Market Economics | Interest Rate Strategy - BNP PARIBAS ...

EUR: Liquidity is Not a Worry for the ECB
• After this week’s MRO, the level of liquidity
provided to the eurosystem with MROs and
LTROs dropped below the level seen at the end
of September 2008, just before the ECB shifted
to full allotment and fixed rate operations.
• Against this backdrop, the reduction of
liquidity in the eurosystem is no longer a matter
of concern as it does not represent any threat.
• STRATEGY: Keep short positions on
6m-12m eonias.
Chart 1: Liquidity is Back to Sept 2008’s Levels
Accommodative liquidity policy reduced stress…
When the ECB decided to turn on the liquidity tap in
October 2008, to prevent the liquidity crisis from
turning into a complete collapse of the Eurosystem,
liquidity exploded. From the end of September to
early November 2008, liquidity provided with open
market operations (MROs and LTROs) surged from
EUR 480.5bn to more than EUR 820bn. At the same
time, the balance sheet of the Eurosystem inflated
from EUR 1.52trn to EUR 2.0trn. Most of the
increase was therefore driven by the strong rise of
liquidity injected into the system by open market
operations, on banks’ request.
Concern about liquidity was high, as reflected in
OIS/BOR spreads. This tension persisted for a while
before fading gradually as the ECB decided to
extend temporary measures. The signal given by the
ECB was clear for money markets: it would keep
accommodative measures as long as there was a
risk of a liquidity squeeze, in a context where several
banks remained largely dependant on ECB’s
liquidity, as they have little access to market liquidity.
This signal helped to ease tensions significantly and
liquidity spreads tightened sharply.
…but raised concerns over the exit strategy
The expansion of the eurosystem’s balance sheet
raised questions over the exit strategy from nonstandard
liquidity measures. Indeed, the acceleration
of the monetary base was seen as a potential risk for
an acceleration of money supply, itself seen as key
driving force for inflation in the long run. As has long
been highlighted by academic work, the chain of
causality between these factors is far from certain as
demand for money is not stable. However, the
expansion of the balance sheet ─ as long as it was
caused by a strong rise in liquidity provided by
accommodative open market operations ─ was a
source of concern at the ECB.
Liquidity is no longer a matter of concern
After this week’s MRO, liquidity provided to the
Source: BNP Paribas
Chart 2: Demand from Peripherals Still Elevated
Sources of Demand for ECB's liquidity
160.0
Spain
Portugal
Greece
Ireland
140.0
Aggregate (RHS)
120.0
100.0
80.0
60.0
40.0
20.0
0.0
Jun-09 Aug-09 Oct-09 Dec-09 Feb-10 Apr-10 Jun-10 Aug-10 Oct-10
Source: BNP Paribas
eurosystem by open market operations dropped to
EUR 478.2bn, i.e. below the level seen at the end of
September 2008 although the balance sheet of the
eurosystem is still almost EUR 450bn above its level
at that time. Hence, liquidity provided by open market
operations is no longer the cause of the balance
sheet expansion. The CBPP and the SMP explain a
third of this, but the SMP is not increasing liquidity as
it is offset by term deposits. As a result, the main
causes lie elsewhere with both currency and gold
reserves large contributors to the increase.
Open market operations are now providing liquidity
EUR 40-50bn above needs. This prevents tensions
on eonias from developing, but is not a concern for
the ECB. In addition, several banks in a number of
countries remain largely dependant on the ECB’s
liquidity. Against this backdrop, the ECB will act
cautiously when it comes to the exit strategy.
However, the current price action at the front end
remains too dovish against our view on the ECB’s
stance and we continue to recommend keeping a
negative view at the front end.
Strategy: Keep short positions on 6m-12m Eonias.
400.0
350.0
300.0
250.0
200.0
150.0
100.0
50.0
0.0
Patrick Jacq 13 January 2011
Market Mover, Non-Objective Research Section
30
www.GlobalMarkets.bnpparibas.com