Size does matter apparently

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It’s probably somewhat fitting that the new LTRO lending operation from the ECB to the continent’s banking sector comes on a year which most people view as a bonus and is full of strange traditions. A woman may propose to a man today apparently while in Greece today is seen as an unlucky day to marry; there’s a lesson in there somewhere.

The first LTRO or Long Term Refinancing Operation saw 523 banks borrow a total of EUR489bn and is largely responsible for the rally in financial markets since the middle of December. Equities have moved higher as risk sentiment has increased while bond yields for peripheral sovereigns have dropped dramatically as banks have used these loans to invest in carry trades. A “carry trade” is when one borrows money cheaply (from the ECB at 1%) and invest it in European debt for a return of 3-5% making the difference in-between. The fact is that given the way bond markets work, the increased demand for these bonds have seen the yields fall and therefore their attractiveness as an investment also falls. So where will the money go? Back to the ECB likely.

We must also be fully aware that these liquidity operations are the European quantitative easing (but instead of the central bank buying assets it is lending money to banks to do so) and therefore this is not a panacea for Europe. Liquidity can lead to solvency, which is the sovereign problem, but these bond movements are curing a symptom of the problem and not the underlying disease.

So what effect will this auction have on the markets? Consensus of the lending figure is around EUR500bn with expectations as low as EUR200bn and as high as EUR1trn. Anything below consensus will likely see risky assets shift lower while we believe that a larger figure will see a spike higher for risk before a reversal maybe tomorrow. We certainly won’t see – famous last words – a similar rally as a result of this lending operation as we did the first. As with any sweet thing, the first provides the most intense sensation and then the marginal returns decrease.

The USD has slipped against its crosses in the overnight session as a result of the general bid tone to the market but would be the destination for funds should the release of loans turn out to be a damp squib. This has propelled GBPUSD to the highest level in 3 weeks while EURUSD is only moments off the 1.35 level.

Sterling moved higher yesterday as a result of the latest survey from the CBI that suggested that the UK consumer is fighting back in Q1. The long term prospects for the High St remains difficult of course, as household spending will remain tight but as this comes after a bullish ONS figure last week, some wind has been blown into the pound’s sails. UK consumer confidence came in unchanged between January and February overnight.

Apart from the LTRO, due at 10.15GMT, we have US GDP at 13.30 which is expected to be confirmed at an annualised rate of 2.8% for Q4. We also get the Fed’s Beige Book regional survey at 19.00 which is expected to show that conditions remain tough but improvements are being felt in the wider economy.

Indicative Rates Sell Buy
GBPEUR 1.1813 1.1839
GBPUSD 1.5914 1.5939
EURUSD 1.3455 1.3479
GBPJPY 128.13 128.49
GBPAUD 1.4712 1.4739
GBPNZD 1.8883 1.8911
GBPCAD 1.5795 1.5825
NZDUSD 0.8421 0.8441
GBPZAR 11.88 11.93
USDZAR 7.4615 7.4898
GBPPLN 4.8687 4.8966
EURJPY 108.28 108.55

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