How do you spell Quantitative Easing in German? « LTRO »

Posted on 17. jan, 2012 by Riskelia in Weekly Focus | Commentaires fermés

As the recent S&P’s downgrade puts back the sovereign debt issue on the front stage, the liquidity conditions have significantly improved as shown by three different indicators:

  • The Radar’s trend is flipping to the positive side on dollar and sterling short term interest rates futures. The reason is not that central banks will further decrease their already nil target rates but rather that the interbank market liquidity is improving.
  • The EUR/USD basis swap or the cost to exchange euro cash against dollar cash has noticeably improved going down from 150 bps to 80 bps. The lower cost of dollar funding translates the coordinated actions of central banks to provide liquidity at the turn of November.
  • Last but not least, the European banks cost of funding is slowly normalizing, as reflected in figure 3. The improvement in the euro banks credit cost follows the ECB decision to provide unlimited long term financing to banks up to 3 years (the so called « LTRO »). As a result, the European banks almost borrowed 500 Bil euros from the ECB in December.

As depicted in the chart of the ECB’s total balance sheet, the liquidity provided to commercial banks has not been sterilized. Therefore, the LTRO is clearly a type of quantitative easing which consists in increasing lending to -and deposits from- commercial banks. The last chart shows that the ECB quantitative easing has increased the ECB balance sheet relative to the Fed total assets. ECB’s balance sheet has deteriorated both quantitatively and qualitatively as the ECB provides more loans to the banking system, accepting poorer and poorer forms of collateral in return.

This form of quantitative easing, compatible with the German orthodox view of money and the European treaty, is behind the ongoing depreciation of the euro vs. everything (i.e. USD, other currencies, brent, gold, S&P 500…). This has been one of the most prominent themes identified by the Radar at the end of 2011 and is still a promising bet.

Figure 1: Riskelia’s trends in short term interest rates: Eurodollar, Short Sterling, Euribor 3-6 months



Figure 2: EUR/USD 3 months basis swap or annualized cost to exchange dollars against euro



Figure 3: Riskelia’s normalized liquidity indicators on European banks, cash liquidity and equities



Figure 4: Total Balance Sheet of the European Central Banks in Billion EUR (Bloomberg)

Figure 5: Ratio of Fed to ECB Balance Sheets compared with the EURUSD exchange rate (from Bloomberg)


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