More on the dollar crunch and the liquidity drop | FT Alphaville

More on the dollar crunch and the liquidity drop

Right, here’s some early reaction to the latest central bank liquidity drop.

It comes from RBC’s Michael Cloherty, who makes the astute observation that it is now cheaper for foreign banks to borrow dollars from their central bank than it is for a US bank to borrow from the Federal Reserve:

The cost of borrowing from the currency swap lines was cut from OIS+100bps to OIS+50bps. In addition, the ECB has cut the excess margin it was charging on these trades from 20% to 12%, so the all-in cost of borrowing for European banks will fall by more than 50bps. This is effective as of Dec 7.

Note that it is now cheaper for foreign banks to borrow dollars from their local banks than it is for US banks to borrow dollars from the Fed, so we could see a 25bp cut in the discount window in the coming days to level the playing field.

Again, we look at this facility as eliminating the liquidity element of LIBOR (banks don’t need to be as afraid of lending term because they know they have a backstop liquidity source that won’t be that expensive, which means the money market curve stays flatter) rather than thinking that LIBOR will move all the way to the new ceiling. So we think LIBOR can still creep a bit higher than spot, but it will be difficult to get higher than 60bp.

Of course, this won’t solve any of the problems in the Eurozone. But it does buy a bit more time — apparently something might be cobbled together in time for the summit meeting in Brussels on December 8-9 – and it reduces the risk of something nasty happening at the end of the year.

But it’s not a game changer, says Cloherty.

This is a very big deal if you are trading Eurodollar contracts as the Fed was more aggressive (we thought they would go to OIS+75bps rather than OIS+50bps), but it doesn’t change any of the fundamental issues in Europe. The major help to risk assets is that those investors no longer will need to see LIBOR rise relentlessly (and it should make year-end a little less messy), but we don’t think this is a real game-changer.

A point echoed by RBS:

The net read here is that this is a clear positive for market sentiment. At the time of writing 3m EUR/USD cross currency basis has tightened considerably (currently 23.5bp tighter since the move at -134bp) and front contract USD FRA/OIS has tightened by 10-12bp today. However, ultimately this is just a backstop and doesn’t fundamentally change the bigger picture. We intend to follow up later with a more detailed note.

Update: 14.06 (London time)
Nomura takes a different view and we are all saved.

It’s always darkest before dawn and today’s coordinated move by central banks harks back to the crisis-fighting days of late 08. We are encouraged that the monetary authorities are indeed back on the case again working as a team. Global banks are obviously interconnected and thus given the USD funding tensions of late this global CB coordination is a sign that folks in the right places are “getting it.”

Alternatively, they are scared witless by the inaction in Europe and decided to do something. But we digress.

By no means does this address all of the issues facing markets (and we remain worried EU policymakers drop the ball) but it removes one roadblock and signals that perhaps more help is on the way. It is also, from a very high level stand point, a vote of confidence by the Fed that they view a euro breakup risk as low because an sort of increase in the FX line usage will result in more Fed exposure to Europe.

We think more positive surprises could be on the way in the form of more easing in the weeks/months ahead by all authorities (our economists see QE happening for G4 soon). Net, next 6 weeks of forced realignment by monetary authorities and eventual fiscal players will set the tone for price action for next 6 months. Reminder, let’s not forget the massive spread compression that happened post 08 into mid-09 which created a night/day experience for investor sentiment.

Back up the truck, then. Risk assets are headed higher.

Related link:
Central banks move to ease European dollar crunch – FT Alphaville