Relieved at the results of Wednesday’s three-month LTRO offer? Not so fast.
We’ve noted ad nauseum that lower-than-expected demand for the European Central Bank’s three-month Long-Term Refinancing Operation (LTRO) — on the eve of the expiry of its €442bn 12-month LTRO — could hide discrepancies between eurozone banks.
Last year, 1,121 banks tapped €442bn of one-year ECB loans at a fixed rate of 1 per cent when market rates (Eonia) were broadly similar. About half of that €442bn was used for what was once seen as a ‘riskless’ carry trade; banks used ECB funds to buy longer-dated government bonds. The other half was probably used as pure bank funding.
On Wednesday, 171 banks tapped €132bn at a rate of 1 per cent, when market rates are about 0.46 per cent. And they’re probably not using that money to buy government bonds now, either.
Put simply, if 950 banks didn’t renew their requests for ECB funds on Wednesday, 171 banks did — and far above current market rates. And for something other than frivolous carry trades.
What’s more, we still have wait to see the results of the ECB’s six-day fine-tuning operation, coming up this Thursday, to get a full picture of the end state of eurozone liquidity and the future of money market rates. As UniCredit has already noted, if demand for the six-day tender is relatively high, say €100bn, there will still be excess liquidity in the eurozone. If it’s lower, say less than €70bn, there won’t be.
In which case we can expect to see rates like Eonia and Libor rise.
And now that we know we’re looking at a two-tiered existence for eurozone banks — those that can fund themselves in the interbank market and those that still have to rely on the ECB — we can guess that a rapid rise in rates could be difficult for some to take. In which case, we could still see rates like Eonia and Libor rise on fears of bank counterparty risk. It’s a tough job, this weaning-off-liquidity thing.
And, some might say, still a highly-improbable outcome.
Check out Citi’s Jürgen Michels:
The small take-up of the 3M LTRO shows that there is not huge appetite from banks for funding at 1% for three months. However, it does not mean that banks would not have appetite for ECB funding at 1% for 6M or 12M. And the result of the LTRO definitely does not mean that the euro area is ready to swallow a substantial increase in money market rates – that in normal times would be equal to two or three ECB rate hikes. Hence, in order to prevent such an increase, we expect extra ECB action, probably next Thursday.
In which case we could really be looking at onwards, upwards, forever European liquidity.
Results of the ECB’s six-day allotment are due at 10.20am London time.