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For most of February, the market was anticipating ‘leap day’. What was gained this year was more than just an extra 24 hours – the market was anticipating the gift of hundreds of billions of euros from the European Central Bank (ECB) as part of the second round of 3-year Long-term Refinancing Operations (LTROs). And Mr Draghi did not disappoint.
Take-up at the facility was larger than expected at €529.5bn versus a median market estimate of €470bn. Of this, a bit more than €200 billion was rolled over from previous loans, meaning that approximately €320bn of net new liquidity has been extended to the European banking system. The previous LTRO in December added approximately €240bn net out of the €490bn allotted. This means that a trillion euros gross has been loaned to European banks for three years, and over half a trillion euros of net monetary expansion added by the ECB in less than 3 months.
Whichever way you slice it, these are astonishing numbers. To put this in perspective, the ECB’s balance sheet was at €2 trillion last summer and rose to €2.7tn as of last Friday. This latest addition of liquidity is likely to push it over the €3 trillion mark, depending on what other operations the bank undertakes.
The scale of the operations undertaken by the ECB under new President Mario Draghi has already attracted criticism from the Bundesbank chief Jens Weidmann. Of particular concern for the Germans is the loosening of collateral requirements for the LTRO loans – the Germans are afraid that, as the Eurozone’s biggest creditor, they are being increasingly exposed to questionable credit risk through the ECB system - not to mention the large net exposure of the Bundesbank to the peripheral sovereigns.
For the latter reason, Germany will have to continue to support the eurosystem – it cannot afford not to. However, the political climate in Germany is hardening. 60% of Germans were opposed to the latest bailout deal for Greece, which was voted on by the German parliament this week. The deal was passed by a large majority but Chancellor Angela Merkel was unable to pass the legislation without the help of the opposition. This bodes badly for her control over the governing coalition. With recent polls suggesting that French President Nicolas Sarkozy is likely to lose his bid for re-election this year, political instability remains a huge risk to a Europe that has gained a short-term reprieve from the ECB, but remains years away from solving its chronic problems.
A greater than expected take-up in the LTRO has continued to lend support to markets, with the S&P futures making a fresh, 12-month closing high again this week. However, in the absence of any fresh positive impetus it is difficult to see what will drive the market higher from here. Nevertheless, the mood is positive and as of now the market still seems to be in the mood of ‘buying the dips’, adding risk on any pullback. On the same day as the LTRO, Federal Reserve Chairman Ben Bernanke testified before Congress and struck a relatively bullish tone, indicating that he was surprised by the relative strength of recent employment data. While he emphasized that many risks remain, particularly in Europe, he failed to make any mention of QE3, which has rattled commodity markets somewhat.
Equities: US equity markets have remained near their highs for the move this week, refusing to give much ground but struggling to push meaningfully higher despite higher than expected LTRO numbers. European equities have had an interesting time of it post-LTRO, initially selling off to test the recent support levels before rallying back extremely strongly. European equities, at the time of writing, are outperforming their counterparts across the Atlantic, with the best major market performance this week coming from Italy.
There has been a lot of talk recently in the US markets about how much of the performance of the major indices, year-to-date, has been driven by Apple. The market value of Apple crossed the $500 billion mark this week. For some perspective on this, it is worth noting that this is larger than the annual gross domestic product of Ireland and Portugal combined. Apple is one of the most owned stocks by fund managers. A number of commentators have begun to question how sustainable this is. Next week Apple releases its new version of the iPad and the first major launch since Steve Jobs passed on.
Fixed Income: The relative aggressiveness of Bernanke versus Draghi has driven the spread between ten-year bond yields in Germany versus those in the United States this week. As the much-anticipated QE3 seemed less likely yesterday, US Treasuries were hit hard, and US 10 year bond yields traded back above 2%. On the other hand, German bond yields continued to grind lower this week in anticipation of LTRO. Italian 10-year bonds also performed strongly this week, with yields breaking back below 5% for the first time since the market first began to panic about the sustainability of Italy’s economy towards the end of last summer.
Currencies: After Bernanke’s testimony on Wednesday, the dollar has broken out of its range for the last five days and remains poised on the verge of breaking out of its downward trend since its recent highs in January. Much of the move in the dollar is versus the Japanese yen, which continues to weaken, whereas the Euro is unchanged on the week relative to the greenback (at time of writing) after selling off in the wake of Bernanke’s comments. The British pound has had a strong week, up 1.5% in the last 5 days, while the ‘Aussie’ dollar remains very strong after its huge rally this year. Interestingly, the title of best performing currency year-to-date is won by the ‘Kiwi’ dollar, which is up 8% YTD.
Commodities: The major action in commodity markets this week has been the incredibly rapid collapse in the gold price on Wednesday, as it became apparent to the market that Bernanke would not mention further quantitative easing in his testimony to Congress. In a few seconds, spot gold fell about $50 dollars a troy ounce. Less than six hours after Bernanke spoke it hit a low of $1687, having lost $100 dollars, before recovering somewhat in the overnight market. This shows how jittery this gold market is – with a number of investors in the United States trading gold on margin, the volatility can be brutal.
Silver has become gold’s more volatile cousin amongst speculators. After gaining 5% in the day ahead of the LTRO, silver lost almost 9% in just over an hour before recovering 3.5% overnight – a white knuckle ride for even the most hardened investor.
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