The ECB’s auction of 3Y funds back in December has been credited with any number of things, from staving off a full-scale credit crunch in the eurozone to helping the rally in peripheral bond markets and also supporting the best start to the year for world stock markets for 15 years. Next week the ECB will undertake the second 3Y auction, but does this mean more of the same if take-up is high? In all likelihood, probably not.
With regards to the EUR 489bln that was taken up in December, there are a few things that we do know and a few we should. Firstly, it is sometimes forgotten that the net increase in liquidity was EUR 193bln because a lot of funds matured around this time and banks switched to borrowing longer-term rather than refinancing through shorter-term repos with the ECB. Secondly, the ECB’s own analysis showed that there was a strong correlation between bank refinancing requirements in the coming year and take-up in the 3Y refi. This adds weight to the view that the auction did play a key role in reducing refinancing risks in the banking sector, with banks in the Eurostoxx 600 outperforming the main index by nearly 6% over this period.
Whether the carry trade has been more internal (investing in EUR-denominated assets) or external (non-EUR) is more difficult to ascertain. Certainly, the data from the ECB showed banks to have turned net-buyers of government paper in the last two months of 2011, but the data for the early part of 2012 is not yet available. Given the ECB’s sense that bidding was more linked to refinancing needs, then the rally in external assets appears to have been an indirect rather than direct consequence of the auction of funds.
This brings us to next week’s offer of funds at which the market will be in something of a no-win situation. If take-up is large (over EUR 500bln, some talk of up to EUR 1trn), then this takes us towards a situation where the banking system and asset markets are ever more reliant on central bank money, which makes the road to the exits (the ECB stresses that these are temporary facilities) that much longer. This may prompt further gains in risk asset and peripheral bond markets but, for the former especially, it will be an even weaker basis for gains.
Conversely, if take-up is low, whilst this could be taken as a sign of an improved balance sheet situation for European banks, there is a reasonable case for suspecting that markets will fear the rally in peripheral bonds is over. The route to the exits will be shorter, but the fact that this is a 3Y funding auction underlines that we are in this for the long haul. Overall, markets will struggle to be clear-cut on the implications, whichever way the results go.