Veritas – Why LTRO is a mixed blessing

Traders know: ‘do not fight the Fed’. As Europe’s Central Bank opens its second tranche of cheap three-year loans to eurozone banks this week, traders will not punt against Frankfurt, either.

Since 523 banks borrowed a headline figure of nearly €500bn in the first ECB loan tranche in December, that sector’s shares have risen about 25%, outpacing the broader market by 11%.

The iTraxx index of senior financials narrowed from about 250bps over at the start of December, to nearer 200bps over recently.

And as banks put their newly borrowed cash in domestic sovereigns, spreads on the front end of the Italian debt curve came in about 440bps, and 410bps for Spain.

Ahead of this week, Morgan Stanley analysts suggested equity trades on ‘national champion’ banks.

Selective sovereign debt may be interesting if – as Morgan Stanley expects – banks just over double the amount (approximately €54bn) of LTRO-cash they already parked in Italian and Spanish debt.

And with the massive stimulus – analysts widely expect Tranche II usage to nearly match Tranche 1 – ‘short euro’ seems logical.

One thing to bear in mind, though: if newspaper headlines speak of €500bn more usage in LTRO II, then remember the ‘actual’ statistic for LTRO I was not €489bn. It was “closer to €80bn”, after deducting loans that were existing loans simply transferred into LTRO, and usage by non-listed banks and other bank-license holders, according to Credit Suisse bank analysts.

They said: “The facility is getting the market’s attention and is being seen by some market participants as a game changer [but] it is important to note that in reality large parts of the European banking system have already been using ECB liquidity facilities for some time.”

So is LTRO a ‘genius stroke’, as one fixed income fund manager said last week, or is it a good idea but with potentially dangerous outcomes?

The answer is, ‘both’.



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