European Interbank Lending Conditions Deteriorate Fast Post Latest Liquidity Withdrawing LTRO Roll
A week ago we asked whether "Europe was getting ahead of itself as excess cash in the euro banking system drops to post-Lehman low" following the most recent LTRO roll. In it roughly €225 billion in 3,6 and 12 month liquidity providing ECB credit
facilities to Eurozone banks expired and were rolled into a far lower
amount of replacement maturities: only 64% of the full amount was
retendered, meaning about €80 billion in system liquidity was drained. As we then assumed this action was nothing than a myopic attempt to put some lipstick on the slaughtered European banking pig, which in exchange for demonstrating that it has liquidity matters under control was willing to cut its excess liquidity buffer to almost zero. Sure enough, the market now seems to agree. As the chart below demonstrates, virtually every unsecured funding metric has exploded since the action, with the rate on Commercial Paper nearly doubling from the pre-LTRO days, while three month Euribor has once again surged to just under 1%. In other words the market is making liquidity provisioning for European banks very costly, and a threshold may soon be passed when it is cheaper to borrow via the Fed's currency swap arrangement than approaching the interbank market, once again confirming that while the ECB is backstopping all the financial activity in Europe, it is the Fed which is on the hook should the ECB fail.
Even JPMorgan looked at this liquidity disruption negatively:
Is this week’s sharp decline in the excess cash sustainable? The availability of unlimited liquidity at the weekly operation combined with this week’s sharp rise in interbank rates, is likely to trigger some speculative borrowing from the ECB over the coming weeks, but this is unlikely to be large. The main lesson from the expiry of the ECB’s long term operations, both this week and last July, is that the withdrawal of long-term ECB funding discourages speculative activity by core banks and this pushes the excess cash in the Euro area banking system to a new lower range, only modestly above zero.
The market has now spoken and is again forcing European banks to drop the farce, and go back to suckling at JC Trichet's teat as they are so experienced at doing.