Another Flashing Red Light: Euro Liquidity Shortage Leads To First ECB Sterilization Failure Since November 2011

The ECB's original bond monetization program (the SMP) may now be defunct, having been replaced with the mythical OMT which will work as long as it never has to be used (see Spain), but its aftereffects linger on. Specifically, the aftermath of the SMP manifests itself in the weekly sterilization of accrued SMP bond purchases, which at last check amounted to some €208.5 billion. Why do we bring this up? Because a few hours earlier, the ECB failed, for the first time, to find enough demand and interest to sterilize the full amount of rolling peripheral bond purchases, and was instead able to find only enough bidders, 43 of them or the lowest in a year, to "sterilize" just €197.6 billion of the total weekly allottment. The last time the ECB failed in a sterilization action? November 29, 2011, one day before the coordinated global central bank bailout of 2011.

In other words, just like last year when things were going from bad to worse in Europe, the old continent's banks are suddenly facing a major liquidity shortage, which however would not be news to anyone who read our piece from yesterday "Surge In Marginal Lending Facility Usage To One Year Highs Confirms Year End EUR Repatriation" in which we said that Europe's banks "suddenly find themselves needing gobs of liquidity - not USD-denominated liquidity, but domestic, EUR-based." Sure enough, today we just got confirmation of how truly bad this issue is.

But what makes things much worse is that sterilization failures like today are not supposed to happen in a post LTRO 1 and 2 world in which the European banks are flush with €1 trillion in excess liquidity. And yet it did.

This is how the historical weekly sterilization have looked in the past year. What is obvious is that despite our speculation that this is merely a year end window dressing event, since the last such failure in November 2011, there has been no seasonality to the Bid to Cover pattern, which instead has deteriorated in virtually a straight line since one year ago. Anything below 1.0x on the right (Bid to Cover) axis means a sterilization failure as there were not enough bids tendered to cover the full needed amount.

Here is how the WSJ described the last time, in November 2011, there was such a dramatic failure of the ECB to telegraph liquidity sufficiency:

The data suggest that banks are hoarding cash amid the euro zone’s intensifying debt crisis.

The ECB only drained EUR194.199 billion in its weekly operation, below the target of EUR203.5 billion. The target amount equals the total volume of purchases under the ECB’s program for buying euro-zone government bonds on the secondary market.

It is the first time that the ECB has missed the mark on a draining operation since May and only the sixth time since the ECB started its bond-buying program in May 2010. It is also the first time that the draining operation has failed since the ECB revived the program in August.


Peter Chatwell, an Interest Rate Strategist at Credit Agricole CIB, said banks’ concerns about collateral may have prompted them to use their cash differently than they have in the past. Banks right now may “not want to give money to the ECB when there are [treasury] bills on offer and they can be used as collateral at the ECB.”


Following the announcement of the failed operation, the euro dropped against the dollar, reversing gains made earlier Tuesday after Italy’s debt auction.

Ironically enough, today the EUR has soared in the aftermath of the sterilization failure.

Which means two things:

i) either the Bank of International Settlements is actively manipulating the EUR higher in hopes of making market participants ignore this development, as it has done in the past (documented here), or

ii) the surging EUR, as we have speculated repeatedly, is nothing but a function of accelerating asset repatriation as European banks scramble to procure EUR liquidity.

Of course by rising, the EURUSD drags higher all correlated risk pairs, which in turns sends global markets higher. Sadly, this is happening for all the wrong reasons, and reminds us of the quarterly bank DVA/CVA fudge where a bank's bottom line is better the worse a bank's current viability is (as defined by its credit spread risk).

Because what is happening behind the scenes is some confused DE Shaw or GETCO algo is interpreting yet another European liquidity shortage as a risk on signal.

Which, in turn, once again shows what a total farce this market has become.

Source: ECB


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