IFR Comment: What is the quid-pro-quo for restarting SMP?

27 July 2012 | By Divyang Shah, Senior IFR Strategist

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For months foreign investors have been looking for the exit on Spanish and Italian debt. But in recent weeks, concerned that eurozone policy makers were fiddling while Madrid burnt, the exits started to become smaller (wider bid/offer spreads) and investors found it much more difficult to get out (market illiquidity/depth problems).

Divyang Shah, Senior IFR Strategist

But now in a strong signal the ECB President Draghi has put markets on watch for the Securities Markets Programme (SMP) to be restarted and possibly the prospect of providing the ESM with a bank licence.
The key to Draghi’s comment on Thursday is that he is focused on how sovereign premia are hampering the “functioning of the monetary policy transmission channels”.
It was after all problems with the functioning of the transmission mechanism that led the ECB to start the SMP in the first place citing “dysfunctional markets”. It is thus easy to see the ECB taking action via the SMP or even helping to restart the sovereign carry trade via another 3-year LTRO. The ECB could either act now or wait until the day of the ECB meeting next week.
The SMP would certainly help investors as it would provide an avenue to exit and a willing buyer on the other side. The same would be true if the ESM were to be given a bank licence but on both investors will still worry about being subordinated.
The fact that more novel steps are now on the table highlights how the crisis management script in the eurozone has shifted as Spain and Italy prove too big to ignore.
A shift from the ECB in utilising its balance sheet is a game changer but the SMP by itself will not be enough especially if they are conducted in a similar manner to which that has already been seen.
A more lasting solution would involve the ECB providing the EFSF/ESM with a banking licence but the quid-pro-quo for such action will be for speedy political movement toward a more integrated eurozone. These are the very same pillars that Draghi helped script involving fiscal union, banking union, economic union and political union.