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Europe Braces for Long Winter

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By Delusional Economics, who is horrified at the state of economic commentary in Australia and is determined to cleanse the daily flow of vested interests propaganda to produce a balanced counterpoint. Cross posted from MacroBusiness.

Well, it looks like Santa finally stuck his head out of the dark cave for a look around. It is yet to be seen if he rams it straight back in again because he doesn’t like the weather, but at least he has appeared for one night.

In Europe Santa has come in the form of the ECB’s LTRO (Long Term Refinancing Operation):

Italian and Spanish bonds extended their recent rally on Tuesday as optimism grew that banks would borrow large amounts of cheap cash at the European Central Bank’s three-year tender and reinvest it in higher-yielding euro zone debt. Spanish 10-year bond yields fell for an eighth straight session to hit their lowest in more than two months while slowing investor demand for safe-haven German debt pushed Bund futures down by a full point.

“(This) is led by the excitement about the upcoming ECB tender… in this thin market without any supply to take down this obviously gives the periphery some real tailwinds,” said David Schnautz, strategist at Commerzbank in London. Momentum has grown behind the view that investors would return to support peripheral debt thanks to an attractive carry trade made possible by the ECB, whereby banks borrow cheaply at the central bank to invest in bonds with a much higher return.

A sharp fall in one-week borrowing from the ECB and high demand for one-day loans on Tuesday supported the view that banks were freeing up collateral to bid for three-year loans at Wednesday’s tender.

As I discussed last week I expect the LTRO to give a short term boost to sovereigns because it may lead to banks purchasing more short and medium termed debt of their national sovereign bonds and ride the carry trade between those bonds and the ECB’s new long term repo facility. It is yet to be seen if that is the case because there are substantial risks involved in the process and banks already own a significant amount of government bonds. It may just be that banks end up using the facility to roll-over existing debt rather than using it to actively make new purchases.

Given that many of the European banks are attempting to de-leverage and simply hold higher levels of capital in order to meet their requirements under Basel III this makes sense. However, that doesn’t mean that the new LTRO along with the lower reserve requirements wouldn’t have some flow-on effect to bond markets, I am just not sure it is going to be used at the level and/or for the purpose the bond market seems to be suggesting. There are, however, some rumours out of Italy that suggest otherwise.

We will find out the answer to some of those questions tonight when the banks make a choice between the 7-day, 3-month or 3 year ( with a 12 month exit ) repo facility. A good uptake on the later should provide some support for all markets in the short term, at least until it is established exactly what the banks are doing with the facility.

However, as I also stated last week , this operation does very little for the banks existing lending asset quality. That is governed by the real economy. In the parts of Europe where the sovereigns need the most help this continues to worsen as austerity bites into industrial production and employment and the deflation of previous asset booms continues to take its toll.

We already know that Spain is about to embark on a new austerity push with the PM promising a cut of $16.5 billion out of this year’s government budget while he has already acknowledge that the country is probably in recession and the unemployment rate continues to climb past 22%.

We also saw more of this last night from Italy

Italian industrial orders fell 1.6 percent in October after plunging 8.2 percent in September mainly due to a fall in foreign orders, the official data agency Istat said in a statement on Tuesday.

The seasonally-adjusted data showed that foreign orders were down 2.4 percent while domestic orders fell 1.0 percent. Orders were down 4.8 percent on a 12-month comparison. The worst-affected sector were machinery, electronics and textile down 13.8 percent, 7.6 percent and 6.3 percent over the year.

The data was another sign that the Italian economy is entering recession as the government struggles to tackle a debilitating debt crisis.

Joining them is Ireland who unfortunately have become the latest country, along with Greece, in which the IMF has had to admitted their “recovery” program is failing to meet expectations.

Europe should consider additional support for Ireland to ensure the success of its 85 billion euros EU-IMF bailout in the face of a deepening euro zone crisis, the International Monetary Fund said on Tuesday.

Europe’s financial woes are jeopardising Ireland’s ambition to escape its bailout straitjacket and return to market funding in 2013 and the IMF suggested a range of options to help the country’s banks and improve its appeal to private investors.

