ECB: Where is the Shock and Awe ?

The Financial Times reported that as Trichet was holding a press conference after the recent ECB meeting, European central banks were buying large amounts of sovereign European bonds. Reports suggested that the amounts were in 100-200 mln euro clips, 2-4 times more than usual. The market bandied about estimates of the ECB's bond purchases in the 5-10 bln euro range.

Last week's auction of term deposits, to neutralize the impact on money supply of these bond purchases indicated that "only" 1.96 bln euros of foreign bonds were purchased. We played that figure down a bit because the bonds that were bought on the day of the ECB meeting (Dec 2 ) and the following day would not have settled in time.

Today's announcement of the among of terms deposits the ECB will sell tomorrow suggests that Dec 2-3 purchases, plus the amount purchased through last Wed (Dec 8), was 2.67 bln euros. This does represent an increase and is actually the most since the May-June period, when the controversial program was first announced. Nevertheless, it is still quite modest, and if anything, observers are probably surprised with how light the purchases really were. During the first two months of ECB purchases, there was not a single week in which the ECB bought less than 4 bln euros of sovereign bonds.

So why did European bonds rally? There are a couple of answers. First, the ECB's tactics could have fooled short-term market participants. Second, the European peripheral bond rally had less to do with what the ECB did itself and more to do with what the ECB go others to do.

Recall it was that ECB meeting earlier this month that the ECB announced that unlimited 3-month money would still be provided until at least the end of Q1 11. We maintained through the extraordinary ECB liquidity provisions that it was in part tantamount to some fiscal support. We suspect that many banks that borrow for 3-months at 1% from the ECB will park the funds in sovereign euro zone bonds.

As foreign exchange market observers have learned from intervention, it is extremely difficult to estimate the amount of intervention by the price action. For example, when the BOJ intervenes it typically has tried to overwhelm the market with size. In contrast, when the Fed has intervened in the past, it seems to try to finesse the market. The ECB's recent bond purchases, while representing an increase compared with recent months, was more out finesse and getting others to do the heavy lifting than the shock and awe the market suspected.