But we digress. Where punters *have* been trying to play the bearish Europe story is in the rates markets. For the past year or so, the ECB has repeatedly tried to exit its exceptional crisis-mode liquidity policy, through announcing an end to easy liquidity provision and hinting that rates will have to rise. Of course, the fiscal crisis in the periphery has on several occasions forced them to backtrack somewhat from this policy as wave after wave of EU policymaker incompetence has managed to screw up previous attempts at buttressing the periphery states. Of course, now, the ECB seem to be of the opinion that the war has been won, given that apart from the usual suspects (Portugal, Greece & Ireland), Euro-area capital markets appear to be performing pretty well. They also want to keep up the pressure on fiscal authorities to recapitalise their respective banking systems such that those entities currently unable to borrow in the interbank markets - such as NegativeAlphaBank Athens and All-In Bank Dublin - can.
Of course, the flaw in this strategy is that the results of the stress tests are not out for another few months, and given last year's fiasco, markets are bound to be rather more skeptical of the results unless they show a reasonable amount of new capital is needed. Additionally, markets are awaiting the reaction of the newly-elected Irish government to such results that are bound to show that the size of the black hole attached to the Irish banking system has increased to the point that it is not only the English cricket team that have been crushed by its gravity. And while EU policymakers appear to have managed to successfully manage expectations for a not-so-substantive "substantive" new EFSM package at the Ecofin meeting this month, TMM trust Merkel & Co. to monumentally screw it up somehow... after all, as the cliché goes, the trend is your friend.
On top of the above, as TMM noted earlier this week, while Germany is motoring ahead, ECB rate hikes have just the same negative effect upon the periphery in terms of higher financing costs as the evil anti-Euro speculators do when they sell Club Med bonds. With such intra-European divergence, TMM find it hard to see the ECB really doing anything other than talking tough to keep inflation expectations in check, with perhaps the odd hike later this year to show to wage bargainers that they "mean it". The move towards mopping up excess liquidity is likely to continue (see chart below from TMM's mates at Nomura) with 3m unlimited allotments ending, but TMM reckon that until said peripheral banking systems have been recapitalised (at least 6months away), that despite protestations about "liquidity addicted banks" that the ECB will have to keep at least the one week allotments and probably the one month allotments too.
And while Taylor Rules don't work as well in the Eurozone due to the ECB's reaction function being somewhat quaintly a function of money supply growth amongst other things, for what it's worth, TMM's model is shown below (white line) vs. the actual Refinancing rate (orange) and indicates that rates do not really need to rise given the Eurozone-wide output gap. But TMM admit, that this is unlikely to sway those arch-monetarists of the Bundesbank...
...perhaps it is interesting, then, that Darth Weber, erstwhile defender of the Monetarist Empire of the Eurozone has resigned and will not be attending today's meeting. Now, looking at what is priced into the curve is monumentally difficult given the subjectivity around how Eurozone liquidity conditions will progress over the coming months, with anything between one and three 25bps rate hikes priced in by year end, depending upon what discount (if any) one expects EONIA to fix at relative to the Refinancing Rate. And TMM reckon that, rather than being all purely rate hike expectations, the forward curve is more a function of significant risk premia resulting from the memories of June 2008, amongst other things.
TMM have thus far managed to sit on their hands (they have history with Mr T of the love-hate kind), knowing that many punters have tried to fade this over the past couple of months, and avoid buying the front-end, but it looks to them as though the risk reward for a punt on Trichet providing a dovish surprise today looks pretty good...
...they are sure they will be truly regretting this by the end of the day...
UPDATE: Ouch!
Where the hell did THAT come from? Darth Weber may not be getting Mr T's chair, but he hardly needs to be as the BundesECB meld appears to have already occured. Doc Trichet is taking us Back to the Future of 2008".
TMM probably in similar mood to Portugal, Spain and Italy and are wondering what Ireland's chances are of lowering their bailout interest rates...
The Good ship TMM after an encounter with U-ECB:
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