The biggest surprise of Thursday’s trading session?
The strength of the euro — particularly against the dollar.
And that trend is continuing on Friday morning:
The mainstream media are pinning the rally/dead cat bounce on two factors: the ‘successful’ Spanish bond auction (success in this case means they got it away); and fears of a double-dip recession in the US, with all the unpleasant consequences that would entail for the budget deficit.
But there is another more complex factor also helping to push the euro higher.
According to Greg Gibbs of RBS, it’s the rollover of the ECB’s €442bn 12-month LTRO:
The ECB’s money market operations have effectively delivered a significant tightening of monetary policy especially when compared to the effective easing of policy that has occurred in most other economies over the last month.
The result has been a substantial rise in the EUR yield advantage that the market has not been able to ignore.
The ECB policy of shifting the slide-rule on their 1% rate from 12mth to 3mth terms has lifted the overall money market yield curve. The 1% benchmark rate level now means more to where short term money market rates trade.
With less term funding, this has put upward pressure on all yields across the front end of curves. 2yr bund and swap rates rose a further 7.5bp today. Over the course of the last month, the USTr-Bund 2yr yield spread has moved in favour of the EUR by over 30bp to +5bp. The 2yr swap rate spread has moved up by 35bp to +44b in favour of the EUR. In a global environment of falling yields over the last month, EUR’s yields have risen against virtually all comers. The chart below shows the EUR/USD compared to the 2yr yield spread.
Of course, a strengthening euro yield advantage or not, is something of a double-edged sword.
It might help boost confidence in European debt markets, but ultimately a weaker euro is needed to support growth in the region — something which is going to be yearned for as austerity packages kick in.
However, Gibbs reckons the ECB sees things differently:
It is not clear that the ECB has deliberately set out to raise borrowing costs, but perhaps they see this as a step that offsets the shift towards buying periphery government bonds. They think they can afford to be a bit tougher on the money market side since they have become easier on the asset support side.
A tougher ECB. Who knew?
Related links:
The cost of normalisation – FT Alphaville
More please … the 12-month LTRO roll-over ain’t over yet – FT Alphaville
Singing’ a liquid tune – banks tap €111.2bn from ECB six-day op – FT Alphaville