From: US GIO To: Undisclosed recipients:; Subject: Macro Skinny: Draghi sets the floor for Europe Date: Wed, 22 Aug 2012 20:46:40 +0000 Inline-Images: image001.jpg; image002.png; image003.png; image004.png; image005.png Macro Skinny J.PMorgan Draghi sets the floor for Europe The European QE1 is officially here. Mario Draghi's latest speech should be seen as a genuine commitment to stave off EMU break-up risks. His argument: higher yields in the periphery prevent the ECB from easing monetary policy efficiently. As such, the ECB is likely to buy as many periphery bonds as needed to keep yields lows. This language is truly exceptional, and it is comparable to how the Fed and the Bank of England justified their first round of quantitative easing (QE1) back in 20092. It is essentially the European QE1, which is much stronger than SMP - the old bond buying program. The German resistance has collapsed. With the exception of Jens Weidmann—the president of the German central bank—the rest of the German political and monetary leadership has given a thumbs up to Draghi3. The Germans did, however, deny rumors that the ECB is willing to go as far as capping yields for the periphery4. But what Otto von Bismarck5 once said, applies today as well: "never believe anything in politics until it has been officially denied". After all, former ECB president Jean-Claude Trichet denied that the ECB was discussing bond purchases just four days before SMP was officially announced in 2010. Bottom line: Europe has learned that there is no other practical solution than ECB money printing. Managing periphery yields = proactive ECB policy. As a reminder, the mess in the periphery started when foreign investors (mostly Germans) asked for their investment money back. And since the periphery was broke (it spent this foreign capital long ago), it could only buy back these assets by borrowing excessively from the ECB6. As the left chart shows, up until early 2010, the ECB lent e