Funding Squeeze May Haunt Europe Again: Strategist

Key indicators are showing heightened risk of another "funding squeeze" in Europe despite action by the central bank to pump more than 1 trillion euros of cheap loans into the region's lenders through its longer-term refinancing operation, Patrick Perret-Green, head of FX & rates strategy for Asia at Citi told CNBC on Tuesday.

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The EURO STOXX Banks Index has fallen 19 percent from February's highs, Perret-Green noted, while a proxy for the cost of inter-bank borrowing, the three-month Libor-OIS spread, was at risk of widening.

Although the banks index is looking oversold from a technical perspective on the daily charts, Perret-Green said the weekly chart looks "dire." Such indicators point to "a growing risk of another funding squeeze, irrespective of what the central banks may try to do."

Spanish bond yields and credit default swaps are also showing signs of stress with borrowing costs for benchmark Spanish government debt jumping to five-month highs as the "euphoria" generated by the LTRO wears off, Perret-Green said.

The country's apparent inability to control its fiscal deficit - which was 2.5 percentage points higher than its target last year - and its decision to raise this year's target shortfall to 5.3 per cent, from 4.4 per cent, has unnerved investors, Reuters Breakingviews reported on Monday.

Bilal Hafeez, Managing Director and Global Head of FX Strategy Deutsche Bank believes residual risks remain even as the market seems to be more confident about the debt crisis. "I think the issue with Spain is that they did miss their fiscal target for last year and they didn't really announce how they're going to address that until very recently."

Political Cycle

European politics could provide another source of uncertainty for markets, strategists said.

The eurozone crisis is overshadowing France's presidential election, with President Nicolas Sarkozy using the launch of his campaign manifesto to accuse François Hollande, his Socialist rival, of threatening the country with the fate of Greece or Spain, the Financial Times reported.

Casting himself as the guardian of budgetary rigor and economic reform, Mr Sarkozy said it would take just two days for financial markets to turn on Hollande's "festival of spending plans" if the Socialist leader beat him in the election, which takes place over two rounds on April 22 and May 6, the FT said.

Meanwhile, the popularity of Greece's two mainstream political parties, which have backed the country's coalition government, fell to a new all-time low, according to poll results Monday, just days before the official start of the campaign for the country's national election, Dow Jones Newswires reported.

According to the survey, conducted by pollster GPO for TV channel Mega, the conservative New Democracy and Socialists (also known as Pasok) combined would still command just 32.4 percent of votes, while six other parties would also be represented in parliament. About one out of three voters doesn't intend or hasn't decided who to vote for.

Based on the poll numbers, it appears that the election to replace the current caretaker government could yield a fractured result that would require the creation of a multiparty government to follow through on promised changes to continue to qualify for a new 130 billion euro bailout package from international lenders.

A small makeshift bomb exploded on Monday outside a branch of a Greek ministry tasked with cutting 150,000 public sector jobs by 2015, causing damage but not injuries, police said.

"My growing concern is the politics," Perret-Green said. "The French Presidential election is not getting enough attention...(Francois) Hollande's proposals look awful while Sarkozy's aren't enough. And the Italians are backsliding on reform."

Robert Rennie, Global head of FX strategy at Westpac Bank agreed that funding strains could resurface not only because of risks associated with Presidential elections in France but also because of Greece, especially if the opposition wins a mandate and rejects the austerity program and spending cuts pushed through by the coalition government, led by technocrat Prime Minister Lucas Papademos.

"The political cycle is one that's very much going to bring that to the fore," Rennie told CNBC's Squawk Box on Tuesday. "I think we've quietly forgotten about this and I think this debate we've had around the Fed minutes means we're all thinking about U.S. monetary policy but over the next couple of weeks we're going to be thinking about the European political cycle and the state that the Spains and Portugals are in."