Optimism Is Over Ski Tips On LTRO

No Current Positions in Europe in Hedgeye Virtual Portfolio

 

While yesterday European equity markets ripped ahead of today’s opening of the ECB’s first 3YR Long Term Refinancing Operation (LTRO) facility, with 523 banks expected to take up €489 billion in loans at 1% (vs initial estimates of €293B from Bloomberg and €310B from Reuters), European equities have turned down today and sovereign yields actually increased day-over-day.  (Italy’s 10YR rose 20bps to 6.85%; Spain’s 10YR rose 6bps to 5.16%; and the Greek 10YR gained over 100bps nearing 36%!)

This is an initial indication that the LTRO will not be the panacea that the market had hope for yesterday. What a difference a day makes!

While we’re bullish on the LTRO as a facility to help reduce risk by providing more liquidity to European banks, we’d caution against an absolutist view that banks will be buying all European sovereign paper issuance going forward as they’ll stand to benefit from the carry trade, or spread. After all, these same banks have taken significant measures to sell their Europig debt holdings in the last 6-12 months. Why would they jump back in now? 

A more likely scenario is one in which banks look to take care of their own houses first before looking to participate in sovereign bond buying. European banks have an estimated €230 Billion maturing in Q1, or around €720 Billion in 2012, to meet. In this light, we’d expect the ECB’s SMP secondary bond purchasing program to remain critical to arrest sovereign yields, especially in the periphery, despite mandates from the ECB that it is meant to be a temporary facility with limited firepower. To date, the SMP has purchased €211B.

In the face of the inability to lever up the EFSF and no change on the ECB’s position to print money, we do think the opening of ECB’s LTRO facility is bullish, yet we don’t think we’re going to cross some magic bridge that will firewall the major issues. We’ve yet to see one or a collection of definitive programs to really put an arrest to the sovereign and banking crisis in Europe.  The Fiscal Compact of the December 8-9 Summit meeting still leaves a lot of questions unanswered, and the sovereign and bank downgrades of the ratings agencies (though lagging indicators) will continue to drag markets lower. Therefore, we do not expect to see sustained European capital market gains over the intermediate term. 

We’d short the EUR/USD on any bounce to $1.33. 

Matthew Hedrick

Senior Analyst