The bond markets opened up with a markedly different tone this morning as a new buzzphrase lines the lips of clients and brokers:
"LTRO Arbitrage"
With the relaxing of collateral requirements for ECB funding access, commonly thought of as "backdoor QE" since it undoubtedly floods financial markets with new liquidity, the Eurozone has commenced 2012 on a stronger than expected footing.
There has been much debate as to whether these 3yr low-rate loans will actually ease sovereign bond flight, with many commentators arguing that banks will simply use this cash to shore up balance sheets and deleverage. However, with some encouraging Italian auctions and with Spanish paper tightening in markedly over the Christmas period, the evidence would suggest that, at the margins at least, the LTRO arbitrage (borrow from ECB lend to Sovs) is seemingly alive and well.
Of course this is of little comfort in the long-term. Indeed, these measures (combined with the new Fed Swap line announced early Dec) are purely in place to buy time for further policy. We reiterate that there is 0% chance of growing out of this debt. The options are:
1. Inflate
2. Restructure
3. One-time Tax
All seem implausible just now.
Regardless, over the medium term we have begun to build a slight bullish bias, certainly for the next month to 3 months..
Injections of steroid capital require investors to treat markets with short term respect, long term skepticism.
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