Archive - Dec 28, 2011 - Story

• BRIC Decade Ends With Record Fund Outflows as Growth Slows (Bloomberg)
• U.S. says China not currency manipulator; chides Japan (Reuters)
• Japan Deflation Returns as Production Slides (Bloomberg)
• Record use made of ECB deposit facility (FT)
• Irish May Pay Greek Price for T-Bill Market Return: Euro Credit (Bloomberg)
• Italian 10-Year Bonds Rise, Stocks Advance After Debt Auction (Bloomberg)
• Obama to nominate economist, banker, as Fed governors (Reuters)
• Japan relaxes weapons export ban (FT)

Despite European banks hoarding cash at the ECB at record levels as observed previously, Italy succeeded in selling ultra short maturity debt earlier today at interest rates that confirm Europe has managed to stabilize near-term expectations. Specifically, as Reuters reports, Italy sold 1.7 billion euros of 24-month zero-coupon bonds on Wednesday at an average 4.85 percent rate, sharply down from an auction yield of 7.8 percent a month ago.  The Bid to Cover was 2.24 compared to 1.59 previously. Nonetheless, this amount was less than the maximum 2.5 billion euros targeted at the auction. Italy also sold 9 billion euros of six-month bills at an average yield of 3.25 percent on Wednesday, half of what it paid a month ago to sell six-month paper at a bid to cover of 1.69 compared to 1.47 previously. Lastly, the fact that Italy can place debt in under 2 years when the LTRO itself has a 3 year maturity means that the real issuance test will come tomorrow when Italy is on deck to sell 3 Year bonds. As for 10 year BTP, which were trading at over 7% as recently as overnight, that is a different story completely.

If there is anything that the European banks' negative response to the LTRO's invitation to use "free money" and relever even as Europe faces a perfect storm of deleveraging in 2012 (a topic beaten to death by us here previously) is that the problem at the root of the European financial crisis is not a liquidity one - it is, and has always been one of solvency, or, said otherwise, a problem when bank assets do not generate enough cash flow to satisfy cash outflows from bank liabilities, period, the end. Everything else is irrelevant. And while the market is fascinated in complete noise such as at what price will Italian bonds price in minutes, what the real focus should be on is the state of the primary driver that led Europe into (and eventually will take it out of) the credit bubble- housing. Today, Bloomberg provides a quick update of the Spanish housing situation which can be summarized as follows: horrible and getting much worse, because as October data shows, lending has imploded, down nearly by half just from a year earlier, while the average price is down over 7%.

While sovereign spreads are leaking modestly tighter this morning as European credit markets emerge from the holiday hibernation, the ECB Deposit Facility surged 10% further to a LTRO-busting EUR452bn. While we assume there is some year-end 'management' involved here (and some will argue that putting the LTRO-carry-trade to work takes time), the sheer velocity and scale of the ramp in deposits suggests this is not a game-theoretically optimal use of this new-found cash (neg-carry-trade) but instead a clear message that banks will delever and remain risk averse no matter what the central banks 'suggest' is appropriate. Didn't we learn this lesson already in Japan (for two decades of debt minimization as opposed to profit maximization) and the US (Fed reserves skyrocketed as dealer bond inventories drop precipitously?). Also, those saying that banks are just waiting for the new year to start putting LTRO cash to use, there is no reason to wait - Italian BTPs are already at 7% - all banks are doing by delaying is giving up on days of free carry trade, thus this argument is pure rubbish. We are also seeing EUR-USD basis swaps starting to decompress (worsen) once again. In summary: since LTRO day, EUR187 billion of the 210 billion free money has been redeposited at the ECB.