Jury out on ECB’s ABS plan

Solomon Teague
Published on:

Market players are hoping Draghi can overcome liquidity and scale challenges in his much-trumpeted ABS purchase plan – seen by some as QE by another name – but if he fails the central bank will have no option but to resort to QE, say analysts.

The market’s reaction to European Central Bank (ECB) president Mario Draghi’s asset-backed securities (ABS) and covered bond (CB) purchase programme announcement last week left little doubt it was seen as something short of full-blown quantitative easing (QE), with audible murmurs of disappointment.

Some argue the plan is QE by another name and will prove equally capable of weakening the euro and jolting the eurozone into growth as full-blown QE.

  If one included ABS mezzanine tranches, the total ABS programme could potentially be
large enough to
achieve Draghi’s
balance-sheet goal

Nick Beecroft

"It is perhaps strange that the market sees the ABS purchase programme as less impressive than a full-scale QE scheme, a la the Federal Reserve, Bank of England and Bank of Japan," concedes Nick Beecroft, senior market analyst at Saxo Bank.

This might have more to do with presentation than the underlying substance of the respective measures, he suggests – an irrational perception that ABS will not create the subjective 'feel-good factor’ with which QE has come to be associated.

Valentin Marinov, head of European G10 FX strategy at Citi, sees it differently. The ECB’s new measures, which combine the ABS and CB purchase programme with negative rates, is "a game-changer that will boost bank exposure to the real economy via loans".

In this, the ECB is a trailblazer. "The ECB is the first major central bank to combine QE with negative deposit rates, so both pumping money into the system and incentivizing spending it," says Marinov. "It is a turbo-charged QE."

The ABS programme might offer distinct advantages over a government bond-purchasing programme, suggesting Draghi might not see it as a compromise, but a more targeted improvement.

"QE is more likely to help the bigger corporations, but by clearing banks’ credit channels the ABS programme is more likely to help the SMEs [small and medium-sized enterprises], which should in turn be more beneficial for growth," says Jose Wynne, head of FX research at Barclays.

More favourable

It is understandable that the market was hoping for a QE programme that looked more like the Fed one, says Citi’s Marinov, but he predicts the market will come to view the ECB’s measures more favourably than it did at first glance.

"It was the same with the LTRO [long-term refinancing operation] announcement in 2011 – the market response was delayed because it took a while to digest the implications," says Marinov. "There wasn’t a big immediate response to the outright monetary transactions either, or the negative deposit rates announced in June this year.

"But in retrospect it is clear that banks responded positively to those measures. The ECB has delivered a lot."

The market can be forgiven for some level of confusion regarding the ECB’s strategy. The ECB’s new-found regard for the ABS market comes after years of undermining that same market by offering cheaper funding via three-year LTROs.

Both the QE and ABS/CB purchase schemes share key characteristics. Both are designed to promote bank lending to non-financial institutions and seek to actively increase the size of the ECB’s balance sheet back to its former €3 trillion glory.

The biggest difference between QE and this ABS
programme is that the ABS market is finite whereas the government bond market is basically unlimited

Gary Jenkins

Indeed, the ECB’s programme should be seen principally as a means of achieving this balance-sheet expansion, says Mark Wall, chief economist at Deutsche Bank, adding: "If banks don’t do enough to expand the ECB balance sheet by pulling liquidity out with the TLTRO [targeted LTRO], the ECB will stand ready to push liquidity into the system via ABS/CB to achieve its objective."

The ECB’s balance sheet of €2.01 trillion is about €1.1 trillion (or 35%) below its peak of €3.1 trillion at the end of June 2012.

"Taking Draghi’s €1 trillion TLTRO take-up reference from July into account and adjusting the balance sheet for the outstanding three-year LTROs would imply a targeted size of the two purchase programmes of around €450 billion," states Nomura.

This sets the ABS/CB programme and traditional QE in contrast to the more passive LTRO scheme, which relied on banks to apply for capital. Yet, like QE, the ABS purchase programme also depends on demand from non-financial institutions. Neither strategy does much to stimulate demand for credit among businesses.

"The biggest difference between QE and this ABS programme is that the ABS market is finite whereas the government bond market is basically unlimited," says Gary Jenkins, chief credit strategist at hedge fund LNG Capital.

Nomura adds: "Considering the outstanding stock of ABS and covered bond in the euro- area, there is limited scope for large-scale asset purchases in these markets without distorting markets to the disadvantage of investors."