The Big Event - 3Y ECB LTRO

The big event this week was the 3Y ECB LTRO allotment on Wednesday. The allotment ended at EUR489bn, which was considerably more than the market expected. The number could be interpreted both positively and negatively. On the positive side, the LTRO has clearly filled a gap for banks and the massive take-up in this first auction implies that EUR liquidity is not likely to be a major concern in the coming years. In turn this should imply that the short end of the curve should come down. This is an implicit easing of monetary policy and should benefit risky assets. For the credit market we expect the short end of the cash market to perform going forward while CDS is not likely to be affected to any great degree. In addition, the large take-up of liquidity is likely to imply
that we will see very limited issuance of senior unsecured in 2012 as banks have largely prefunded themselves via the ECB. 

On the negative side the problem is that nothing is solved in terms of the capitalisation of European banks and this is in fact the binding constraint for many banks. In addition the large take-up can be seen as a sign of weakness and proof that European banks are still in intensive care instead of the recovery ward. The underlying cause – the sovereign debt crisis – is still here and it will stay with us for a long time. 

Overall, we lean towards the LTRO allotment being a rather positive event. In our view, the big take-up by banks shows that the stigma sometimes associated with central bank reliance should no longer be there. The very attractive pricing and collateral terms have ensured that, in our view. We see a good chance that the liquidity will be channelled into shorter dated fixed income instruments including corporate bonds and this is likely to provide some support during 2012. 

Having said that we still recommend a cautious approach going into 2012 as the debt crisis may intensify again. We prefer the Nordic industrials, which generally have strong balance sheets that can cope with adverse economic development. This has been exemplified this week with both Atlas Copco and Metso getting a positive outlook on their Moody’s rating due to the strengthening of credit metrics that have taken place. For financials we prefer the short end and we think the large Nordic banks are among the safest in Europe due to their limited direct exposure to the periphery countries. 

We wish you a Merry Christmas and a Happy New Year.