“Deepening strains in the euro area have … increased risks to Ireland’s debt sustainability, so prospects for programme success remain fragile,” the IMF said in its latest report.

The IMF said it and Europe had agreed to a request from Dublin to bring forward disbursements for Ireland to the first quarter of next year from the second half to help reassure investors about its liquidity given current market turbulence.

As I have spoken about numerous times Europe’s problems are in part due to economic imbalance under a single currency. Last night’s data once again proved that point with Germany outperforming.

The economic situation in Germany is good and there is no danger of a recession, Ifo economist Klaus Abberger told Reuters on Tuesday.

He said the construction and retail sectors were doing better while there had been a slight cooling off in manufacturing due to increasingly difficult conditions for exporters.

The Munich-based think tank said on Tuesday its business climate index rose to 107.2 in December from 106.6 in November, the largest monthly increase since February.

“The domestic situation remains quite good,” Abberger said.

“Things are going considerable better in Germany (than in Europe as a whole). Europe will end up getting a mild recession while Germany will be able to disconnect from that somewhat. We don’t see any signs of a recession for Germany at the moment.”

He said German companies had not suffered much from the euro zone sovereign debt crisis.

So maybe Santa will only becoming to certain parts of Europe this year.

In other Euronews:

Moody’s gave the UK a wobbly thumbs up
Fitch put lots of banks on negative watch
It appears Greece will stop paying tax returns
Portugal got some more cash
The French securities regulator said it will take a miracle to save the country’s AAA

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9 comments

  1. Lafayette

    As I discussed last week I expect the LTRO to give a short term boost to sovereigns because it may lead to banks purchasing more short and medium termed debt of their national sovereign bonds and ride the carry trade between those bonds and the ECB’s new long term repo facility.

    Funny … seems to me this journalist last week was all full of doom ‘n gloom.

    Never underestimate the chances of a change of heart from an Italian with his hands on the levers of monetary policy.

    Draghi is doing what he must do. It was obvious from the beginning that he would.

  2. Jim Haygood

    ‘A good uptake on the [ECB’s 3-year repo facility should provide some support for all markets in the short term.’

    No kidding! From Bloomberg:

    The Frankfurt-based ECB awarded 489 billion euros ($645 billion) in 1,134-day loans, the most ever in a single operation and more than economists’ median estimate of 293 billion euros in a Bloomberg News survey. The ECB said 523 banks asked for the funds, which will be lent at the average of its benchmark rate – - currently 1 percent — over the period of the loans. They start tomorrow.

    Today’s lending exceeded the 442 billion euros awarded in the ECB’s inaugural 12-month loan in 2009. The central bank will offer a second three-year loan in February and borrowers have the option of repaying the funds after a year.

    Barclays estimates the loans will inject 193 billion euros of new money into the system, with 296 billion euros accounted for by maturing loans.

    http://www.bloomberg.com/news/2011-12-21/ecb-will-lend-banks-more-than-forecast-645-billion-to-keep-credit-flowing.html

    As I see it, the underlying Einsteinian equation is:

    LTRO = QE

    We’ll have to wait for the next edition of the ECB’s balance sheet to confirm it … but the net €193 billion of new money estimated by Barclays likely will be wholly unsterilized. Indeed, the ECB’s balance sheet has expanded at such a rate this year that it seems doubtful that all of their sovereign bond buying to date has been fully sterilized either.

    Compare the ECB’s LTRO to the Fed’s QE1. At the time, the FOMC solemnly promised that the liquidity injection would be withdrawn as soon as conditions warranted. Not only did the Fed abandon that ill-considered promise, it added even MORE liquidity with QE2. In other words, QE is highly discretionary on the Fed’s part.

    By contrast, the ECB’s LTRO has a definite 3-year term. When it expires, the added liquidity evaporates with it. This is more in accordance with the Germanic sentiment of imposing clear rules, versus the ‘wet,’ fully discretionary approach best typified by the Bank of England.

    But there is one small problem. In a Ponzi dynamic, continued (and preferably accelerating) money and credit growth is an imperative. Any shrinkage of liquidity produces financial failures and a recessionary plunge in short order.

