The Bazooka Looking Like a Dud as Banks Redeposit Funds with ECB

We are now getting reports that seem to strongly indicate that the ECB's L.T.R.O. is not working out the way the ECB and many bullish analysts had hoped that it would.

Recall that on December 21, 2011, the ECB opened up its checkbook and allowed banks to borrow unlimited amounts at a rate of 1% for a period of three years. Reports indicate that €489.2 billion of 3-year funds was taken in by the banks.

Here's my summary of "events":

• It was initially reported as very good news as the expectation included in the reporting was that virtually all of those funds would be used to purchase the sovereign debt offerings soon to be done by Italy, Spain, France and others.
  
• Next came reports that over half of the €489 billion was being used to rollover other shorter-term borrowings by banks from the ECB. It became apparent that the amount of "new" borrowing which could be used in a "Carry Trade" was only about €210 billion net funds. Still, this was a large amount and the hope of large sovereign debt purchases remained.
  
• Then came reports that not all of the €210 billion would be used to buy PIIGS bonds. It seemed that banks were simply depositing a fair amount of the funds back at the ECB. On December 23rd it was reported (by ZeroHedge and others) that through the 22nd about €82 billion of the free €210 (roughly €490B less €280B rolled over) had been placed with the ECB's Deposit Facility. That brought cumulative usage of the Deposit Facility to a 2011 record of €347 billion.
  
• Around the same time (Thursday/Friday) yields on Italian 10-year bonds began to "test" the 7% level once again.
  
• Now, today, we get the news that an additional €65 billion has been deposited overnight and the ECB has confirmed that usage of its Deposit Facility has surged to €412 billion, an all time record amount. That is a jump of approximately €147 billion in 2-3 days.

Any conclusions are tenuous at this point but it appears that those 523 banks that tapped the ECB's new 3-year LTRO have either simply rolled over shorter-term loans or have chosen to redeposit the funds with the ECB. The question regarding the redeposit portion is: Why?

For some reason the banks have chosen to grab €210 billion net of funds at 1% and place them back at the ECB where they will receive 0.25%. That means the have chosen a negative carry of 75 basis points and feel that this is a better play than buying higher yield debt from Spain or Italy or even from France (Sarkozy must be spitting nails). Perhaps this is a temporary move; park the funds with the ECB and use them elsewhere soon, but that just doesn't feel right.

Also note that the yield on German 1-year paper has gone negative. (Flight to Quality?) Also, Italian 10-year yields have nosed above 7.00%.

To the above I will add that there is a large (about €8 billion) auction of Italian paper scheduled for Thursday. In our present light-volume environment I am concerned that a "failed" or poor auction could trigger an out-sized negative response in the equity markets.

No boasting intended in the following, I am leading to a point.

I have had a decent year trading and I am very pleased with my results since the market peaked on April 29th of this year. Since then the S&P500 is down -7.2% through Friday. For the same span of time my trading accounts have gained about +12.4%.

Now the point: why risk closing out the year on a sour note? If something blows up in "Euroland" in the next few days, such as the pending Italian auction, the markets could dive sharply. While my accounts would not take a big hit, the loss would likely somewhat dampen my mood just before the upcoming New Year's Eve weekend.

Why risk it?

Therefore, I am considering closing out some of my long positions, and possibly all them, in the near future.

Recall one of my adages for this year has been: Stress Capital Preservation Over Profit Maximization.

Curtis Bergquist
Options Manager: Daily Decision-PRO

P.S. The Daily Decision-PRO Service is up on the year and has beaten the market handily for five months running now.

 

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