rahul.khanna's picture

What does the ABS Purchase Program mean for EUR? And how is it different from a proper QE?

We see a weaker EUR, once more details of the (extent of) QE become apparent in October. Until then, EUR will go into a sideways range as most of the QE expectation is already reflected in the rates. EURUSD is one pair we see weakening from late this year to early 2015 to around 1.2500, given the divergent policy between US and Euro-zone- US is winding up its QE program in October while ECB will start its QE.

Firstly, lets clarify the definition of QE. Draghi said “QE is an outright purchase of assets … rather than accepting these assets as collateral for lending”.  So technically ABS purchase is QE. But the scale and swiftness that can be reached with QE through government securities are not replicated by QE with ABS purchase.

Mario Draghi’s ABS Purchase Program (including Covered Bonds & Residential Mortgage Backed Securities) is one way to boost liquidity and credit in a weak economy, and get banks lending. However, market participants have not warmed to the idea of QE with ABS, as they see it as an example of ECB's conservative approach, which will be long and challenging (cause of supply constraints). A full blown QE, on the other hand, would have provided faster relief to the economy that is in danger of stagnating like Japan.

On paper, plan looks good, by boosting impaired credit markets (ABS) – whose spreads in the secondary market are closely linked with lending rates that banks apply in the primary market of the credits that collateralise these ABS. ECB can hence lower the rates and increase lending by easing credit markets. Eligible ‘Asset backed securities’ are estimated to be about €700 billion and the eligible covered bonds almost doubles that and therefore ECB balance sheet on paper could be raised to about €3 trillion. However, scaling ECB balance sheet will be a considerably difficult task.