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Wednesday, February 29, 2012

Comparison of QE1, QE2 and ECB LTRO effects on equity

Silvio Peruzzo of RBS Global Banking and Markets talks about his expectations from the ECBs second tranche of LTRO.
Q: What do you expect will be the amounts on offer tomorrow? Many people believe it will be very close to about Euro 470 billion, that went out in the first LTRO?
ECBLendingFacilitiesComparison of QE1, 2 and ECB's LTRO - Societe GeneraleECBUsageA: That is currently an expectation. We believe the operation is going to be very similar to the first one in terms of take up although some information that we had today seems to suggest that there may be some upside still to that number. Generally, any take up north of Euro 600 billion will probably be seen by the market as a very significant size and we'll have major implication for confidence. However, anything below that is pretty much in the prices already.
Q: What are banks doing with the money that they got in the first LTRO and what are they expected to do with the money that they will get potentially tomorrow?
A: The initial reaction of the banking system was making sure that the bank bond redemptions; that they meet the funded requirement for the first quarter of this year. In fact, interestingly enough if you take what is in new liquidity out of the first LTRO, not the total take up but just word of that take up is new liquidity. That exactly matches what the funded requirement in terms of redemption pay down of the European banking system as a whole.
I think that was the first thing that banks did with that, paying the redemption, making sure they had the money. The most recent information that we have is that Italy and Spain seems to suggest that some banks are starting to use that liquidity to put in some so-called carry trades in the government bonds space or the sovereign bonds. They take cheap liquidity from the ECB they can generate some profits by holding some sovereign bonds and that has some vicious implication for the fixed income market of some Eurozone sovereign.
So going forward that would probably continue and that is why the market is taking that as positive because it is helping to mitigate the sovereign debt crisis.
Q: We have seen some of the liquidity at least sentimentally find its way back into the equity markets across the world and in commodities as well. How much of it is actually money coming out of the LTRO? How much of it is just relief that European banks are now getting the cash that they need to be able to stabilize their operations?
A: It is a combination of different factors and I would make the following point, which from a macroeconomic perspective is very interesting. I do not think that you need an LTRO or a series of LTROs to experience the risk on environment that was seen since the end of last year. A great deal of what has happened is in risky assets. It could be simply explained by the fact that we started to see a series of obsessive prices to the macro economic data that has happened certainly in the US but also in the core of the Eurozone.
Historically if you look at turning points in terms of surprise macro data, the risky assets environment has improved very substantially. The LTRO is important for the specifics of the Eurozone banking system and the sovereign crisis. Nevertheless, the macro environment in the western world has improved and that has been one of the main driving forces of this risk on return and that is our assessment. However, obviously the LTRO or the Eurozone is still in big trouble we believe.
Q: What will happen with Greek banks tomorrow considering the S&P downgrade to selective default? Will they be able to participate in the LTRO, using what kind of collateral and if they are not able to participate then what happens to the Greek financial system, how badly off will it be?
A: Ideally as far as the Greek sovereign bond collateral is concerned, there are some measures in place which European policy makers have pre-emptively aligned anticipating again the factor that rating agency were going to downgrade Greece. In fact, what is going to happen now is that the EFSF will provide the credit enhancement for the Greek bonds in the euro system and they will allow up to euro 35 billion of Greek collateral in sovereign bonds to continue be accepted in the euro system-refinancing operations.
There should not be any major fall back of this initiative on bank liquidity. There are some consequences in terms of bank financing. The Greek banks can always use the emergency liquidity assistant that the national and central bank of Greece can continue to provide. It has a penalty rate so it is going to be more expensive for Greek banks to get funding but it is still an option that they can use. I would exclude that the downgrade can trigger a dry up of funding from the central bank system for the Greek banks here.

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