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Wednesday, 29 February 2012

The ECB is handing out sleeping pills to the financial markets: ‘sweet dreams, you b*stards…’

Nurse: “Sweet dreams, you b*stard”
Protagonist: “I remember now, I remember how it started”

This evening I was haunted with a feeling that the actions of Mario Draghi and the ECB are very similar with those of the nurse at the start of Queensrÿche’s legendary album ‘Operation Mindcrime’.

For those who don't know this musical masterpiece, here is a synopsis: the 'antihero' is under influence of a mad scientist that wants to start a world revolution in order to throw over the corrupted governments. Things go wrong and the anti-hero is arrested and locked up in a mental hospital. This is were the record sets off.
 Of course this has nothing to do with today's situation.

The story of this record is not important now, but the beginning is: 
while the hero of this true masterpiece album wants to remember what went wrong some time ago and how he came into the mess that he was in at that moment, the nurse in the mental hospital where he was locked up, sedated him with the words: “Sweet dreams, you b*stard”.

The analogy with the financial markets and the ECB is stunning. While the financial markets really want to disclose the problems that the banking industry and the European sovereigns have currently, ‘nurse’ Mario Draghi gives them a shot of €uro-sleeping pills through the banks. After this shot, the financial markets dream on for a month or so.

Today the news was published that the ECB handed out another €529 bln in credit ‘sleeping pills’. It clearly hopes that the financial markets will forget in what a dire situation the large European banks and the Euro-zone sovereigns are, in reality.

The Financial Times wrote a cover story on the renewed ECB lending scheme today. Here are the pertinent snips of this story:

The European Central Bank on Wednesday injected €529.5bn into the eurozone financial system as 800 European banks took advantage of the ECB’s cheap three-year longer-term refinancing operation [...], which offers lenders an interest rate of just 1%. 

The ECB’s first three-year loan programme in December, which saw 523 banks borrow €489bn, was widely seen as a “game changer” that helped to avert a liquidity squeeze in the European banking system. 

Wednesday’s figure included funds rolled from shorter dated operations. About €310bn of net new liquidity was added to the system – much more than in December’s loan auction. “This is at the higher end of market expectations and should have a positive impact on risk assets especially when compared to the €193.4bn net liquidity add that was seen from December’s LTRO 1,” said Divyang Shah, global strategist at IFR Markets.

Suki Mann, head of credit strategy at Société Générale in London, said “You can reasonably assume that any major short-term funding issues have now been alleviated and the market can move on. The fact that more banks participated is a result of the collateral rules being widened.”

Banks, particularly those in Spain and Italy, are thought to have already used the first round of cheap money from the ECB to buy their governments’ sovereign bonds, helping to drive borrowing costs lower. Recent figures from the ECB show that Italian and Spanish banks increased their holdings in sovereign bonds by 13% and 29% respectively over a two-month period between December and January.

Some [people] have warned that eurozone banks risk becoming addicted to the cheap funding from the ECB and that it may not be long before the central bank has to commit to a third LTRO.

However, Mario Draghi, the ECB’s president, stressed earlier this month that the measures were temporary and the central bank would not pre-commit to making them a permanent feature of monetary policy.

And yes, the patients, called ‘financial markets’ are again sound asleep.

As a matter of fact, during the last two weeks Greece is stashed in the mausoleum of the Euro-zone with a sign: ‘small enough to fail’. Nobody cares about this poor country anymore.

At the same time, the banks in the more important PIIGS countries Spain and Italy have again enough financial fire power to force the interest rate of Italian and Spanish bonds down; the proverbial emperor from Hans-Christian Andersen’s fairytale shows his new clothes again and looks indeed magnificent.

And everybody is happily shouting: ‘look how low the interest rates of Italy and Spain are currently. Now the Euro-zone is safe. And Germany finally seems to be going to expand the firepower of the Euro-zone’s bazooka EFSF/ESM (European Financial Stability Facility / ~Stability Mechanism). This will make the Euro-zone a much safer place too’.

But please look at the facts:
  • Greece is –  with -7% negative growth in 2011Q4 y-o-y – going through the heaviest economic contraction in years – maybe even in history
  • Spain, Italy and Portugal are not likely to return to prosperous times soon. During the last year, the focus of the EU and the Euro-zone has been exclusively on financial stability and not on regaining economic prosperity. The results are predictable: negative growth, with Spain as a relative outlier, as this country had ‘only’ negative growth in Q4.
  • Germany seems to head towards a recession with negative growth in 2011Q4, while economic ‘Mighty Mouse’ The Netherlands is already officially in one. France had anemic growth of 0.2%, but was celebrated like a true champion.
  • Of the 18 countries that sent Q-o-Q data to Eurostat, 12 reported negative growth. Of the 9 countries that didn’t report Q4 growth data, at least four will have negative growth, is my assumption.

But the financial markets fall happily asleep and have very vivid dreams with all kinds of colors and shapes. It are the drugs, y’know!

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