    Thus, if the euro still exists three years from now (surely not with its current membership), the ECB will be obliged to renew the LTRO. Both QE and LTRO are de facto PERMANENT.

    By the end of this decade, the cost of living will rise accordingly, scourging the poor and the elderly as the banksters’ fiat currency fraud always does.

    1. PghMike4

      I was wondering when someone would point out that the ECB giving unbounded loans to the European banks is equivalent to the ECB acting as a lender of last resort, except they also get to throw a lot of cash at the banks at the same time, based on what I guess people call the “carry trade” (lending the banks money at 1%, and letting them lend it out at 3-6%).

      It sure sounds like they’ve pushed off the end for 3 years, and I don’t doubt they can repeat this as necessary for as many 3 year periods as required.

      Of course, the austerity programs are still stupid, but at least the whole Eurozone won’t collapse in a perfectly avoidable disaster.

  3. Jim Haygood

    Michael Ashton, a well-informed and articulate commentator on money and credit matters, offers his take on LTRO:

    Increasingly, it is dawning on market participants that the recent move by the ECB to offer unlimited quantities of 3-year money to banks to buy domestic sovereign bonds is just the crazy scheme that might work. The effect of it, if it works, is to:

    (a) push off the day of reckoning for the EU, which will still come as surely as the sun rises, by up to three years;

    (b) ease the transition from the Euro back to distinct national currencies (because if every bank has loans and assets from their own nation rather than from the whole of the EZ the breakup will be less traumatic for those institutions); and importantly,

    (c) print money, since the ECB giving money to a bank to buy bonds is no different than the ECB directly buying the bonds. Admittedly (c) is only true if the ECB doesn’t sterilize the loans.

    And so, after working this through, you get inflation-linked bonds outperforming their nominal counterparts by 11bps. It does seem to support the reflation trade, since part of the deal from the central banks must be that they will keep rates low (the Fed has already promised explicitly to keep them low for two years).

    Spanish 10-year yields have abruptly fallen back to near 5%, which is as low as they have been in 13 months. Italian bondholders are less-impressed (perhaps because the ratio of bank balance sheets to sovereign debt isn’t as good), but 3-year yields are back to 5.58% and 10-year yields at least haven’t gone any higher.

    It has been a long-shot bet all year that the EU would find a way to delay this train wreck. They failed in Greece and failed to build a firewall to prevent other countries from circling the drain dramatically and publicly. But it has also been a long shot for many, many years to bet that “the system” would collapse.

    http://mikeashton.wordpress.com/2011/12/20/flim-flams-can-work-for-a-while/

    1. Frank

      Correct but please complete the picture with 1) the financing needs in the US where the new debt alone is over 1 trillion U$ 2) the financing needs in the UK where the new debt alone is 10% of the GP. If this is a race to hell it’s not so important who will be the winner when at the end all participants will reach the goal of total destruction.

  4. psychohistorian

    Ah, the latest in can kicking “technology”. Lucy didn’t even pull the ball/can on this kick.

    Then there is the Michael Ashton reference to “reflation” in the quote through Jim Hagood.

    Is reflation the subtle method of instituting long term pain for the public to insure that all that Fed Maiden Lane dreck is made whole as well as similar dreck in the EU and elsewhere?

    So now reflation for our “betters” is driving the bus. How quaint.

    If we had a clue what the derivative bets are going forward we could probably make more sense of the lurching “forward” by the various parties.

    History will be written by the winners.

  5. Fiver

    The Matrix now seems to consist entirely of Balance Sheets – new ones, old ones, hidden ones, pop-ups, revolving, infinite beans, audit-free, the works. If nothing else, this should at least buy some much needed breathing room for all the parties in Europe to think more clearly about where they REALLY want this to end up, rather than responding on the fly to daily monetary and political attacks from all quarters. I don’t believe fiscal union is that place. Use this time wisely, peoples of Euroland.

  6. American slave

    Its to bad they dont print and loan some extra money for renewable energy power plant construction. than country’s especially Greece can stop importing gas and coal and instead export electricity there by giving them export taxes.

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