In the 1987 hit movie Predator, Major “Dutch” Schaefer, played by muscle man Arnold Schwarzenegger, orders his team-member to “get to the chopper” to escape the jungle creature. Markets now expect European Central Bank President Mario Draghi on 22 January to flex his monetary muscles and save the day by jumping into his metaphorical helicopter and throwing huge amounts of cash at the Eurozone’s problems.

1. Draghi, get to the chopper
In the 1987 hitmovie Predator,Major“Dutch” Schaefer,playedbymuscle manArnold
Schwarzenegger,ordershisteam-memberto“getto the chopper”to escape the jungle creature.
Markets nowexpectEuropeanCentral BankPresident MarioDraghi on22 Januaryto flex his
monetarymusclesandsave the dayby jumpingintohismetaphorical helicopterandthrowinghuge
amountsof cash at the Eurozone’sproblems.
What markets expect
Of course thisisa crude metaphorbecause quantitative easing(QE) isnotakintoprintingmoney
and simplydistributingittoeverymanand womaninthe hope thatbondyieldsfall andgrowthpicks
up[1].Nevertheless,marketsare expecting,almostwilling,the ECBto deliveraboldbond-buying
program at itspolicymeetingon22 January(the announcementisdue at12.45 UK time and
PresidentDraghi’spressconference issettofollow at13.30).
The SwissNational Bank’srecentdecisiontoabandonthe EUR/CHF 1.20 floorhas ledtospeculation
that the SNB knowssomethingwe don’taboutthe scale of the ECB’splannedQEand fuelled
expectationsthatthe ECBwill have itsownshock-and-awemoment.
What the ECB will announce – Devil in the detail
While mostparticipantsagree onwhatthe broad frameworkmaylooklike,the specificmodalitiesof
the ECB’s QE are far more uncertain,the productof complex andprotractednegotiationsamongst
the mainactors. In particular,Germanyisintentonshapinga bond-buyingprogramthatminimise
the costs itbears andthe riskof skewedincentive structures.
As oftenthe case,the devil willbe inthe detail,including:
 Size:Draghi saidhe expectedthe central bank’sbalance sheettoreturnto March 2012
levels(aroundEUR3trn[2]),implyinga€ 800bn (5% of GDP) bondbuyingprogram;note this
was an expectationnota firmcommitment;There’sanargumentthatsize doesn’tmatter
because the package will be ultimatelybe asbigasit needstobe to drive inflationbackup
to 2%. That may be true but we shouldnotunderestimatethe signallingpowerof QE.The
announcementof asmall package coulddentitseffectivenessand leadeithertoits
premature abandonmentorthe needforanevengreaterpackage thanmarketsoriginally
hopedfor.
 Type of debtpurchased:Thissize wouldlikelytohave toinclude Eurozone memberstates’
sovereignbonds,notjustprivate debt;
 Who will buywhat:Germanyispressuringthe ECBto ask the 19 individual central banksto
buytheirowncountry’sbondsand be responsibleforanylosses,withweakersovereigns
askedto putaside greaterprovisions.Thiswouldflyinthe face of the risk-sharingprinciple,
as espousedforexample inthe SMP.The ECB may be restrictedtobuyingonlybondsof a
certaincreditratingor maturity(Germany’spreference isreportedlyforshorter-dated
bonds) or bondsissuedbythe EuropeanInvestmentBank.
 Conditionality:Germanofficialshave statedtheirpreference thatanyformof QE should
impose rigorousconditionalitysonthe countrieswhose bondsare beingpurchased,
includingthe adherence tofiscal reformtargets.

2.  Program tenure:The programislikelytobe open ended,aswasthe OutrightMonetary
Transactions(OMT),or at leastuntil inflationisclosertothe ECB’s 2% target.
How it will work in theory
Market participantsandpolicy-makerswill have aslightlydifferenttake onwhatthe ECB QE should
seektoachieve,butIthinkits objectivescanbe summedupas follows:
1. Near-term,put a lid on Eurozone systemicrisk. Thisis a lesspressingorambitiousgoal thanin
the 2012 whenthe OMT wasannouncedanddespite neverbeingenactedseeminglycontributedto
curbinghighgovernmentbondyieldsandacute systemicrisk(i.e.countriesexitingthe Eurozone).
While contagionisalwaysarisk,systemicweaknesstodayplaguesmainlyGreece withsovereign
yieldsnearrecordlowsinIreland,Italy,Portugal andSpain (seeFigure 1).
Figure 1: 10-year governmentbondyieldsare nearrecordlows…exceptinGreece
2. Medium-term,generate jobs,economicgrowthand inflation. Thisis arguablya far biggerand
increasinglypressinggoal.Eurozone unemploymentrate isflat-liningat11.5%, inflationwas
negative inDecemberandinflationexpectationshave fallenwith5y-5yinflationswappricesnow
sub-1.5%.While the channelsthroughwhichQEisdesignedoperateare countryandtime specific,
theytendto include increased lending,confidence(viaassetprices),borrowing,spending,
investmentandexportcompetitiveness(see Figure2).

