European Central Bank (ECB) boss Mario Draghi has sparked a blistering rally in global asset markets by lending banks as much as they want for three years at 1pc, but bond experts say the side-effects are toxic and the benefits are wearing off.
"It's a sugar rush," said Alberto Gallo, European credit chief at RBS. "It lowers the risk of defaults, but also lowers recovery rates if things go wrong."
Lenders must provide the ECB with collateral, at a haircut of up to 65pc, using up ever more of their balance sheets. The ECB has first claim on these assets, pushing other creditors down the pecking order. The longer it goes on, the worse it gets.
"There is no such thing as a free lunch. Liquidity today comes at the price of subordination tomorrow," said Mr Gallo, warning that BBVA, BNP, Commerzbank, Intesa, Santander and Unicredit are all vulnerable.
Banks took up €498bn (£421bn) in the first long-term refinancing operation (LTRO) in December. Mr Draghi said the loans had averted a "crunch" in the first quarter of this year as banks struggled to roll over debt. Markets are enraptured by Draghi's "bakooza", convinced that it is a long-awaited "game-changer" that eliminates the danger of an EMU death spiral.
However, investors may have been lulled into a false sense of security. If the second LTRO next week is too big – with some forecasts of €1 trillion – it may even threaten the global rally.
Mr Gallo said the LTRO has badly eroded the capital structure of banks, pushing many over the edge towards junk status. Spanish and Italian banks are using the ECB money to buy more of their own governments' debt than is covered by equity, becoming a "levered option on sovereign risk".
At the same time, the ECB has set off bond market tremors by exerting 'droit de seigneur' to shield itself from losses on its €40bn holding of Greek bonds. This has automatically reduced other creditors to junior status.
"If the ECB is going to take that kind of action in Greece, it could do it elsewhere," said Ian Stannard from Morgan Stanley. "This is very bad for psychology and could deter global investors from buying any peripheral debt."
The ECB holds €220bn of Greek, Irish, Portuguese, Spanish and Italian bonds. Private investors have been relegated overnight to junior status in each case.
Huw Van Steenis, Morgan Stanley's bank strategist, said the bazooka is no panacea even though it has averted a shock as lenders slash loan books in a frantic rush to meet core tier one capital ratios of 9pc by June. "The LTRO will not stop the Great Deleveraging," he said.
He expects European banks to delevearge by up to €2.5 trillion over the next 18 months, and €4.5 trillion over the next five years, matching the pattern seen in Japan.
Monetarists say the bazooka is likely to feed through into money supply growth over coming months, lifting Europe out of the doldrums, though proof of the pudding will be in the January data. All key measures of the money supply contracted late last year, a potentially dangerous development.
Simon Ward from Henderson Global Investors said the bazooka is better than nothing but a bad way to inject liquidity. The ECB would have got more bang per buck and avoided a host of problems if it had launched quantitative easing (QE) for the whole eurozone. "Their back door method is a form of disguised QE but it's a less efficient way to inject cash into the economy, it subordinates bondholders, and concentrates the ECB's credit risk in the periphery," he said.
By forswearing QE as an Anglo-Saxon vice, the ECB has inadvertently resorted to a more insidious vice.
The Telegraph
No comments:
Post a Comment