- Big LTRO elicits little excitement; FX market reacts more to little from Bernanke
The EUR 529bn allocated at yesterday’s second 3-year LTRO was a little higher than our estimates of 400-500bn, and not significantly greater than market expectations of 470/500bn. The tender adds a net 314bn in liquidity (after subtraction of other shorter LTROs expiring), and significantly adds duration to the ECB’s liquidity provisions. This should see further reductions in BOR-OIS spreads; and also further lower peripheral spreads, particularly in the front end. The bank refinancing worries have now effectively been put to bed; and the Italian and Spanish sovereign refinancing peaks look much less daunting. All this is positive EUR and positive risk – although the reaction post-announcement hardly set pulses racing. Against this however, the additional liquidity means that the EUR is set up almost as nicely as USD, JPY and CHF to be the global funding currency. The EUR’s higher interest rate remains an obstacle – and so there will be plenty of focus on the ECB next week.
But at this stage – and as was abundantly clear from the reaction to Chairman Bernanke’s semi-annual testimony last night – more important to currency markets than further ECB easing is the direction of Fed policy, and specifically the prospects for QE3. The USD remains the funding currency of choice for a number of reasons – liquidity and access to that liquidity among them – but only for as long as the Fed continues to reassure that rates will stay low and that the liquidity spigot will stay open. Our economists did not read anything of great significance into what the Fed chairman said yesterday. Yet the mere acknowledgement that the labour market has been performing better than the Fed had expected given their read on domestic demand indicators, alongside the failure to offer any additional encouragement to hopes of more policy easing, was enough to provoke a strong reaction: risk aversion sent the USD broadly higher and gold down an astonishing $100 on the day. We would suggest that positioning is likely to have played more than a small part: the moves seem somewhat overdone in comparison to much more measured equity and US Treasury market moves.
- Will Bernanke try and undo the damage?
But was this really Bernanke’s intended message? Part of Fed folklore – derived from the Volcker and Greenspan eras – is that the beauty of having back-to-back testimonies before the House and Senate is that they provide an opportunity for the Fed chairman to undo at the second bite of the cherry any damage done during the first. If the Fed was at all disquieted by Wednesday’s price action, then we might expect some attempt by Bernanke on Thursday, before the Senate banking
Committee (10:00edt) to qualify some of his remarks. That may be wishful thinking to some caught the wrong way and if Thursday proves to be a carbon copy of Wednesday, we could well see a further unwind of USD shorts. The question then is whether we will simply see preferences regarding the choice of funding currencies for risk taking behaviour shift elsewhere, and where the EUR and JPY could both quickly vie for supremacy, or a broader ’risk-off’ move.
- PMI time
With Mr Bernanke acknowledging the apparent disconnect between employment/unemployment data and the Fed’s read of demand, and after Tuesday’s very weak durable goods orders data, today’s manufacturing ISM data is going to be of particularly keen interest. A small rise (54.5 from 54.1) is expected and we would gauge that weaker than expected numbers will elicit the kind of risk-positive response (‘QE3 more likely’) that we saw after the durables data. Strong data could well perpetuate Wednesday’s moves, meaning a stronger USD across the board. Likewise if Initial claims were to come in below 350k. On other PMIs, the official Chinese print came in at 51.0, marginally above consensus of 50.9; helping to reassure on AUD and NZD. Eurozone PMI data meanwhile is final February data with much less potential to excite. UK PMI in contrast could if strong (market 52.0 from 52.1) easily provide the impetus for a fresh move lower in EURGBP and (if very strong) a fresh assault on the 1.60 level on GBPUSD.
BNP Paribas