247Bull.com Editor: In December 2011 and February 2012 the ECB pumped more than one trillion euros into the Eurozone banking system in two offerings of 3-year loans. The program, which was known as the Long Term Refinancing Operation (LTRO), was designed to avert a second credit crunch and with the help of other measures, it did so.
The banks that took advantage of the loans repaid 134 billion euros from the first tranche of three-year loans on 30 January, and Reuters has reported that they will repay 125 billion euros from the second tranche on 27 February. These loan repayments mean that the ECB’s balance sheet is actually shrinking while those at the Fed and BoJ are growing rapidly.
This development is generally seen as very bullish, and a sign that European money markets are healing and that bank’s are more confident about their access to funding. However, as Stephanie Kretz and Karen Guinand at Swiss private bank Lombard Odier warn, the early repayment of LTRO loans could mask another problem.
They note that “banks are repaying LTRO loans by aggressively running down excess reserves held in their current account facilities at the ECB – down to €377bn from €560bn mid-January – extending the sharp €2.1trn drop in total assets of the eurozone banking system since the May 2012 peak.” They go on to say that, “this means that credit to the private sector is contracting. At the end of last year, loans granted to eurozone residents had fallen by €686bn from their June 2012 peak… Given the still vastly excessive leverage of eurozone banks versus their Tangible Common Equity (TCE), this process has much further to run, implying that tight credit conditions are here to stay.”
In any event, for the time being the euro looks set to continue to strengthen both against the US dollar and the British Pound.
There are three key factors contributing to a stronger EUR/USD.
First, European sovereign tail risks are diminishing. The political situations in Spain and Italy are a near term concern, however, the euro’s existential crisis is over. According to Intrade, the probability of a country leaving the eurozone by the end of 2014 has dropped from a peak of near 75% to 20% today.
Second, the ECB is not participating in the “currency war”. ECB President Draghi is not particularly worried about the current level of the euro, noting that the real effective exchange rate is near its long run average. Meanwhile, the ECB’s balance sheet is slowly contracting as banks repay their LTRO loans.
Third, the euozone’s balance of payments is improving significantly. The trade surplus reached a new record high of €12 bn in December. This suggests that the current account surplus continues to grow. With long term capital inflows also turning up, the basic balance surplus is increasing.
The bottom line
Maintain a long EUR/USD position.
Article courtesy of http://bcaresearch.com