There’s too much liquidity in the eurozone (for now)

Posted by Izabella Kaminska on Mar 31 17:21. 2 comments.

One view regarding the unexpectedly poor showing at Wednesday’s last ever six-month Long-term refinancing operation (LTRO) by the ECB is that there’s too much liquidity in the eurozone.

Barclays Capital’s Laurent Fransolet emphasizes the point in his take on the financing operation. More…

One view regarding the unexpectedly poor showing at Wednesday’s last ever six-month Long-term refinancing operation (LTRO) by the ECB is that there’s too much liquidity in the eurozone.

Barclays Capital’s Laurent Fransolet emphasizes the point in his take on the financing operation. As he stated on the day (our emphasis):

The low number can be explained by 1) the fact that the market rate for the same maturity was much lower than the bidding rate (also compared to previous LTRO), 2) the fact that there is already a large surplus, so most banks do not need extra money as such, and 3) the ECB probably pushed banks not to bid aggressively (by having an indexation mechanism, and maybe exercising some moral suasion).

Today’s small number does not change much the liquidity conditions in the euro area: there is still a very large surplus, of more than 200bn, way more than enough to keep EONIA low for the coming 3 months.

Here, meanwhile, is a pictorial view of just how much excess liquidity is currently stalking the system, also from Fransolet (who also points out that the recent rise will be down to banks’ liquidity needs decreasing, rather than the liquidity provided increasing):

And for those wondering how that liquidity surplus might be affected by the maturity of previous operations and the expiry of programmes further down the line, BarCap’s Euro Weekly note from last week offers the following chart reflecting exactly that :

According to the above, therefore, a critical point might lie in June. That’s when the €442bn borrowed by banks in the 2009 1-year LTRO comes up for refinancing.

After that, though, it’s not clear at all whether euro-system liquidity will remain as abundant. As Fransolet wrote on Wednesday:

While 1 week and 1 month operations will remain at full allotment (until at least October), this does not guarantee that there will be a liquidity surplus anymore: it will very much depend on the appetite of banks to borrow from the ECB at such shorter maturities. On balance, we think EONIA will remain low probably until October, but we would not bet aggressively on this: EONIA market rates for July/Sep could rally further, but post October rates look already quite low to us, not discounting any normalisation until Q1 2010 at least.

There are two points to be stressed with regards to that. One, as Barclays Capital points out, is the fact that banks will find it impossible to refinance the total €442bn at the ECB – especially since the three-month LTRO will be limited to €100bn by then.

In fact, some €150bn probably won’t be rolled over at all, say the analysts.

The second point is how the Euro Overnight Index Average (Eonia rate) might react.

In all likelihood the benchmark rate will remain low until at least October, say the analysts, as banks will still have unlimited access to the ECB’s weekly and one-month operations.

Nevertheless, the degree to which they do will depend “on banks’ appetite to borrow from the ECB at 1 per cent for much shorter maturities”, BarCap argues.

One thing is sure: the relationship between the liquidity surplus and Eonia will not be as predictable as before.

Which might turn out to be a big thing if you consider just how stable the rate has been since the ECB started its liquidity operations last June:

As for those monthly spikes, Fransolet explains they correspond with reserve maintenance periods at the ECB, when the central bank comes into the market to mop up liquidity.

The surplus at those times thus becomes smaller or negative, which has the effect of pushing Eonia higher. The spikes do not therefore reflect volatility in the rate.

Related links:
What does weak demand for ECB funds mean? – FT Alphaville
So farewell, 12-month LTRO – FT Alphaville
The ECB as liquidity monster – FT Alphaville
RIP Eonia – FT Alphaville

Beware, repo rates are on the rise

Posted by Izabella Kaminska on Mar 23 09:36. 1 comment.

It’s been less than a month since the Federal Reserve resumed its Supplementary Financing Programme in a bid to begin draining liquidity, but the effects are already creeping into the rate market.

Note the rise in overnight dollar-Libor rate here: More…

It’s been less than a month since the Federal Reserve resumed its Supplementary Financing Programme in a bid to begin draining liquidity, but the effects are already creeping into the rate market.

Note the rise in overnight dollar-Libor rate here:

And also here in the OIS one-month swap rate:

The SFP’s resumption will eventually bring up to $200bn worth of collateral back into the market in the interim period. The thing to consider, though, is whether it’s all been a bit too much for the market to take on already.

As Barclays Capital’s Monday collateral report explained, absorption problems are appearing (our emphasis):

The repo market’s inability to easily absorb the extra $200bn worth of collateral supply created by the re-introduction of the SFB program has been a major surprise.

The regular monthly settlement of the 2y, 5y, and 7y auctions (which typically are about $90bn) have in the past year only caused a brief back-up in collateral rates of just a couple of basis points.

Clearly, the SFB program’s return was the straw that broke the camel’s back – instead of moving back to pre-debt ceiling levels of 15bp, general collateral has overshot and has averaged about 18bp in the past week. There is nothing in the near-term supply outlook to cause that to change – the Treasury will sell a net $21bn in bills this Thursday, which is hardly enough to push repo rates much heavier than they already are.

Pushing repo rates ‘much heavier’ means seeing them cheapen. Which means Barclays believes that (for the time being at least) the market may have reached some sort of saturation point.

