Tuesday, October 21, 2014

EURGBP does the business | Corporate and covered bonds, and ABSs

Our call on the EURGBP worked out well yesterday. The pair got through the support provided by the 200 period EMA on the four-hour chart without too much difficulty, as can be seen above (blue line). However, while our focus was on the pound Sterling, the main engine for the drop turned out to be weakness in the Euro. No matter, we’ll take it. The Mandelbrot routine knew the direction of the pair.

And the reason has to do with the asset purchase activities and intentions of the ECB. It was known that the European central bank was starting its asset purchase program yesterday, but this had been well telegraphed so was expected to have been priced in. But in the morning a report emerged to the effect that they were also contemplating adding the purchase of corporate bonds to the mix, and this had the effect of weakening the Single Currency. The amount of money put aside for this overall program, in the trillions of Euro, is enormous.

Corporate and covered bonds, and ABSs

You might be wondering about the difference between a covered bond, issued by a bank, and a corporate bond. So was I, so on your behalf I looked it up. While covered bonds are also corporate bonds, in the sense that the issuing bank is a corporation, they are backed by cash flows from mortgages and similar loans, which gives comfort to the purchaser. Plain vanilla corporate bonds have nothing to back them other than the viability of the issuing corporation (so it can be assumed that these will need to have a good credit rating to satisfy the ECB). Asset Backed Securities (ABSs) are as it says on the tin: securities that have assets, such as property, behind them.

When the story about corporate bonds being added to the ECB asset purchasing program broke, a source “close to the central bank” said that this had not been discussed by the Governing Council. Our EU correspondent tells us that this is not a very meaningful formula as the matter will certainly have been considered at many meetings between the Chefs de Cabinet and their staffs (the people who do all the meaningful work) of the various interested parties.

All in all, it adds further to the impression that the bias attached to the Euro at present is to the downside. The whole asset purchasing activity is as close to Quantitative Easing (QE) as the ECB can get, and QE in the US resulted in a weakening of the greenback, which is only now being reversed with the termination of the program. It also worked wonders for the equity markets, so can we now expect a surge in European stocks?

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