NEW YORK, Feb 27 (IFR) - It’s a big week for risk markets as we get another (and likely final) installment of the ECB’s 3-year LTRO, where we expect take-up to be around euro 500bn. Unlike in December when the liquidity helped to mitigate concerns over tail risk, the impact this week will likely add a kicker to markets already flirting with risk-on.
LOOKING BEYOND THE HEADLINES: The December 3-year LTRO might have had a size of 489bn, but the actual net new liquidity add was only 193.4bn, because some 277bn of liquidity was shifted from shorter-dated operations to the new 3-year. This week there are some 253bn of liquidity operations maturing, and in addition we have a special 1-day operation. The allotment at the 3-year LTRO needs to be adjusted for how much is rolled from the maturing operations to get a better idea of the liquidity add. It seems likely that net new liquidity will be greater than the 193.4bn that was allocated in December.
INTERPRETATION WILL BE POSITIVE: Market sentiment is thus that whatever the size of the allocation, it will interpreted as positive for risk markets. A higher-than-expected allocation will see a focus on the liquidity impact for risk markets, while a lower-than-expected allocation will be viewed as a sign that eurozone banks are seen as less risky. This is the setup of the market that has moved from pricing out the tail risks (especially on a Greek default) and has been grudgingly forced to focus on pro-risk trades.
NOT EVERYONE LIKES TO PARTY: When the music is playing it seems that some people just have to dance, and the longer you stay on the sidelines the more tempting it becomes to throw away your inhibitions and join the party. Monetary easing from the BoE (a further GBP 50bn QE), BoJ (additional JPY 10tn in QE) and the Fed (lower for longer on Fed Funds as well as continuing QE) has made sure that a drying punch bowl has once again been filled to the brim. The fact that volumes remain low suggests that participation remains low, and there are still plenty listening to the music and not yet dancing.
Unlike Q1 2009, the markets are aware that a liquidity-fueled binge on risk can be damaging to P&L and are more cautious. However, the ECB’s LTRO could help to add a larger kicker to risk assets, especially as stock indices have shown little intention to correct, preferring instead to move sideways before the next small leg up. The longer this continues, the more difficult and uncomfortable it becomes for players who had dived into safety and liquidity to remain on the sidelines. (Divyang Shah is a global strategist for IFR Markets)