Although it’s not a situation the bank’s analysts believe will last for long. The market still has a further $125bn of coupons and bills to be introduced over the next two months. This, they say, will likely see repo rates trade ‘heavier’ over the next month, rising as high as 20 basis points before retracing ahead of a more pronounced Fed tightening announcement, involving reverse repos.

Eventually those interim rate increases will also feed through to Libor and OIS swap markets. Although whether that’s down to the technicalities of too much collateral in the market, or outright Fed tightening policy, is more difficult to say. As Barclays Capital explain:

With a lag, Libor and OIS rates have begun moving higher, and the heaviness in repo may provide 3m Libor with enough momentum to breach 30bp. However, these technical factors are uncorrelated with any move by the Fed to drain reserves or tighten policy.

Instead, our economists expect the Fed to raise interest rates in September – which may be a few months earlier than the consensus. With reverse repos unlikely to begin until late June at the earliest, our sense is that markets may be over-reading what to us seems to be a purely technical reaction to an overabundance of collateral in the repo market.

Instead, we find the tightening the correlation between repo and the effective funds rate over the past two weeks to be much more intriguing. This suggests that the market’s expectation that an oversupply of collateral from the Fed’s reverse repos would cause GC to invert to OIS – that is, trade an average of 8bp higher than the prevailing OIS rate in Q4 10 might be too optimistic.

That said, we were under the impression that one of the SFP program objectives was indeed to apply upward bias to interest rates?

In which case, the policy does appear to be working.

Related links:
Operation Drano – FT Alphaville
A discreet draining operation? – FT Alphaville
Bernanke in the dock over exit strategy – FT

Overheating China – reaction

Posted by Neil Hume on Mar 11 10:40. 1 comment.

A bit more on the stronger than expected Chinese inflation data. Economists now expect further policy tightening measures and sooner rather than later.

Barclays Capital:
In view of the higher-than-expected inflation in February, More…

A bit more on the stronger than expected Chinese inflation data. Economists now expect further policy tightening measures and sooner rather than later.

Barclays Capital:

In view of the higher-than-expected inflation in February, we revise upward our projection of average CPI inflation for 2010 to 3.5% from 3.0%, which implies a rise in the headline rate to around 3.5% by mid-2010 and 4% by Q4. This is compared with the government target of 3% announced at the NPC meeting.

Consequently, we revise our call on the benchmark interest rate and now look for a hike in Q2; previously we expected rated to begin rising in Q3. We now project three increases of 27bp in the benchmark rates in 2010 – one in Q2 and the remaining two in H2. We maintain our projection of real GDP growth of 9.6%, but change from upside to balanced risks around the baseline, owing to the quickened pace of tightening

Morgan Stanley:

We continue to see multiple RRR hikes as necessary over the next few months to sterilize the liquidity impact from the BoP surplus, with the next RRR hike likely to be in the very imminent future. The first interest rate hike of 27 bps could come as early as April, in our view, followed by two more hikes in 3Q and 4Q. Nevertheless we stand by our call that Renminbi appreciation (against US$) will not resume until 2H10, although appreciation on a trade-weighted basis is already taking place given the US dollar’s recent and projected strength against other major currencies in the course of this year.

And finally, Goldman Sachs:

Although inflationary pressures remain moderate for now, we believe if there are no measures more decisive than the modest (although relatively frequent) RRR hikes, we are likely to see higher inflationary pressures. Recent comments by a number of policymakers that there are no signs of inflation yet are worrisome as it indicates a lack of willingness to take more decisive measures until higher inflation actually occurs.

Having said that, we still believe policymakers will take a combination of tightening measures in the coming months to prevent overheating. These measures are likely to be targeted at FAI-related areas given the government’s strong emphasis on stimulating private consumption and the unwillingness to fully utilize the exchange rate as a policy tool to influence exports growth. We expect these so called macro tightening measures to include a mixture of credit controls, further RRR and interest rate hikes, administrative controls on investment approvals and funding and other “industrial policies” to curb investment activities in sectors regarded as having problems such as overcapacity.

Melody's note, Comment from RBS (but its estimate for CPI, PPI n bank loan are all way wrong):

More concern about growth: property-sector FAI and export growth in 2H10
Returning to centre-stage, in our view, is the need to cement growth in 2010. While policy makers prefer stable to steadily rising property prices, these have seen nothing but extreme volatility. Combined with possible uncertainty about export growth in 2H10 and the close of the politically sensitive NPC session, we may have several months of relatively benign良性的 regulation of property, which may help property FAI. The risk is that if property prices start rising again, it may lead to greater social tension and more regulatory actions just as the supply of residential property increases in 2H10F.

A slight reversal of the exit/normalisation trade for several months?
We see 2010 as a year of ‘touching the stones to cross the river’ for policies in China, with the government reducing excess liquidity as the real economy improves. The implication is negative for asset plays and positive for transportation and industrials. Ranked by top-down incremental yoy growth, we prefer export-exposed sectors to consumption and FAI-related sectors. That said, in the coming months, we may see a slight reversal of the policy exit/normalisation trade. We believe the sectors that will benefit incrementally are property, energy, materials, cement and consumer discretionary. Defensives and agriculture inflation hedge may perform less well on postponed policy exit and reduced inflationary fear. The impact on banks should be positive on low valuations and reduced tightening fears.

Over to you, Chinese policy-makers.

Related links:
Roach: Pooh-pooh to Chinese bubbles - FT Alphaville
Chinese liquidity – and stocks – go BOOM! - FT Alphaville