While Today’s Market Dump Was Certainly Dramatic … Here’s Why Tomorrow It Could Get Even Worse

Why Tomorrow It Could Get Even Worse (ZeroHedge, Oct 13, 2014):

While today’s market dump was certainly dramatic, it was a function of the scant liquidity in the market (as we warned would be the case first thing) and outsized moves following last week’s mauling, not the result of any fundamental (or not so fundamental) news.

That could change tomorrow, and change for the worse, because as Barclays reminds us, tomorrow is when the European Court of Justice (ECJ) is scheduled to hear testimony on the ECB’s non-existent Outright Monetary Transactions program (OMT). Recall that the OMT is the imaginary (again: non-existent) byproduct of Draghi’s “whatever it takes” speech: a byproduct that was supposed to exist purely in the imaginary realm (as it was merely a verbal bluff, one which was never meant to be actually activated), and never actually take practical shape (hence, why the OMT’s legal term sheet still does not exist, over two years later).

Sadly for Draghi, and the entire Deus Ex theater that managed to send European peripheral bonds from record wides yields to record low, tomorrow it will attain some much dreaded shape.

And while a ruling on the legal questions forwarded by Germany’s Constitutional Court is not expected this year, the hearing and questions posed by EU judges may give some early insights into their views and to what extent they might share the view of the German court that, unless several restrictions are imposed, the OMT should be considered illegal under European law.

As Barclays notes, specifically the EU court may agree that the ECB cannot promise pari passu treatment with other creditors in the case of nominal losses (haircuts) on its public bond holdings but must insist on full repayment.

What’s worse is that in addition to undercutting and mooting all of Draghi’s July 2013 bluster, next to the OMT itself, the ruling could also have an adverse impact on the effectiveness and design of broad-based ECB government bond purchases (QE) which many banks believe will be announced by Q1 15. Unless they aren’t of course, should the ECJ shoot itself in the foot and demand more clarity on the OMT which can only have an adverse outcome.

Full comment from Barclays:

European Court of Justice scheduled to hear testimony on the ECB’s OMT on 14 October

The ECJ has scheduled a hearing on the ECB’s OMT for next Tuesday, 14 October (starting at 9am CET), which we expect to last all day. Under the OMT, the ECB could purchase, without limitation, bonds of a member state that has entered into an ESM aid programme and agreed to be subject to its conditions. Earlier this year (see German Constitutional Court’s referral of key legal OMT aspects to European Court of Justice is good news, 7 February) the German Constitutional Court (GCC) in an unprecedented move referred a long list of questions to the ECJ (see Appendix below) for a preliminary ruling after it declared admissible a constitutional complaint by some 30,000 plaintiffs (Gauweiler and others) against the OMT. The discussion and specifically questions posed by the EU judges to the parties involved (the ECB, etc) during the hearing might give some early insight on their views. We do not expect the ECJ to come to a ruling this year but the court’s advocate general may announce the schedule for the proceedings next week. Usually, it takes the ECJ about 16 months on average to rule on cases referred by national courts which implies that the OMT ruling could come by June.

German court insists on several restrictions for the OMT

The German constitutional court put some pressure on the EU court and made clear its view last February that there are important reasons to assume that the OMT would be illegal under EU law as it exceeds the European Central Bank’s monetary policy mandate and violates the prohibition of monetary financing of the budget, unless certain restrictions are imposed. These should require “that the acceptance of a debt cut must be excluded, that government bonds of selected Member States are not purchased up to unlimited amounts, and that interferences with price formation on the market are to be avoided where possible.”

Clearly the latter would make an ECB option to proceed with full blown public QE virtually impossible.

So for all those who, rightly, point to the market’s oversold condition, news out of Europe tomorrow could lead to even more selling especially where it really hurts: Europe’s peripheral, and massively mispriced, bonds. A fair warning, just in case anyone is feeling particularly  BTFDippy.

2 thoughts on “While Today’s Market Dump Was Certainly Dramatic … Here’s Why Tomorrow It Could Get Even Worse

  1. The entire western economy is put together with chewing gum and rubber bands. This is what happens when oversight vanishes or becomes corrupt.
    The US markets have lost over a trillion dollars……except most of it is debt and air…….the FED will stop feeding the greedy guts $80 billion a month to cover their bad bets.

    Now, here is a link to eastern news. Everyone in Putin’s land is growing and making money. He has managed to isolate the US and EU from the rest of the world economy…..not out of malice, but because of fool sanctions put on them by nations that no longer have the credibility or financial strength to do it……The rest of the world economy is moving along nicely without us…..how much power the US has lost in seven short years……

    http://www3.nhk.or.jp/nhkworld/english/news/

  2. I just did a quick review of debt to GDP of relevant nations…….because the real problem is debt. The west is mired in it while the rest of the world, those with BRICS (except Japan which is doomed) are in surprisingly good shape. From the debt clock…..
    Nation Public Debt: GDP External Debt:GDP
    UK 93.1% 464%
    France 96.6 262
    Germany 79.9 218
    India 45.1 289
    Greece 144 1062
    Ireland 133 173
    Italy 141 58
    Japan 222
    Mexico 34 27
    Russia 6.5 33
    Spain 120 235
    US 77 100

    Unfortunately, the debt clock does not cover other nations I am interested in knowing about like Brazil and much of South and Central America……….But, the contrast between Russia and the west is quite notable.

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