toward political parties that advocate for an EU breakdown and the return to former national currencies.

In such unclear and still rather fluid environment, with analysts and traders already discounting a big QE announcement as a done deal, but still short of major details, we expect markets to be pretty much flat until the official ECB announcement this afternoon.

In the run up to this much anticipated Policy Meeting, the Euro proved to be rather volatile, spiking after the circulation of the above rumours yesterday afternoon, just to pare gains before the closing of the trading day in US, and gaining again overnight.

With most investors taking in account a further depreciation in the Euro after the ECB press conference, it will be interesting to see how much of the expected QE’s effect is already priced in the 17% drop experienced by the Euro over the last 8-9 months.

This article was issued by Paolo Zonno Trader/Analyst at Calamatta Cuschieri. For more information visit, www.cc.com.mt . The information, view and opinions provided in this article is being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice. Calamatta Cuschieri & Co. Ltd has not verified and consequently neither warrants the accuracy nor the veracity of any information, views or opinions appearing on this website.

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