The run-up to European Central Bank president Mario Draghi’s announcement of outright monetary transactions (OMT) on September 6 generated even more frenzied outpourings from the financial commentariat than usual.
Given that the entire contents of Draghi’s speech had been leaked to Bloomberg the day before, the heightened anticipation of his press conference was doubly baffling. One observer wryly captured the mood perfectly on the morning of the announcement, tweeting: “What are you guys wearing for the ECB thing? I’m doing a floor-length skirt, Michael Kors satchel bag and like a loose ponytail...”
Market reaction following Draghi’s confirmation of what everybody already knew was predictably extreme. Within hours the Markit iTraxx Europe was 7.5 basis points tighter at 132.5bp, its tightest level since early April; Spain’s spreads tightened 50bp to 400bp and spreads in Ireland moved below 400bp for the first time in nearly two years.
Asset managers have made a lot of money over the past few years by jumping on these brief bursts of euphoria and, given the well-flagged nature of ECB or Federal Reserve announcements, this is an easy trading strategy to execute.
Known as “melt-up” or “crash-up” rallies, they are a great chance to sell volatility through the news until the inevitable period of dampened expectations sets in. Since the German Constitutional Court rules on the legality of the European Stability Mechanism (ESM) on September 12, this month could provide a double-whammy – or a very swift reversal of fortune.
Given that everybody gets the eurozone joke by now, it is slightly depressing that market overreaction is still so intense. Draghi may claim that he has provided a “fully effective backstop to remove tail risk from the euro area” but unless Spain’s prime minister, Mariano Rajoy, decides to play ball, all this third attempt at a bond-buying programme is buying is time – and not much of it.
The ECB will buy bonds only from governments that have submitted to a European Financial Stability Facility/European Stability Mechanism programme – be it full or precautionary. Spain, which faces a huge refinancing hump at the end of October, is the acid test.
Draghi says that whether or not the OMT will be applied to Spain is entirely in the hands of its politicians. If they decide that the conditionality embedded in the OMT scheme is simply too much for them, it will be back to the drawing board – again.