Archive - Dec 21, 2011 - Story

As warned here repeatedly, there are only two ways of looking at today's LTRO - a risk on perspective according to which European banks will double down even more, load up on carry, and buy even more sovereign debt, knowing full well the market will eventually punish them for holding this paper, or a risk off, in which banks will shore up capital to prevent massive asset sales and equity dilution in the upcoming deleveraging wave. And with multi-billion BWICs already hitting the tape in the past week, confirming Euro banks are dumping assets, judging by the gradual blow out in European yields, finally the market has also understood that it is the latter that is happening, not the former. Lastly, as a reminder, European deleveraing needs in the "near-term" are €2.5 trillion, meaning today's LTRO barely covers 20% of total needs, and is even less if some banks indeed foolishly decided to partake in the carry trade.

Below are select knee jerk responses by Wall Street analysts, which as warned repeatedly, are broadly skeptical for one simple reason: by delaying much needed ECB intervention, which is the only "bazooka" in this case, the solvency crisis in Europe's financial core will continue to escalate until the next time around it will require far greater stop gap measures. Bottom line - this solves nothing.

UPDATE 1: Broad risk assets leaking lower now after initial positive reaction

UPDATE 2: BTPs now 25bps wider than early morning tights

With expectations around EUR300bn, the EUR489bn print is well above expectations.

• *ECB ALLOTS EU 29.7BLN IN 98 DAY REFINANCING TENDER
• *ECB AWARDS EU489 BLN IN THREE-YEAR LOANS VS EST EU293 BLN
• *ECB SAYS 523 BANKS ASKED FOR THREE-YEAR LOANS

The initial reaction seems to be risk on as EUR is rallying. Gold and Silver are also rallying. Stocks and CONTEXT rallying but BTPs not reacting aggressively yet.

The over-expectations print suggests more a safety net against short-term debt maturities than new borrowing for the carry trade (banks have been actively derisking in the last few months and we would be surprised if new borrowings were used to relever). Furthermore, the 'over' print makes one wonder how much more pickup there will be at future offerings thus suggesting the leaking wider in BTPs (for example) reflects the market's selling the news (or discounting of the flow expectations).

We assume the major peripheral banks were the most active in taking up this cheap money.

As overnight markets leg higher once again, with all risk assets correlating higher, UBS provides a Japanese perspective on the problem of European bank under-capitalization and the impact of the 3Y LTRO. Obviously the relative take-up of the 'bailout' will decide just how much 'free-money' the banks can potentially reap (were they 'ultimately' all-in enough to do the carry trade) before the EBA's capitalization deadlines, but it is clear that even in an extremely large take-up scenario (and extended deadline) - the earnings will not come close to covering bank (capitalization) needs. The Japanese rear-view mirror perspective on this is hardly supportive as the Europeans follow the same 'short-term-solutions-and-zombification-via-capital-needs-extensions' strategy which will inevitable require the investment (read bailout) of public funds (as it did in Japan in both 1998 and again in 2003). UBS recommends buying JGBs on any selling outcome from the current market's perceptions - and given the shifts in TSYs in the last two days, we can't help but want to grab some of that knife.

As strange as it may seem, the current market environment of highly correlated risk assets and surge/plunge movements in prices does indeed lend itself to the contrarian view that Citigroup's credit research group has to 'do what feels wrong' in 2012. This has proved very profitable in the last few months and they warn that the consensus view that 'its okay to miss the first leg of the rally, I'll catch the second' may be a losing proposition as the current chase we are seeing in the last few days (and saw on 11/30 for example) exemplifies the rapid one-way shifts in credit, equity, and in fact every asset class at the merest hint of solution (or problem). Citi lays out five scenarios for 2012's credit market (and the concomitant equity markets) basing their opinion on market (VIX and rate level and vol movements) as well as fundamental (the economic surprise index we have been extensively discussing), and technical (issuance and trading volumes) and see spread compensation for default as negligible and mostly prone to systemic risk which should disappear in the low probability 'very bullish' scenario. The highest probability scenario is continued sovereign stress, which we agree with, and a very range-bound trading market as systemic risk remains high (though not cataclysmic) with the floor on secular spreads notably higher than pre-crisis levels. We do wonder though when we see spreads 'switch' regimes from reflective of systemic risk to reflective of fundamental (recessionary slowdown) cyclical risk.