So — the ECB’s 3-month liquidity operation saw less demand than expected on Wednesday. Approximately €132bn versus consensus expectations of some €250bn, to be exact, which left markets and the euro to rally after the announcement.
Nevertheless, as Unicredit’s Luca Cazzulani warned in his LTRO guide, there are some risks associated with too little demand for the facility — specifically demand below the €140bn mark, as has transpired.
As he noted previously:
If the amount of liquidity rolled over is only 140/150bn, the Eurosystem would revert to“neutral liquidity stance”. This would have a dramatic impact on MM rates, which would most likely jump back towards the refi rate. Bund yields would also suffer, as investors would price out the recent safe-haven rally.
Which means: with demand coming in well below €140bn, so-called ‘normalisation’ of the money-markets begins in earnest on Wednesday — especially since all excess liquidity has now essentially been wiped out of the eurozone in one fell swoop.
Take for instance Wednesday’s three-month euro Libor. This rose markedly even as other rates stayed steady:
And here, for dramatic effect, is the associated chart of 3-month euro Libor:
This in itself is a reaction to rising Eonia rates (Euro OverNight Index Average) – the actual overnight euro interbank borrowing rate for interbank deals done on the day.
The rate will have been lifted by the active return of banks into the real money market, and also due to the evaporation of excess liquidity.
As Barclays Capital noted on Tuesday regarding the potential effect on Eonia:
All in all, the liquidity surplus will be substantially lower it has been up until recently, with the potential to push EONIA higher and to make it more volatile in the coming months. This should also tighten FRA-OIS spreads in near maturities. At these levels, all other things being equal, it also highlights that the market expectations of a normalisation of EONIA by end-2011 is quite optimistic (ie, late).
The crucial factor therefore comes in how those (distressed?) banks which did have reason enough to borrow from the ECB — at fairly uncompetitive rates versus what the real market has to offer — cope with the potential normalisation of wider rates.
After all, the reason the original 12-month facility worked was because it succeeded in driving down overall market rates, via the carry trade it opened up.
But now we have the awkward situation in which a two-tiered money market structure may have been developed. Those banks stuck on the ECB drip feed — and those potentially managing their exposure to those very banks.
What’s more, what does it say that the average borrowed on a per bank basis has actually doubled? Last year, 1121 banks tapped $442bn, today 171 banks tapped €132bn – which means the average borrowed by banks has gone up from €394m to €771m.
The problems in the system hence haven’t gone away — as demonstrated by those banks that see fit to use the facility–they’ve potentially just been localised.
In the meantime, all excess liquidity that was there has been sucked up completely.
Related links:
Numbers for LTRO-watchers – FT Alphaville
The €442bn question – a guide – FT Alphaville
July 1 could be the day liquidity dies – FT Alphaville
LTROpprobrium - FT Alphaville