European Credit Signals LTRO Ineffectiveness
Blinded by the light of the European equity market, one could be forgiven for thinking that LTRO 2 has indeed had some stabilizing impact on the European (and even the world) economy market. However, just as we have been aggressively pointing out, this is not the case (or at least not a sustainable case) as we see the 'LTRO-stigma' rising - now 10-15bps wide of its post-LTRO best levels - as LTRO-behooven banks trade notably wider (worse) than non-LTRO-subservient banks. What is very clear is that European credit markets, which are now trading at their worst levels post LTRO are much more concerned at the unintended consequences of the massive subordination and dependency than the equity market appears to be. Senior financial credit spreads are underperforming as they re-price for the broad subordination that has occurred but investment grade and high-yield credit in Europe is dramatically wider today even as stocks levitate. With ECB deposits breaking records and bank funding costs rising (as opposed to the hoped for drop), it seems unlikely that all this freshly minted collateralized cash will find its way out to the real economy and do anything but further zombify European banks and implicitly drag economic growth down (as credit markets appear to be better at discounting once again).
The red line is Senior financials - notably lower (wider) and underperforming the Subordinated financials (light blue) as the entire capital structure of European banks is pushed down by the ECB. The broad credit market is very notably weaker post LTRO as opposed to the magically levitating equity market.
The last time we saw this pattern was 3 weeks ago and credit and equity converged with equity underperforming less than credit outperformed. Perhaps the fact that there is less expectation for an ECB rate cut and further LTROs around the corner means that the liquidity-driven exuberance of stocks will revert harder to the risk-aware credit markets this time.