LONDON, July 25 (IFR) - Not for the first time, it would seem prudent to paraphrase that dreaded restaurant critic Anton Ego from the Disney/Pixar animation Ratatouille. What this market needs is some fresh, clear perspective.
Things always get a bit crazy as the summer holidays start to kick in, but are the moves we have seen since last Friday in both the periphery and broader credit markets justified?
There are plenty of reasons to argue yes. At the beginning of this month, we saw a major relief rally after the Spanish bank bailout was confirmed at the EU summit. Unfortunately, though, the problems in Spain reach way beyond the banking system, as we can see by the regions’ requests for help that sparked this latest sell-off.
The likelihood is, therefore, that if yields stay at these elevated levels, then Spain will need to go cap in hand to the Troika for a fully fledged sovereign bailout. To that end, El Economista’s report this morning - that the German government is urging Spain to request a EUR300bn sovereign bailout package that would negate the need for the Tesoro to come to the market for the next two years - had more than a ring of truth about it.
In Greece, quotes from EU officials on Tuesday afternoon that the Troika’s debt reduction targets may be missed were thoroughly predictable, and those same officials also stated that further debt restructuring would be necessary.
That, of course, is a very delicate subject. From a political point of view, European policy-makers will not want to take a major haircut on Greek debt holdings, so we can look forward to a vigorous stand against OSI from the likes of Germany and Finland. One would imagine, though, that the ECB would be forced to wear the haircut on its SMP holdings should OSI become a reality.
And therein lies the crux of this latest inflexion point in the sovereign debt crisis. If the ECB is going to carry some of the burden of other potential debt restructuring from bailed-out countries, the cost will be enormous.
Hence, it would make sense for Draghi and co. to introduce more non-standard measures at the ECB meeting next week. The ECB council could, of course, opt for LTRO 3 (anyone for a perp LTRO?).
The first three-year LTRO back in December had the desired effect on Italian and Spanish yields, but the second at the end of February had much less of an impact. One suspects the benefits of a third operation would be even more diluted.
Cutting the depo rate to zero last month had a big effect on off-core markets, but none on the periphery.
So what does the ECB have left? If the aim is to bring Spanish and Italian yields down and keep them there, the central bank needs a regimented, scheduled buyback scheme, which to all intents and purposes is QE.
One suspects, however, that this will only be the last resort, and hence the markets may well be disappointed next Thursday. (Editing by Julian Baker, Alex Chambers)