On Tuesday, FT Alphaville presented you with some whining banks.
They were complaining about the inexorable rise of Libor and the punitive cost of central bank liquidity. No financial firms, they said, would want to use the currency swaps provided by the European Central Bank (ECB) and the like, until it made economic sense to do so. In other words, they wouldn’t use them until the day the cost of the swaps was equivalent to rates on the interbank market.
Wednesday could be that day, according to BNP Paribas:
In Europe, as the cost of USD liquidity has continued to spike, we have finally entered territory where tapping the ECB for short term currency swaps has become sensible which could help to stabilise the situation provided banks don’t fear the stigma too much. Eurodollar futures are stopping their uninterrupted fall and this could help to end fire selling of risky assets.
Anyway, the liquidity is there, for banks who are willing to pay for it. And it could be joined by more.
Here’s Alan James from Barclays Capital:
The ECB’s weekly USD 7 days tender will likely be at the usual ois+100bp rate (it always has been conducted at this rate, when it was a fixed rate). It is possible that in addition, later this week, the ECB announces another USD 3m operation with the same terms, maybe for next week. This would then really provide a backstop, now at relatively more attractive terms, and show the real demand for USD funding by European banks. Our US colleagues are hosting a conference call this afternoon: “Libor has doubled. Now What?”
Libor has doubled, so the central banks step in (yet again). That seems to be what.
It’s a point also picked up by Citigroup, who think that the ECB is about to (yet again) open its liquidity floodgates, in the form of extra Long-Term Refinancing Operations (LTRO) and reduced rates for swaps.
Over to Citi’s Jürgen Michels:
Without action from the ECB, the expiry of the first 12M LTRO on July 1 will lead to a significant tightening in liquidity conditions. However, as we have seen in the decisions of May 10 and at earlier stages during the financial crisis, we expect that the ECB will introduce extra measures in order to ease market tensions. In our view, the ECB is likely to expand the full allotment of the 3M LTRO beyond June and is also likely to offer extra 6 M LTRO’s with full allotment and an indexed rate at some stage. In order to ease increasing tensions in the USD funding, the ECB might also reduce the interest rates for the USD swaps somewhat. The ECB provides the next USD FX swap [Wednesday].
JP Morgan’s David Mackie goes even further — all the way to the eurozone interest rate:
. . . what happens if financial market conditions continue to deteriorate markedly. Are there any policy options left? There are some simple things that could be done. The ECB could cut the policy rate by 50 basis points. We never understood why the ECB stopped at 1%; indeed, we had expected the policy rate to trough at 50 bp last year, but it didn’t happen. Perhaps now is the time. This would reduce funding costs for banks but it would not be a panacea by any means. But, beyond this, any other policy move would be highly problematic.
What’s amazing about this is that there seems to be a general agreement that there’s already plenty of liquidity sloshing around in the system. Most banks just don’t want to access it at punitive rates.
Indeed Citi’s Jürgen Michels says as much:
In addition to the widening spread between unsecured and secured money market securities, the data of the ECB open market operations suggest that tensions in the banking sector are building-up. The number of banks tapping the ECB Main Refinancing Operations (MRO) increased from around 67 in mid- April to 83 this week (see Figure 2). As we have argued recently, these banks have little or no access to the market. Otherwise they would prefer paying 0.36% for one-week funding in the interbank market rather than 1.0% for using the ECB’s facilities. The amount that banks tapped in the MRO (where the ECB provides liquidity with full allotment) has also increased in recent weeks. Indeed, the amount of liquidity provided in [Tuesday’s] MRO of EUR 106bn is the largest MRO allotment since early July 2009 (See Figure 3).
But although a group of banks have difficulties of getting liquidity in the market, overall liquidity in the euro area is ample. Today’s huge oversubscription (EUR 86bn bids for EUR 16.5bn term deposits) of the ECB one-week term deposit highlights this. (Note that the ECB runs the one-week term deposits in order to absorb the liquidity stemming from the outright purchases of government securities.) As a result of the huge demand for the term deposit, the average interest rate (0.27%) of this operation was just a bit above the 0.25% that banks receive in the ECB’s overnight deposit facility. The strong use of the deposit facility by around EUR 195bn on average year to date is another clear sign of the excess liquidity in the euro area.
And yet here, it seems, are all the banks lobbying for more of that liquidity.
There’s shades of a 2008-esque solvency vs liquidity argument in all this. BNP Paribas, for instance, seems to have conflated the two while campaigning for additional liquidity, noting that:
Europe cannot afford financial asset prices to weaken as it would weaken bank balance sheets even more. Instead, European authorities should do whatever it takes to support asset prices. This strategy would avoid further write downs, reduce market volatility and allow banks to make money . . . What helped to solve the crisis in 2009 was been central bank providing currency liquidity at adequate (non penalty rates). Markets and banks are desperately waiting for this policy move.
Anyway, for those who are curious about just how much liquidity eurozone banks really need, Wednesday’s ECB operations should provide some good data points.
Watch the three-month LTRO, in particular. Here’s why, from BarCap:
There will also be interest in how much of the weekly MRO will be rolled over in the 3m LTRO conducted [Wednesday] at full allotment. In a way, this may show how much people are bidding for ECB liquidity just for hoarding (if they are happy with one week liquidity) or for real liquidity needs (if the bidding is for 3m). Our best guess is for a fairly low number at today’s LTRO, say EUR15bn.
Related links:
Those Libor laments in context – FT Alphaville
Cosmic European commercial paper – FT Alphaville
‘Heightened levels of interbank funding could be with us for some time’ – FT Alphaville