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Decimal Digest
06 Aug 2012

Central Banks ready to fire ‘one more salvo’?

The last few days have been quite remarkable in the sovereign bond markets, mainly due to antics of the ECB chief, Draghi. For a change, this time around, Fed’s Bernanke was quite sedate, restraining himself to just jawboning about further easing; while his counterpart across the Atlantic was busy rewriting the operating rules governing the functioning of ECB, in the face of the tide of objections from the Bundesbank.

Many market participants are busy figuring out the motivation for this change of heart at ECB. They would do well to remember what Napoleon said, “Never ascribe to malice that which is adequately explained by incompetence.”

It is our belief that the fallacies in the design of Euro have brought the situation in Europe to the current impasse, hurting real economies not only in Europe, but across the world. Now Draghi is showing his willingness to correct one of the major flaws1 in design of the Euro, by standing ready to provide unlimited liquidity to “solvent” sovereigns. However, this does not automatically mean a resumption of economic growth in Europe, as the banking sector in Europe is still in a state of shock & labor reforms in Europe are still half-baked.

Hence, while ECB’s possible propping of sovereign bonds in Spain & Italy may not be sufficient to revive real economic growth globally or to solve Eurozone long term problems, however, combined with possible quantitative easing from Fed, the combined firepower can provide a nice short-term prop to risk assets.

1 Here we support the role of central bank in propping its constituent sovereign debt, merely because it is an accepted practice across the world, practiced either overtly or covertly.


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