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type of regulation would reduce monetary velocity
and, if the decline in velocity were not compensated
by a sufficient increase of central bank liquidity,
would push the USD higher. In addition, less USD
liquidity would not bode well for risky assets, which in
recent years have enjoyed a liquidity-supported rally.
EMU’s contagion and liquidity
Most commentators are debating the pro and cons of
a currency union in terms of diverging intra-EMU
competitiveness and wealth levels, leaving liquidity
considerations outside the debate. The IMF and
EMU on the one hand and Greece on the other have
finally agreed on a EU 110bn support package
spread over three years, with Greece committing
itself to a substantial budget consolidation
programme. Concerning the liquidity implications of
the programme, we have to differentiate between
IMF and EMU funds. IMF funds have a liquidity
increasing effect as the IMF takes SDRs out of its
balance sheet and converts them into EUR. Hence,
IMF funds work like a monetary/fiscal support
programme. The EMU part of the programme has
fiscal but no monetary effects.
EMU has provided Greece with a EUR 75bn bridge
loan aimed at keeping the country out of capital
markets for three years. EMU countries will mostly
raise these funds off balance sheet by issuing bonds
and transferring these funds to Greece. If these offbalance-sheet
programmes have no effect on
national budgets in the sense that expenditure plans
are left unchanged, raising these funds in the capital
market would be a plus from a global liquidity point.
However, national budget deficits are high across the
eurozone and off-balance-sheet funding will not fool
financial markets with regard to the risk premium to
be paid for these assets. Remember the German
unification days when GDR-related expenditure was
funded via unification bonds? At that time, German
bond yields reflected the higher German borrowing
needs and the market did not care if the additional
funds needed for German unification were funded on
or off the federal balance sheet. Nowadays there will
be no difference. In order not to see their own
financial credibility being undermined, EMU countries
supporting Greece financially will have to cut
domestic expenditure or increase domestic taxes.
This will especially apply to countries with high debt
or deficit levels such as Portugal, Spain, Ireland, Italy
and France. So the EMU bridge loan represents a
fiscal transfer, but will not increase the pool of fiscal
means available for the eurozone. In this sense, the
EMU package is different from the IMF money, which
in fact brings new funds into the eurozone and hence
provides a measure of relief.
However, we still believe that EMU instability will
negatively affect global liquidity. Greece illustrated
how the sovereign crisis has undermined the banking
Chart 5: Liquidity versus Equities
Source: Reuters EcoWin Pro, BNP Paribas
Chart 6: EURUSD Rate Differential to Turn
Negative
Source: Reuters EcoWin Pro, BNP Paribas
sector. Financial interdependencies among the
Greek insurance and the banking industry are a
worry given that Greek pension funds were not using
the golden rule of investment diversification. Rather,
they were putting most of their assets into domestic
bonds and to a lesser degree into equities. Greek
pension funds hold EUR 29bn of Greek bonds.
Meanwhile, Greek banks’ access to private money
market funding is not sufficient to allow their liquidity
needs to be covered by ECB repos. Hence, ECB
collateral rules will be crucial for Greek bank funding.
On Monday, the ECB loosened its collateral rules.
This does not only effectively represent an easing of
monetary conditions, it will also expand the ECB’s
balance sheet risk –working against the EUR.
Bank funding conditions have tightened
The spread between euro-denominated German T-
Bill rates and rates paid on the interbank market has
moved to its highest level since November 2009,
indicating that money market risk premia are on the
rise. Banks of peripheral countries in particular are
facing higher funding costs and, while the TED
spread may not have reached alarming levels we
watch it to assess the level of financial risks. A
further widening of this spread in conjunction with
tightening monetary conditions in Asia and the US
implementing financial sector reform may cause
Hans Redeker 7 May 2010
Market Mover, Non-Objective Research Section
63
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