Draghi Passing Torch to Bernanke

Keeping that stimulus Torch Alight
The US economy has not escaped the threat of a double dip. It happened to the housing sector and it could well occur to overall growth as seen from the latest personal consumption expenditure figure. US Q2 GDP slowed to 1.5% from 2.0%–lowest since Q3, while personal consumption expenditure slowed to 1.5% from 2.4%, the lowest since Q2 of last year.

5-year LTRO?
Already hearing from two well placed sources that the ECB’s next LTRO could be as long as 5 years at a refi rate of 0.50% (following another 25-bp cut in official rates). Such would be a prominent example of the ECB’s shock-&-awe in delivering the next blow to sovereign bond yields. This would be consistent with Draghi’s comments on delivering upon his promise to stabilize risk premia. The ECB may be known for doing things it says it will NOT do (such as buying bonds in 2010), but is NOT known for refraining from things it says will do (always delivered on signaling rate changes, & long term LTROs).

ECB’s Carry Trade Strategy
By lowering the refi rate to 0.75% from 1.00% and allowing Spanish yields to hit a fresh record earlier this week, the ECB is allowing further expansion of the wider carry differential for the commercial to exploit at the next LTRO. This way, commercial banks can tap in ECB’s 3- year money at 0.75% or 0.50%, while gaining +7.0% yields on Spain and Italy. This improves banks’ incentive to participate in the latest bank scheme.

And with €440bn in the EFSF/ESM well below the + €800bn needed in firewalls to stem a collapse of confidence in Italy and German sovereign debt, the ECB are starting to make up for the void by triggering verbal shock awe (expressions of desperation) asking the market to “take their word for it”. Such remarks aim at keeping markets afloat ahead of the summer vacation of EU leaders. This would likely be followed by similar expressions of confidence in Jackson Hole in late August, until a 4-5 year LTRO and actual QE3 are unveiled by late QE3.

ECB Carrot & Greek Sticks
While Draghi served the carrot in the way of promising a powerful firewall for the Eurozone’s ailing debt markets, Greek politicians may deliver in the way of “the stick” by agreeing on €11.7 bn in spending cuts in order to receive the next bailout tranche of €29 bn. An agreement in Athens would amplify the latest EUR/USD move towards our projected EUR/USD “bounce” target of 1.2380, followed by 1.2470 – 55-day moving average – a technical level not broken since May. Weekly and monthly stochastics remain negative across the board, which suggests that any rallies are seen underpinned below 1.25.

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