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Today’s Alpha

For the first time I share here with my digital fellows a post by FT’s Alphaville David Keohane.

This week promises to be important in the Markets, specially the ECB meeting on Thursday. David Keohane tells us what might happen about the probable decision to drop again the main Interest Rate in the Bank’s mandate. But there’s also the expectation of the announcement of extraordinary measures targeting economic Growth in the Eurozone. Following the LTRO(1) of 2012 what will come next…?:

‘ We got the trial ballon, after all, and everybody does so love an LTRO.

That table should be read from left to right btw, with the first option — Small and Medium sized Enterprise loans only — being the weakest and subject to the strictest conditions and the last option — a capped rate LTRO — being the meatiest.

Nomura’s bet, in line with said trial balloon, is on option two, loans to non financial corporations only. It’s also the one most closely aligned to the initial stage of the Bank of England Funding for Lending Scheme and largely in line with recent Reuters reports, where, as a minimum, each bank can borrow an initial amount of up to 5 per cent of its stock of existing NFC loans (not restricted by size of loan in this option), as at the most recent quarter.

But even if Draghi is stressed out by the stubborn refusal of loan growth to NFCs to turn positive in the first quarter of this year (as it should have based on an identified lag structure in the ECB’s October 2013 Monthly Bulletin) it’s not totally clear how much can be done or if a market used to scale from central banks on a mission will be impressed if it comes in at the lower end of estimates. The LTRO in 2012 saw €1tn pushed out, after all.”

Further Keohane, nicely agrees that relying in the Capital Markets for financing, even if only for the big companies, is a good thing. But deleveraging is to continue. Borrowing for Non-financial companies engaged in Construction & Real Estate was the main driver of new loans in the Eurozone (a classic long term durable goods non transactable sector….). Which warns of the limitations of the actions that Central Banks might pursue in orther to kick-start Growth:

‘ Not only have large eurozone companies shifted into capital markets for their borrowing (a good thing) there’s a deleveraging process underway which it would probably be best not to throw off track. As Nomura said, “two-thirds of the increase in euro area loans to NFCs between 2003 and 2008 were accounted for by loans to construction and real estate, an incredible number” and “out of an estimated stock of loans of EUR3.8trn to NFCs at the end of 2013, close to EUR1.4trn or 36% of the outstanding stock was to C&RE. While down more than EUR200bn since the peak, it is still up EUR800bn from the beginning of 2003.”

That’s not to say a targeted LTRO would be useless, as insurance alone it has merit, simply that it’s usefulness is limited.

More so from the ever readable Greg Fuzesi of JP Morgan:

Even if the ECB does not worry about carry trades, there are a number of challenges with targeted LTROs. First, even if the ECB offers cheap funding, the capital cost/risk stays with the bank. This is the main issue at present and requires other policymakers to act (e.g. guarantees by the EIB, regulatory efforts to boost securitization). Second, Euro area banks already have access to unlimited ECB funding at the refi rate at short maturities (up to three months) and are steadily repaying the last two LTROs. Hence, there can be questions about how much more attractive an FLS-style facility would be. The availability of short-term ECB funding also makes it much harder to add on any price incentives or penalties to LTROs. Third, in a flow-based scheme, the net lending targets may need to differ by country given the huge differences in loan demand and deleveraging trends across the region. This adds complexity. Fourth, if the ECB wants to help banks cheaply fund new real economy loans (especially to SMEs) it may need to lower the haircuts on collateral (as these can be 50% on individual SME loans). Fifth, the ECB has been looking to its asset quality review and stress test to address the underlying problems in the banking system and it still expects improvement later this year. Hence, it may see only a near-term need for funding support. Sixth, some ECB governors have expressed concern about getting too involved in directing bank lending. Lastly, LTROs may have the effect of injecting excess liquidity and lowering Eonia, but this would not be the ECB’s main aim.”

I predict it will be an important week indeed….


(1 )Note: LTRO : Long-term refinancing operation by the European Central Bank after the Eurozone sovereign debt crisis.





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