3. Figure 2: The channelsthroughwhichQEissupposedtoworkits magic
How it will work in practice
As I argue in EuropeanCentral BankQE: a little late tothe party,that’sa tall ask forwhat isinmost
instancesameasure of last resortand one whichisbeingintroducedverylate inthe game.The Fed
stoppeditspurchasesof mortgage-backedsecuritiesandTreasurynotesinOctober2014 while the
BoE’s lastQE size increase wasinJuly2012.
The milliondollarquestioniswhetherthe lowercostof moneyandhigherquantityof moneywill
translate intogreaterconfidence,borrowing,spendingandinvestment.Asthe experienceof Japan
showed,the ability to borrowis notthe same as the willingness to borrow nor shoulditbe a
substitute forreform.Furthermore,onlyahandful of countries,including Germany,are inaposition
to fullycapitaliseonamore competitive euro.Ultimately,itwilltake months(aneternityinmarket-
terms) ratherthan daysor weekstoproperlyascertainthe efficacyof ECBQE, inmy view
Weakereuro isno miracle bullet
The voidsbetweenwhatthe marketsexpect,whatthe ECBannouncesandwhetheritworksare
trickyto measure andmuddythe euro’spath.
However,Ithinkthatif the ECB deliversabigandboldplainvanillaprogramwithrisk-sharing–the
latterlookingincreasinglyunlikelyinmyview –the euromay temporarilyrebound –ironicallynot
whatthe Eurozone’sexporter’sneed.The pressure medium-termmaystill be onEUR/USD downside
as the questionisstill when,notwhether,the Fedwill hikein2015.
If the ECB underwhelmswithahardto digestmiddle-of-the roadorwatered-downprogramclipped
and curtailedbyGermandemandsthe euromayresume itsslide onmarketexpectationsthatthe
ECB will have nochoice butto announce anotherprogramto paperover the cracks in cyclical and
structural GDP growth.
In anycase, the FX marketwill likelytemperitsenthusiasm,orlackof,giventhatGreece is holding
electionsonlythreedayslateron25th
January.Opinionspollsstillhave Syrizaleadingsome formof
coalitiongovernmentbutitcouldbe weeksbefore the new governmentarticulatesaclearstance
regardingGreece’sausterityprogramandexistingbailout-package whichstillhasEUR 15bn to
disburse.

4. It isnot unfeasible thatonce againthe Eurozone hasto choose betweenasignificantrestructuring
and/orwrite downof Greekdebtor lettingGreece leave the monetaryunion –not be the backdrop
that Eurozone leadershopedforastheygrapple withrelaunchinggrowth.
Olivier Desbarres currently worksasan independentcommentatoron G10 and Emerging Markets.He
is a formerG10 and emerging marketseconomist,ratesand currency strategistwith over15 years’
experiencewith two of theworld’slargestinvestmentbanks.
[1] QE amountsto a change in the compositionof the private sector’sbalance sheets,swapping
bonds(lowliquidity) forreserves(highliquidity) andacorrespondingincreaseinthe central bank’s
balance sheet(incidentallythe physical creationof banknotesandcoinsinthe US isthe preserve of
the Treasury,not the Fed).The twinobjectiveistolowerthe costof (long-term)moneyandthe
quantityof moneybankscan lend,withthe ultimategoal of boostinglending,confidence (viaasset
prices),borrowing,spending/investmentandultimatelygrowthand/orinflation.Butthere is
“creation”of moneyonlyif increasedbankreservestranslate intoincreasedlending.
[2] See http://www.ecb.europa.eu/press/pr/wfs/2012/html/index.en.html
Sources
Fig1 – www.investing.com
Fig2 – www.olivierdesbarres.co.uk