September 7th, 2012 by Hafiz Noor Shams
Yet just another day in the year of crisis monetary policy. And of course, yet another acronym to add to the alphabet soup.
The acronym of the day is OMT. That stands for Outright Monetary Transaction. It is a unlimited but sterilized bond buying program aimed at keep yield of sovereign bonds down, with some conditions, without seniority privilege.
The market is responding relatively well to the OMT but I think the OMT is insufficient to address the woes Europe is facing. The European Central Bank cannot do everything but the monetary policy is a potent firepower nonetheless and I think the ECB has not been using it.
From money supply point of view, the word unlimited is misleading because it is a sterilized operation. That means the ECB can purchase an unlimited amount of bonds, injecting unlimited amount money into the system and then withdrawing the same “unlimited” amount of money from somewhere else. So, any purchase of sovereign bonds by the ECB necessarily means someone else will suffer.
The sterilization is done because Europe, or rather Germany, is so much against quantitative easing, apparently still hung up from inflationary pre-World War II experience.
The sterilization aspect is not different from the previous but defunct program called the Securities Markets Program (the SMP).
It appears to me that the only real difference is the no-seniority nature of the OMT. Then again, as Alphaville at the Financial Times quoted a Mr. Nowakowski, a fixed income strategist at Roubini:
The ECB can promise to be pari passu, until a default threatens and it can then pressure Euritania to let it swap into local or international bonds without CACs that receive special treatment, exactly as it did with Greece. They could still argue, though not in good faith, that those bonds are not senior to anyone, they just got lucky again to get such a great offer. The ECB has tremendous leverage on countries whose banking systems depend on it for funding, so it can call the shots. [Joseph Cotterill. Seniority, the SMP and the OMT. Alphaville. September 6 2012]
So, why again is the market rallying?