A wall of liquidity with little place to go...
Just when you thought you were helping the market, the media are now starting to bash the ECB for doing too much. In various Dutch and Anglo-saxon media we find headlines such as "ECB bank support could harm debt market" and "Money market struggles with massive support from ECB". So the 1 trillion EUR liquidity shot has overdone it, or, is this a classic case of big unforeseen actions tending to have big unforeseen side effects ?
The problem would be that the ECB LTRO nearly matches the entire European bank senior debt coming to maturity in 2012 (400 bio), 2013 (375 bio) and 2014 (325 bio). In a worst case scenario, this would mean that when banks pre-fund themeselves all the way into 2014, 1 trillion of potential investment assets disappear from the market because these maturing bank bonds won't be rolled over. And this is a problem because from the nearly 7 trillion sized European corporate bond market, 46% is taken by banks and 22,5% by other financials (insurers). And insurers and pension funds desperately need bonds and coupons for their clients. And as a result they have to invest in...what ? Some observers already mention that behind the scenes, these financial players are approaching banks and begging them to still issue paper. And then comes the question of course : at what yield ? Certainly in view of the fact that that there is always the ECB to ask money for at 1%. And we have seen markets anticipating on this drying up market trend with both financial and industrial corporate spreads coming down considerably. And with yields now approaching unattractive rates in general (read negative real interest), another phenomenon has seen the light, ie a mass exit from out of money market funds. And apparently these flows have gone elsewhere, such as Asia and Far East, resulting into unattractive yields there as well.
So we have too much cash with little if any place to go. Some news media mention that it has become so bad that various financial players have opted to even park their money at the ECB. And they point to the fact that the overnight facility at the ECB last Friday reached a new record high of 820 bio EUR. And some maverick blogs (zero...) even claim that this is the virtual bankruptcy of the system because in contrast to creating money, the central bank operations in the end result in money destruction. Why ? Because banks borrow at 1% for 3 years from the ECB and park their money at the same ECB at 0,25%. Now that doesn't make much sense and the analysis is therefore wrong as well. LTRO has probably ignited sovereign carry trade because when a bank uses money from the LTRO to buy (government) debt in the secondary market, the amount will show up as a deposit at the ECB, this time on behalf of the seller's bank. And if a bank buys government bonds in the primary market, the amount will also show up as a bank deposit at the ECB if the government spends the receipts or places them at a private bank.
It still leaves us with the following questions : If not much place to go, where will the money finally end up ? It's an important question because at one stage, even the carry trades on European sovereigns will be played out. And then comes the question where the next asset bubble will be. May be that's the intention : drive every supposedly safe investor into more risk assets such as high yield and equity. Or maybe in the end, money velocity will start to increase and then we have the end game kicking in : inflation and how to tame this particular beast.