Post-ECB Boost, Will the Risk Rally Continue?

The European Central Bank’s second mass liquidity injection into the European banking system should help the risk rally continue in the short-term, but has not erased long-term concerns about the euro zone, investors and economists told CNBC Thursday.

Euro bills and coins in cash register tray
Euro bills and coins in cash register tray

After moving up following the announcement Wednesday, European markets fell later in the day when Federal Reserve Chairman Ben Bernanke dampened expectations for more quantitative easing.

The price of gold, traditionally a safe haven for investors hiding from risk, had its biggest drop in three years Wednesday.

“Markets have had a good run and reached an interesting technical junction,” Nancy Curtin, CIO, Close Brothers, told CNBC.

“I think if good news continues, the rally could have another 10-15 percent from here.”

The first three-year Long Term Refinancing Operation (LTRO) in December was followed by a stock market rally and a return to riskier assets, after the losses in the latter half of 2011, as it eased concerns about the state of the European banking system.

Critics point out that its effects have not yet been felt on European economies. The euro zone is expected to fall into recession in the first quarter of 2012, after growth shrank in the last three months of 2011.

“A lot more money is going to be sloshing around that has to find a home. I fear that it will go more towards risky assets,” Simon Smith, chief economist at FXPro, told CNBC.

“December was about balance sheet repair but this time around there’s very little control. You have to cross your fingers and hope banks take the right decision in terms of long-term sustainability.”

He predicted that the euro would fall to around 1.20 against the dollar over the next three to six months as optimism about the US economy continued.

“There is some sense in the US that QE is working. In Europe, these banks are still needing to recapitalize and refinance, and leverage ratios are still quite high,” Curtin said.

She added that cyclical companies have been quite oversold and predicted some “cyclical respite” this year as the appetite for risk returns.

"The LTRO is in danger of hardwiring the fragmentation of the EU banking system which is already underway by making the ECB the de-facto market maker of last resort intermediating between banks in Germany and those in Italy and Spain,” Sony Kapoor, managing director of think-tank Re-Define, told CNBC.

The large number of banks – 800 – which took up the second round should be “encouraging” for the real economy, as it indicates that a lot of smaller banks took up the funds, analysts at Barclays Capital wrote in a note.

“For the banks who do have market access, the market funding will be more easily available and cheaper; for those banks who had limited market access, we suspect market access will remain difficult, but the ECBfunding is now providing a viable medium-term alternative,” they said.

“The generally positive mood in risky assets - which has been helped by the LTROs as well as a number of other factors (including the economic data, and investor positioning) - is likely to continue.”