IFR Comment: Play flatter curves on €1trn Feb LTRO allocation
Divyang Shah, Senior IFR Strategist
The FT reports European banks may raise almost €1trn from the ECB at the three-year LTRO on February 29. While the December LTRO managed to raise some €489bn, we must keep in mind that after other shorter dated liquidity operations are taken into account, the net increase in liquidity was €193.4bn.
Analysis from the ECB shows banks’ bidding behaviour at the last three-year LTRO was positively related to rollover needs in the next three years, and negatively correlated to the residual maturity of outstanding debt (see “ECB - More colour on 3-year LTRO allocation”; Jan 19). This is likely to still hold as banks look to get ahead of their funding needs, and the liquidity also trickles down to sovereign debt.
Fat tail risk has been taken care of, and while solvency concerns remain, the liquidity has bought more time. Along with talk of an enlarged firewall we could see much flatter curves on Spain and Italy
Spain has been most active in taking advantage of the LTRO, with auctions already this month helping it meet 20% of its gross funding needs for the year. Other countries have been more measured, but the key is that the liquidity has been working its magic. The market may then be surprised as another strong allocation at the next three-year LTRO would have a very significant positive effect for risk-on.
The FT story is based on what the Eurozone’s biggest banks have said, suggesting they could “double or triple their request for funds”.
“Banks are not going to be as shy second time round,” said the head of one eurozone bank at last week’s World Economic Forum in Davos.“We should have done more first time.”
What is interesting is that banks seem to have shrugged off the view that excessive reliance on the LTRO is a bad thing, and it is interesting that the ECB seems to be helping foster this view.
Under Trichet the message was that the liquidity was temporary and for an emergency, but this sentiment does not seem to hold true anymore as the LTRO is now seen as a free-for-all. A strong uptake at the LTRO in February will only widen the gulf between other peripheral countries with Greece and Portugal.
Fat tail risk has been taken care of, and while solvency concerns remain, the liquidity has bought more time. Along with talk of an enlarged firewall we could see much flatter curves on Spain and Italy. We would once again look to play for flatter curves on Spain and Italy from the current 2/10yr slope of 222bp (stop at 245bp) for Spain and 225bp (stop at 250bp) for Italy respectively, looking for a move back down below 100bp for both.
