Markets were fairly quiet on Tuesday, with currencies settling down after large moves on Monday. Most of the action, such as it was, came on Durable Goods Orders and US Consumer Confidence announcements, which did not last long. By all accounts, markets are waiting for results of the second Long Term Refinancing Operation, to be conducted tomorrow by the European Central Bank. The first LTRO took place on 21 December, when banks took EUR 489 billion from the ECB. The central bank issued loans on three years term at a rate of 1%. At that time, the biggest recipients were banks in the weaker Eurozone countries. For example, banks from Italy received EUR 110 billion, Spain EUR 105 billion and France EUR 70 billion. Greek and Irish banks asked for EUR 60 billion EUR 50 billion respectively.
This time around, we could expect more extensive participation of banks from other countries. Even banks that do not need additional capital may be tempted with the prospect of borrowing money at 1% rate and using it to purchase bonds yielding 3-5%, depending on the country. Most expect tomorrow’s operation to be similar in size to the first one, or about EUR 0.5 trillion, although opinions vary widely, including some projections of EUR 1 trillion allotment. The ECB is believed to be accommodating all requests, as long as banks provide proper collateral. This collateral is secured through the bank’s own national central bank, meaning each country vets the collateral for the loans given to their banks. Since these requirements have eased somewhat from previous offering, we could see more borrowing.
Combined LTRO and MRO (main refinancing operations) by the ECB to date.
Markets anticipate this even on par with interest rate decisions from central banks, meaning it is important and could create massive volatility. Reaction in currencies will depend first on how much money is borrowed and then by which banks. If the ECB distributes similar amount to the previous operation, in the EUR 400-600 billion range, the reaction could be muted. Should the banks borrow less than expected, say EUR 300 billion, the EUR-USD could fall. On the other hand, subscription above the projected upper range, EUR 700 billion and above, is likely to start a rally in the EUR-USD and spill over to other currencies.
Personally, I will treat this event like interest rate decisions from central banks and sit it out. I consider reaction to this type of announcement as unpredictable, with rewards not worth the risk. At the same time, should new trends emerge, I will probably join in that direction. That however, must be no sooner than 15 minutes after the release, and maybe as long as 1 hour. After all, if results are surprising, the new trend for real, it should last longer than several minutes offering more opportunities. I might even consider using binary options for a short-term play, if the move has legs.
Mike K.
