LTRO and the Markets

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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