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LTRO and the Markets

MacroAndCheese's picture
Submitted by MacroAndCheese on 02/18/2012 12:29 -0400



 

So far, LTRO has played out so much like QE II in particular (QE I took place in so much chaos that it was hard to judge the impact) that it's almost hard to believe. The following graphs show just how similar the two programs have been. Moreover, not only has the reaction been similar in terms of the programs' respective markets, but also the impact has been felt in nearly identical ways on both sides of the Atlantic.

S&P QE2

The chart above shows the S&P 500 from the time of the famous Bernanke speech at Jackson Hole on August 27, 2010. Although QE didn't start until that November, the market rose dramatically in response to the expectation.

 S&P LTRO

Above is the same S&P 500, this time in response to LTRO, the European equivalent of the US's QE II. As you can see, so far the reaction is nearly identical. LTRO was initiated on December 21, 2011.

 DAX QE2

But QE II and LTRO were not just US affairs, of course. The German DAX (above) had a nearly identical reaction to both measures. We see that although the DAX during QE II was a bit choppier, the overall impact was very similar.

DAX LTRO

Here we can see the effects of LTRO in its true QE-like form. The market has been moving relentlessly higher, irrespective of news and economic data releases. Since the December 21 LTRO initiation, the Dax has risen more than 18.5%.

Crude QE2

QE II impacted not only stocks but also all commodities, including crude oil. (In fact, one of the criticisms of QE II was its impact on the cost to consumers of gasoline, foodstuffs, etc.) Here crude oil has risen by about 15%, very similar to the stock markets.

Brent LTRO
The price of brent (the European version of our West Texas) has risen steadily from the December 21 start of LTRO. Here the price is denominated in euro to more fully reflect the impact on European consumers.

(Bloomberg is the source of all data used in the graphs.)

ECB President Mario Draghi has announced two tranches of LTRO, the first having taken place in December as noted, and the second due on February 29, in less than two weeks. Draghi has bent over backwards to ensure maximum participation, including very materially relaxing collateral requirements. He has also arranged for the passing the credit decision down to the central bank of the country of origin of the borrowing bank, where the collateral can be held.

Although the most recent LTRO II size talk is of a deal somewhat smaller than the first one in December, I would be surprised to see anything but a larger number. First, let's remember that the size of the program is unlimited, or "full allotment." Second, we have seen that Draghi's intention is to push as much liquidity into the system as possible by relaxing credit standards down to the bare minimum. Third, despite official denials, there seems to be a tacit wish on the part of the ECB that banks use this opportunity to purchase more sovereign bonds, to help fund cash-starved peripheral Eurozone governments. French President Sarkozy has encouraged banks to do so.

The difficulty as always is trying to forecast the reaction of the markets. Given the rally we have seen from mid-December, it is certain that much of the impact of LTRO has already been priced in. In the near term, it would take a very large LTRO operation to significantly move the market higher, while a package on the order of the EUR 300-500 billion currently expected would probably disappoint.

We should keep in mind that in the case of QE II the market did in fact "buy the rumor and sell the fact," with a long rally from August 2010 into that November when QE II was initiated, followed by a correction of about 4% immediately afterwards. Over the three months that ensued, however, the S&P began a second leg, rising nearly 15% more. Despite the numerous headwinds out there, bears need to be nimble, and ready for the possibility of higher highs. Bulls have the wind at their backs, though this market is too rich for my blood.

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Wed, 02/22/2012 - 04:37 | 2184000 sikefeier0728
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Sat, 02/18/2012 - 17:26 | 2173613 hyper-critical
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Great post. I think people who expect "QE's" to have the same effect on markets over and over again are going to be sorely mistaken. Conversely, I think people who think at some point the system is going to acutely implode are going to be wrong as well.

Markets and the economy are way more complex than that, and it's refreshing to see an objective analysis of our present situation from someone who is honest about his uncertainty of how things will play out going forward.

For the first time in years, last week the currency markets looked like actual markets...it wasn't purely a 'risk on/risk off'-dollar up/dollar down situation. So refreshing. Though I don't expect 'real' markets to return in earnest until after the deflationary re-start occurs sometime in the (potentially distant) future, it gave me hope that at some point during my lifetime they will rise again.

MacroAndCheese - definitely adding your blog to my list. Cheers Tyler.

Sat, 02/18/2012 - 18:28 | 2173718 MacroAndCheese
MacroAndCheese's picture

Thank you for your support Tyler.  It's frustrating, I like having a view even if it's wrong, and though I'm a small short the QE stuff is not something to take lightly.  I use a lot of models and indicators I've developed over the years, and during QE II they just flat out stopped working.  I'm seeing that again, though this time out I understand why.  I'm not alone either, I know that other teams are having the same problem.  So for now it's stay small, live to fight another day.   Cheers     SJM

Sat, 02/18/2012 - 15:58 | 2173374 JohnKozac
JohnKozac's picture

This flood of money will gadually trickle into a gradual surpra-inflation pattern in prices---food, metals, oil, gas, etc.

