FT Alphaville " The OMT and "limits" Well, this is good news... Reuters have corrected their copy on what had sounded like confusing remarks made on Monday by Luc Coene, Belgian central bank governor, about the maturities of the debt the OMT will buy. It had certainly confused us, in an earlier version of this post - sorry. He also said parts of the new programme's design meant there were built-in limits to how much it could spend. Only bonds with three or fewer years until they mature will be bought under the plan, and Coene said that governments would not be able to manipulate their issuance to take advantage of the new scheme. "We will only buy the debt with the remaining maturity of three years and part of the conditionality will be that the maturity structure of the debt may not change so that they (governments) cannot put all the new debt in the short end of the market," he said. And after the three years this debt matures, maybe we will buy new debt but there is an implicit limit on the amount of bonds we will buy through that programme. It provides reassurance that the OMT will not be restricted to buying up only bonds issued before a government requests an OMT-ESM programme. That might have been a worrying sign for creating a pricing divide between old and new bonds, and on that basis attracted cautious analyst comment on Tuesday. It's a sign of how sensitively signals on the OMT are being taken, and how much is still unclear about it, absent an actual activation through a government request. We still have reservations over this "built-in limits" idea. Sure, the OMT was always going to be "limited" in terms of maturity - the "limit" is an anchor for short-term yields - but we feel it's still a slightly mixed message by Coene here. After all, compare the statement (in the OMT's technical features) that "No ex ante quantitative limits are set on the size of Outright Monetary Transactions." Surely the ECB isn't buying short-term debt to set a limit per se but because of the (we think bang-on) economic rationale for short-end purchases. This has been that the front end of peripheral yield curves is where fear of redenomination losses hits hardest, and where the transmission of the ECB's policy rates has become most broken. There was a further echo of this in the ECB's latest monthly report, which stated that "The short-term nature of securities purchased should help to... limit the persistent expansion of the Eurosystem balance sheet." The signals are mixed. The second thing's this interesting condition of sovereigns not issuing too much short-term debt. We already know that the OMT will be concurrent with sovereigns agreeing to a primary market bailout (or a precautionary credit line) from the ESM, under key conditions. It makes sense that if the ESM will be buying in primary, ergo it would have a say in ensuring that a sovereign isn't increasing risk in its debt maturities. Although as it happens, Mario Draghi has already indicated that governments might actually have very few practical incentives to moral hazard anyway: We will monitor the situation very carefully, but, at the same time, one assumes that countries would like to keep a structure of debt issuance which is balanced across all maturities. So there is a danger, there is a risk, but it is not at all clear that debt issuers will actually move in this direction because it has a cost, namely of unbalancing a maturity structure which was probably balanced to begin with and has taken many years to achieve. That is, after all, what ails the peripheral bond markets. They are riven by fragmentation and a vulnerability to liquidity (rollover) risk. It would be a masochistic sovereign which gamed its maturities to the short term. Wouldn't it? Related links: Volatility and the OMT - FT Alphaville Burying a banking licence - FT Alphaville Interview with Süddeutsche Zeitung - Mario Draghi, ECB This entry was posted by Joseph Cotterill on Tuesday, September 18th, 2012 at 17:03 and is filed under Capital markets. Tagged with ecb, eurozone, OMT, redenomination, Sovereign debt.