How much will be tapped at this month’s ECB three-year LTRO operation?
Estimates are increasingly being revised lower.
One reason is that there are plenty of indicators to suggest that funding taken at the last operation in December has yet to be invested and that excess liquidity prevails. And we’re not just talking about the use of the ECB’s deposit facility.
Another case in point is the take up of the ECB’s reverse liquidity operation (used by the ECB to drain SMP purchase-related liquidity) where overbidding has become increasingly common.
Nomura’s Guy Mandy spells out the situation in a note on Monday:
These represent a significant level of funds looking for longer maturity higher yielding returns, and importantly that are not earmarked for usage for one week (at minimum). If the ECB drained this liquidity via the provision of debt certificates of varying maturities, it would push high quality collateral into the market which would help facilitate an increase in interbank lending. Meanwhile, Eonia yields are above those in 2010, despite greater levels of liquidity in the system. This partly reflects the distinction between uncollateralised deposits with a “riskless” ECB, and with a “risky” Eonia facility. Without fresh liquidity measures, such as debt certificates, we think the additional liquidity provided by the next LTRO is not likely to influence Eonia significantly, but if there was no functioning wholesale funding market bank credit could become more stressed through the year, which could lead to Euribor widening.
That’s to say, banks picked up a helluva lot of excess ‘just in case’ liquidity which is now being routinely pumped into the ECB’s sterilisation ops — and locked up for at least a week in the process — because the facility provides for the best use of funds for now.
None of this is helping the Eonia rate, which is still deemed risky in the grand scheme of a collateralised (rather than uncollateralised) lending regime. Hence Mandy’s call for debt certificates. Not only would these provide a useful place to park excess liquidity for now but, as Mandy also notes, they’d go some way towards resolving the shortage of “safe assets” in the Eurozone.
After all, who needs more unproductive excess liquidity?
With regards to the scale of the overbidding that’s taking place at SMP sterilisation operations, check out the grey shaded area below:
As Mandy comments:
Bids in last week’s ECB reverse liquidity operation to drain SMP purchases amounted to €352bn to drain €219.5bn, showing €132.5bn in additional non-invested liquidity. There is clearly a significant level of incremental liquidity since the December LTRO that is not being invested or utilised for productive purposes. This also lends weight to the argument that expectations of a significant uptake at the next LTRO may be overstated.
Which is why he makes the following case for ECB debt certificates (our emphasis):
In our view the ECB should be facilitating funding rather than replacing it, with one area it could influence being the short term repo markets. At the moment general collateral repo is trading rich partly due to the level of Eonia, but also the availability of high quality collateral. The difficulty in engineering an increase in high quality collateral in Europe, as the US Fed did with the TSLF and SFP programmes where Treasuries and T-bills were used, is that Europe is disaggregated without a single pan-euro instrument.
Therefore a replacement instrument is needed. We think ECB debt certificates (DCs) could fulfil this purpose (see also Funding tensions require ECB action – 7 December 2011). The ECB could replace the 1-week SMP facility allotment amount with one week DCs, and offer up to one month and/or longer DCs to drain additional unproductive liquidity. This could go a long way to cheapen secured funding in the market. While we realise this may be just an incremental measure, we also do not see there being a single overriding solution to the euro area problems.
Previously liquidity was used to help explain the differential between the ECB refi and Eonia. Given the amount of liquidity in the system this is now a comparison of uncollateralised deposits between a riskless (ECB deposit facility – an effective market rate floor) versus the “risky” (Eonia) facility. While the riskiness of Eonia should not necessarily be overstated, it does still have a credit element given its unsecured status, which, given the weaker state of the banking sector, may be one reason why it is trading higher than levels in 2010 despite current liquidity levels being higher. Risk is clearly reduced by the decrease in default probability of banks within a system where the central bank is injecting liquidity. That said, the general banking earnings topography looks somewhat uneven, which may keep the rate on a higher floor vs. 2010.
All in all, very logical thinking we would say (especially, the bit about the lack of a single pan-euro instrument).
After all, while an ECB debt certificate wouldn’t be a definitive replacement for a Eurobond, it would definitely go some way to bringing uniformity to the eurozone collateral markets. A nice side benefit, meanwhile, would be that banks could use the certificates to raise funds against as and when needed — though this time in private secondary markets (hence weaning themselves off ECB assistance).
And that, ironically, would help the ECB regain even more control of European money market rates.
Related links:
On a negative deposit rate at the ECB - FT Alphaville
The curious case of ECB deposits – FT Alphaville
Why France could be on the wrong side of the Eurozone crisis - FT Alphaville
One Eurobond to rule them all - FT Alphaville