The latest turn-of-screw occurred this week in the long-running court room battle – in Germany's constitutional court – between the ECB and a group of German academics and lawyers. The latter allege that the prime purpose of the former's Quantitative Easing (QE) programme has been to get cheap funding for Italy, Spain and others with German money.
The court has given the ECB three months to prove that this was not the purpose, and that its programme served the cohesion of the euro. In theory the court could order the ECB to sell out the QE assets if the ECB fails to prove its case. That would be of grave concern to money managers.
There is good reason to believe that the German court is a paper tiger, though, since it has no jurisdiction over the National Central Banks (NCBs) of the countries which hold the assets of main concern e.g. the Banca d'Italia and the Banco de Espana. The QE programme structure is that the bonds are bought by the NCB of the bond's issuer. The ECB has anyway the avenue of an appeal to the European Court of Justice, always a good delaying tactic in the past, the ECJ being likely to sympathise with a fellow European-level institution over a grubby member state, even if it is Germany.
But the matter should remain on the radar of money managers.
The plaintiffs appear to have underestimated the amount of monetary support being provided by the Eurosystem – the hydra consisting of the ECB and all of the Euro-area NCBs. This is laid out in the book "Managing Euro Risk" that I co-authored with Barnabas Reynolds and David Blake, and which was published in February of this year by Politeia.
It's EUR7 trillion, not the EUR2-3 trillion that is the QE programme balance:
|
Programme |
Amount |
Comments |
|
QE |
EUR2.6 trn |
Assumed to be funded by the TARGET2 gross balances that are netted off before becoming public |
|
Loans to euro-area resident Monetary Financial Institutions |
EUR3.5 trn |
To secure, with the respective haircut, the EUR3.1 trn of loans to "MFIs" (i.e. banks) shown in the Eurosystem balance sheet |
|
Net TARGET2 balance |
EUR1.0 trn |
The matching amount of credits and debits in ECB monthly reports after netting, and excluding the EUR200 bn overhang on the ECB annual balance sheet |
|
Total |
EUR7.1 trn |
|
The Eurosystem owns or controls (meaning it has accepted bonds as collateral for lending) an amount of bonds that equates to 70% of the entire general government gross debt of the Euro-area, as it is tracked by Eurostat.
The Eurozone bond market has basically become a monopsony - a market with only one buyer.
Oddly this would give the ECB their reason for not stopping QE, or rather for certainly not selling out the QE portfolio or winding down the loans to banks. If that one buyer becomes a seller, the market collapses and it is not in the interests of the cohesion of the euro for that to happen.
Money managers do not generally seem aware of the degree to which the Eurozone financial market has been bought up by the Eurosystem, no doubt because the operations have been carried out by 20 market actors (the ECB and the Euro-area NCBs) and within 7 or 8 different programmes.
As a result money managers need to concentrate on this court case because its outcome could cause the Euro interest rate environment to move in a sharply upwards direction and right along the yield curve.
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