When the European Central Bank announces how much cheap money banks in Europe want from its second LTRO(Long Term Refinancing Operation) at 5am ET tomorrow analysts warn that investors may use it as trigger to sell.
‘The risk is to the downside’ says Mark Ostwald at Monument Securities. ‘Like Greece, people are pumping it up to be a major event. But we still have the same risks. It’s the end of the month. With the huge gains we’ve had in equity markets and high yield debt, look for people to construct an excuse to sell and find pockets of disappointment.’
The announcement December 8th that the ECB would offer ‘unlimited’ 3-year cash at 1 percent has contributed to a two-month rally in risk assets because it shored-up banks’ medium term financing, diminishing the risk of a systemic, Lehman-style collapse in Europe. The S&P 500has gained almost 9 percent since then.
The results—rising risk appetite, tightening credit spreads and higher trading profits at investment banks—are reasons Morgan Stanley is recommending an overweight on names like Goldman , Societe Generale and Credit Suisse going into earnings season.
‘The outcome (of tomorrow’s second LTRO) will be almost be as important for the US markets as for Europe”, predicts Bank of America Merrill Lynch.
In Europe, Italian 10-year bondshave risen 9 percent, French bank Societe Generale is up over 20 percent and a 31 percent surge in Germany’s Commerzbank has helped lift Frankfurt’s Dax by 14 percent.
“There can be little doubt that the ECB’s decision to funnel nearly half a trillion euros into the Euro zone banking sector in late December had a profound market impact” says Neil Mellor at BNY Mellon. “Indeed, ECB president Mario Draghi concluded that a ‘major, major credit crunch’ has been averted,” says Mellor.
Bulls hope the banks will take-up cash beyond their own future funding needs. So that when they get the cash on Thursday they will opportunistically invest the extra in peripheral sovereign debt, further bringing down government yields. ECB figures show this same thing happened in France and Span with the first LTRO.
Morgan Stanley concludes the market has been largely supported in anticipation of a large take-up.
The most obvious trigger to sell will be disappointment on the amount of money banks say they want. That seems very possible, as some bulls tout a number of 1 trillion euros.
Not only is that number equal to 10 percent of Euro Zone GDP, it’s twice the Reuters consensus of 492 billion euros. In fact, Deutsche Bank notes whisper numbers falling to the 350 – 450 billion euro range. Bank of America Merrill Lynch predicts only 150 – 250 billion in ‘new cash’ (i.e. the actual amount by which the ECB’s balance sheet expends beyond rolling over loans).
A ‘knock-out’ take-up might also soon turn sour, raising concern the banks are too reliant on the cheap cash and engaging in activity will not prove sustainable at market prices. Inverstors may also fear that the ECB’s balance sheet has swollen to a point where its solvency is hostage to recession in the Euro-zone.
Morgan Stanley warns that the market may wake-up to the realization it’s overestimated the positive impact LTRO’s have on sovereign debt long term, having detected the law of diminishing returns operating in past ECB efforts. Bank of Americasees some banks as outright sellers of the debt they bought during LTRO 1.
BNY Mellon cautions that markets will increasingly focus on the deteriorating fundamentals for peripheral and burgeoning political risk: ‘It must be remembered that the ECB’s long-term liquidity provision is a means to an end, not the crisis-resolution ‘end’ itself’ writes analyst Neil Mellor. If that is the case, Deutsche Bank’s Jim Reid questions if the ECB can actually afford to make tomorrow’s LTRO its last: “If we’ve learned anything it’s that whenever intervention stops, the crisis slowly re-emerges.”
No one’s forecasting a market rout. “This is more about soggy auctions – taking the cream off the top” says Mark Ostwald.