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LTRO Round Two

02/24/2012

Next Wednesday, February 29, the European Central Bank (ECB) will conduct its second round of Long Term Refinancing Operations (LTRO).
 
On December 21, the ECB conducted its first round of LTRO with eurozone banks accessing 489 billion euros. The success of the December round of LTRO is reflected in the repricing higher of global risk assets. Take a look at the 10-year government bonds for Italy and Spain since December 21. (Figures 1.1 & 1.2)
 
 
Two conditions contributed to the success of the first LTRO:
 
1.  The ECB lowered the credit rating threshold for collateral, specifically on asset-backed securities (ABS).

•   For the upcoming second round, seven of 17 eurozone central banks will now accept credit claims – a move that will further increase potential collateral and expand access to even more banks.

2.   The ECB provided a much needed “duration extension,” up to three years, for banks’ funding needs. This ultimately bought some much needed time for banks not to aggressively deleverage balance sheets. Additionally, it stabilized the uncomfortable decline in the value of the euro currency. (Figure 1.3)      
 
Expectations for the second round of LTRO:
 
•   Estimates of 470 billion euros for the February 29 offering are slightly below the first round of LTRO.
 
•   Italian & Spanish 10-year government bonds will be the ultimate arbitrator of round two’s success or disappointment
 
•   Of the possible 470 billion in borrowing, MOST important will be what is considered “new money:”

o   December 21: Of the 489 billion, 296 billion was existing ECB loans rolled into three-year duration; 193 billion was considered “new loans.”
 
o   Next week’s round two estimates call for 300 billion in “new money:”   

-  A higher take-up of “new money” is positive and confirms further easing of liquidity conditions and new cash available for reinvestment in higher yielding (riskier) assets.

•   Finally, a third round of LTRO has not been announced. However, I expect the recent rise in energy prices may pause the ECB from offering further LTROs. Already some ECB members have expressed concern regarding rising energy prices and the impact of further liquidity. German ECB council member Jens Weidmann recently stated “the central bank mustn’t lose sight of its mandate to control inflation by taking on excessive risk.”
 
 
Figure 1.1 Italy 10-Year Government Bond since December 1, 2011

Source: Bloomberg
 
Figure 1.2 Spain 10-Year Government Bond since December 1, 2011

Source: Bloomberg
 
Figure 1.3 Euro Currency December 1, 2011 to Present

Source: Bloomberg


 

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