Onto Draghi 8217 s ABS Plan

Will this week’s release of fresh lows in Eurozone inflation at 0.2% and evidence of contraction in German and France manufacturing PMIs, force the ECB to announce the much-anticipated purchases of asset–backed securities and covered bonds at Thursday’s meeting?

Draghi will have to weigh the risks of market disappointment over balance sheet expansion guidance are high after tepid demand at first TLTRO auction and expectations that ABS program may also fall short of desired size

Greek & Cypriot junk

Up until this week, the extent of planned ABS purchases depended on eligibility criteria set by ECB on which loans to accept. But on Wednesday, the ECB announced it would include Greek and Cypriot “junk” loans as part of the bundles of private sector loans used for ABS purchases. The inclusion of Greek & Cypriot loans plan faces staunch opposition from Germany but it could pass if the majority of the ECB’s Governing Council approved it. If passed, the inclusion of those loans would free up billions of extra liquidity at Greek and Cypriot banks as they are encouraged to offload unwanted loans and create more credit to households and businesses in need of vital financing.

Balance sheet guidance

Market estimates of an ABS shopping plan tomorrow range between €400-500 bn over 2-3 years, with a likely split of €150bn buying of ABS and €250bn of covered bonds. The amount may just become the latest guidance of ECB communication to the market.

But there is a possibility that Draghi will prefer to remain ambiguous on details of ABS program as any mention of size or duration would probably disappoint markets, unless it’s otherwise substantial in volume.

Any quantitative easing take-up of sovereign bonds may be considered in December after the ECB has reviewed the results of the 2^nd TLTRO, the ABS impact and the results of the Asset Quality Review.

FX Implications

Traders are aware that the reaction function of ECB policy making has gone well beyond interest rate announcements and LTRO take-ups. As inflation nears zero, liquidity-driving measures are no longer seen as a positive for the euro as was the case back in the 1^st and 2^nd LTROs. This time, the Fed is set to end quantitative easing while the ECB readies to re-open the book of quantitative easing. Plummeting Eurozone interest rates (sovereign yields and LIBOR) will keep EURUSD under pressure following the inevitable bounce resulting from corrective USD pullback. $1.2800 is likely seen before $1.2400.