Increase the money supply always increases prices as it circulates through the system (paraphrasing Murray Rothbard):

 

http://www.amazon.com/Man-Economy-State-Murray-Rothbard/dp/0945466323

 

Sat, 02/18/2012 - 13:58 | 2173077 Manthong
Manthong's picture

So who wins the race to the bottom?

Don't you think Japan has an unfair head start? 

Sat, 02/18/2012 - 13:52 | 2173064 MarkTwainsMustache
MarkTwainsMustache's picture

What happens when LTRO or QE has the opposite effect on markets?  Convenient for you to leave out Japan's QE effects which were (and continue to be) nil.  People that believe that stock markets are the result of something so negligible as liquidity are being too naive in my opinion.  

Sat, 02/18/2012 - 17:05 | 2173561 disabledvet
disabledvet's picture

this is the interesting part in my view. first off if liquidity dries up (as happened after Japan QE'ed) then you really do get a depression--so you undermine your argument. leaving that aside however i now agree "plunging the interest rate is just the beginning of the battle." at some point "risk" in the form of "confidence such that the private sector will start lending again" must return--and return to scale. In the USA that's pretty simple: equity markets. If that thing shoots higher then private sector lending has returned--and should the cost of capital remain "at or near zero" as it does so...then "only the mere taxpayer has born the brunt of the attack." Fast backward/forward to Japan/Europe. Both suffered identical problems to us: massive real estate speculation. In Japan we're talking Tokyo, in Europe we're talking PIIGS. Japan understood our Great Depression very well when they "collapsed their market"--as it turned out though their response still failed as the bulk of the population moved to Tokyo "where all the action is" and the bulk of production still ended up being outsourced to the rest of Asia. This is not for lacking in innovation mind you--look at how much Japanese we use in our lives--televisions, cameras, cars, motorcycles: best of the best. Scary when you think about it: "still not good enough." In short "no end user demand." I think the same thing will happen in Europe. All this mercantilism creates a poor consumer class. Chairman Bernanke realized this...has refused to let the banks pay out a dividend...and bascially ordered them to restore credit growth "via the Fed window." Obviously this has been..."GREAT"...news for government borrowing...as those interest rates have plunged and programs have been maintained...for now. that is all changing now tho...as bascially the entire system in order to function must restore consumption patterns and to do so must start hiring and putting people back to work. is it working? the stock market sure thinks it is. I don't know what Trichet was thinking when he did nothing. He basically blew up the entirety of the European financial system "and called it winning." Needless to say "Draghi did a 180 degree turn times a trillion." I don't see how the center holds because "cramming austerity down Greece's throat" is one thing...Spain and Italy? I don't think so. We'll see if "the center can hold"...but i see "beyond American style unemployment issues" (which are already there in Europe btw) really starting to take their toll on the various Governments of the Union. We talk about "the unfairness of it all" here in the USA...but there are historical animosities at work over there...stuff that simply cannot be contained as they are "over here." (Here the PTB--the Propagandists mainly--simply buy the politicians and tell them "do this, do that." The Federal Government on the other hand...that thing is HUMONGOUS. Again "i see the Peregrine Falcon winning on this one."http://www.youtube.com/watch?v=j3mTPEuFcWk&feature=player_detailpage

Sat, 02/18/2012 - 13:27 | 2172994 maxw3st
maxw3st's picture

Excellent collection of charts showing the QE effect of LTRO. Interesting that HFT's have continued to run up the Euro and Aussie, in lock step with the S&P, despite the obvious devaluation of the Euro that's in fact going on. Despite the obvious benefits to banks of this QE, there is no likelihood that the increased liquidity they are enjoying will end up in increased growth for the EU. The concurrent run-up in oil prices on both sides of the Atlantic is more than enough to smother any benefit to any industry other than oil. For the rest, increased oil prices will more than offset any prospective stimulative effects. In short, EU's version of QE will dilute the value of the Euro, increase profits for the banking system and oil industry, and be a drag on income for everyone else-corporations and individuals alike. Increased prices at the pump come straight out of demand for all other consumer based spending.

Sat, 02/18/2012 - 13:47 | 2173051 MacroAndCheese
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It also creates the ever-popular zombie institutions by propping up many banks that should be heading off to the glue works.  That same mentality was alive and well in Japan all through the '90s and naughties.

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