Effective yield targeting on Draghi's mind, says UBS

The ECB in its all important monetary policy meet decided to keep key rates unchanged. In an interview with CNBC Europe, Bhanu Baweja, Head of Research & EM Strategy at  UBS said he was positively surprised with ECB president Mario Draghi's stance. According to him, Draghi has introduced a condition and says that if Europe's debt woes increase, he would step in and take care of it.

Baweja believes what Draghi is doing is effective yield targeting, though he is not going to say it.

Below is the edited transcript of the interview on CNBC-TV18.

Q: What is your view on the ECB policy decision?

A: I think it did surprise me positively. The markets I thought was little ahead of themselves. I think Draghi has helped focus the minds of the politicians. One of the biggest worries for this market was that even if Spain does the right thing, even if it leads us to the right thing, there is just not enough fire power in the EFSF or the ESF.

What Draghi is saying to you is that if you do the right thing and that is a big 'if', so there is conditionality. He says, if you do the right thing don't worry about limited funds and EFSF, I am going to come in and help you. He has effectively put a gun to their head and put a cheque book in front of them and said this money is yours to take if you do the right thing.

Q: How is that different from what was there before, isn't that the same message we have had from both the ECB and the Germans and other core European politicians?

A: It is not because the S&P, which he did earlier was just addressing dysfunctional markets. What is a dysfunctional market? It is not where yields go to 11%. That wasn't yield targeting. This is effective yield targeting.

He is not going to say that but he is saying I am targeting risk premium and that is very Fed like. I am targeting risk premium that falls within my mandate. He is saying, I am targeting a certain part of the risk premium, which is a convertibility premium and there is no way you can isolate that convertibility premium. So how do you target something you cannot isolate?

The point is not to be very scientific or very technical about isolating that risk premium. But as long as he says I am going to isolate that risk premium and target it lower, he is saying, I am targeting a yield and that is effectively very different from S&P because the S&P says if the market is dysfunctional, I am going to come in.

What is dysfunctional? It means there is no bids, there is no ask, there is no market clearing price. This is different and this is saying, I am going to intervene a lot more if you do the right thing. He has put the ball back in the politicians' court. So you have to be nervous when the ball is in the politicians' court. That is why I am remaining long volatility and modestly short risk.

His entire premise is that I am going to help you now and I didn't help you a year back because this time there is more Europe. There is demand, there is consolidation within Europe and we are moving towards a fiscal union and the banking union.