Rally round the flag
The European Central Bank unleashed a second round of its long-term refinancing operation last week and revealed it has provided a further €529bn of funding to European banks.
This follows the €489bn injected into the European banking system last December to calm nerves in the investment markets and provide reassurance about the financial strength of European banks. The strong start to the year in the markets has been attributed in part to the LTRO.
SVM Continental Europe fund manager Hugh Cuthbert says: “European equity markets were slow to react to the ECB’s extra liquidity measures, in the guise of the long-term refinancing operation bearing in mind the initial take-up of €489bn took place in December.
“However, the turn of the calendar year appeared to be the signal for a rally in markets. Credit markets also took heart from these additional liquidity measures with the spread dramatically tightening between Spanish/ Italian sovereign debt and that of more stable Germany. This, in turn, resulted in a sharp rise for those equities perceived as more risky, such as cyclicals and financials.”
But will the latest injection of liquidity help to sustain the strong start to the year the investment markets have seen?
The second round of the LTRO is bigger than the first round in December and a lot more banks have taken advantage of the cheap funding this time round, around 800 compared with 523 in December.
Fidelity Worldwide Investment director of asset allocation Trevor Greetham says: “The ECB’s two long- term liquidity injections do not solve the underlying solvency problems in the euro area but they could push the crisis back into remission for a while if they give economic growth a boost.
“The global backdrop is improving, with the ECB’s action coming in the context of a wide range of easing moves from other central banks around the world.
“”There are increasing signs that stimulus is starting to take effect and a US-led upswing in global growth is under way.”
Greetham says the firm has moved to take advantage of short-term market improvements but is sceptical on whether any rally is sustainable.
He says: “We moved over-weight equities and commodities in our multi-asset funds in February for the first time since July 2011.
“The key question for us is how long the loose policy stance lasts. A premature curtailment of central bank liquidity, due to a rise in inflationary pressures or simply due to complacency, could lead to another downswing in global growth, as we saw in 2011.”
Fixed-income markets have also been beneficiaries of the introduction of the LTRO.
Waverton global bond fund manager Jeff Keen says: “According to the iTraxx Europe Index, five-year senior investment-grade CDS costs dropped to around 140bps from a high of around 210bps seen in November last year.
“Meanwhile, issuance and appetite for corporate bonds in the primary market have also been strong.
“Companies such as Compass, Petrobras and maiden issuer Everything Everywhere had successful, highly subscribed launches which, although offering attractive spreads for investors, still represented beneficial funding rates for these firms and highlights the improved strength of corporate health and financing visibility.
“Banks also managed to raise funding through the issuance of senior unsecured debt, something that was impossible during the fourth quarter of last year, as a result of the improved confidence and diminished risk of bank failure brought about by the LTRO scheme.
“If the improving confidence in the region’s governments and financial systems can be sustained, the appetite for risk assets will likely strengthen further.”
However, Threadneedle head of multi-asset Toby Nangle injects a note of caution when he warns there is still a lot of longer-term uncertainty over the ECB’s actions.
He says the liquidity injected by the ECB has prevented a short-term very rapid restructuring by the banking sector but it may have given them some breathing room.
He says: “The LTRO operations appear to have drawn a line beneath the funding requirements for European banks for at least the next year but what is not yet clear is whether they have prevented a deleveraging of the European banking system, or facilitated it.
“Banks now have time to wind down their balance sheets in an orderly manner should they so wish, and this would clearly be extremely negative for economic growth in the periphery, especially when combined with renewed fiscal austerity.
“We are watching the monetary data closely to ascertain how this develops.”