Summary – Draghi Finds His Voice - Unfortunately

After stating unequivocally last week that he would do “whatever it takes” to support the euro, European

Central Bank chief Mario Draghi failed to deliver at the bank’s monthly policy meeting. With great hope the

masses would take him at his word, Mr. Draghi stepped into the post-meeting presser and followed last

week’s promises with more promises this week.

• “The euro will stay.”

• “We’re not rowing back.”

• “It is within our mandate to do whatever is within our power…”

• “I am not a crook!”

Oh wait, that last one was from someone else.

The Italian banker did say one thing we can all agree on: “Monetary policy will not be enough.”

Judging by the market’s reactions, perhaps he should have just left it at that.

What’s Important…

Signs of stress in Germany are emerging. In addition to deteriorating public support for difficult euro-zone

nations, the seemingly invincible German economy is taking a turn downward as measured by their all-

important manufacturing sector. Where will public support be once the effects of a second recession are

fully realized?

Spain is expected to request another bailout, just a month after the last one. Failure of Prime Minister Rajoy to

effect any real banking reform along with a volatile reliance on external investors to support the country’s

debt imply Spain is not making much progress toward reform after June’s bailout. According to Credit

Suisse, the country must borrow a whopping €385 billion prior to the end of 2014 which will be difficult to

pay back given GDP is currently negative and the cost of borrowing has topped 7 percent.

ECB shot itself in the foot with Greek bond purchases. Part of the reason Draghi’s comments have fallen flat

stems from last year’s Greek debt cramdowns the bank instituted so that it wouldn’t take losses on that

nation’s debt. Those purchases were made under the Securities Markets Programme (SMP) which is now

defunct given any further purchases would likely cause a run on the target country’s debt rather than create

the support intended.

Quick Hits: Europe Outlook August 3, 2012

What to Look for…

Money market rates are signaling further cuts by the ECB within the next three months, but this will likely

not be the only action taken. Draghi will surely attempt to back up his recent brave words with bold action,

but it will be difficult.

Legalities behind potential supportive actions by the ECB, EU, and even the IMF are byzantine and

incongruous at best. In addition, the ECB must balance its desire to remain independent with the risk of

appearing inactive – something the Fed is facing today as well.

A Picture is Worth…

Source: Bloomberg

Written by:

Joe Morgan Chief Investment Officer SVB Asset Management @SVBJoeMorgan jmorgan@svb.com

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10-Year Spanish Yields