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By Gaurav Kashyap, Head of DGCX Desk at Alpari ME DMCC
The week was dominated by speculation regarding the size of the ECB's second LTRO. In a bid to promote liquidity and additional easing across the Eurozone, the ECB announced its first LTRO in December in which 523 European banks borrowed a total of €489bn at an interest of 1%.
On Wednesday, the ECB announced that its second LTRO was worth a much larger €529.5bn with 800 European banks partaking in the LTRO. The announcement dwarfed market expectations which were poised at €470bn. In a bid to bring cheap liquidity to the region, improve European bond market conditions and thaw out interbank lending, the ECB's extension will shore up European banks' capital bases and provide the region the additional liquidity in a bid to avoid another credit crunch.
The two LTRO actions worth a combined €1 trillion have been directly responsible for falling yields and solid bid-to-cover ratios in several bond auctions in debt ridden European nations such as Spain, Portugal and Italy. When borrowing at 1% from the ECB, the more aggressive European banks can reinvest those loans into higher yielding assets (into debt of risky European governments) and earn several percentage points off the spread.
While the measures will no doubt bring short-term liquidity in the markets and have helped in bringing down the yields on short term Italian and Spanish debt, the long term effects are more questionable with yields expected to move higher once the effects of the LTRO wears off. In fact the Euro's reaction to the larger than expected LTRO was rather curious - the pair dropped 50 points against the Greenback with European equities largely unchanged in the hours following the announcement.
Bernanke testimony sees US dollar rally
Perhaps the doubts that this would the ECB's last LTRO (the central bank's balance sheet is approaching €3 trillion) weighed down on risk sentiments but it was Fed Chairman Ben Bernanke's comments late on Wednesday which compounded the Euro's misery.
In his semi-annual testimony to the US Congress, Bernanke held off on the need for QE3 when he described the US expansion has been 'uneven and modest' with 'positive developments' in the labour market. He did admit that unemployment remains 'elevated' and with prices in control, the Fed will continue to have an accommodative and open stance on monetary policy. The lack of QE3 measures and the dovish language of the Fed saw markets dip significantly as the US Dollar rallied across the board.
With US output at 3% (revised upwards from 2.8%), an improving labour market (the unemployment rate has dropped to 8.3%, the lowest level since March 2009) and subdued price growth (YoY CPI ex Food & Transport at 2.3%) there is little need for the Fed to introduce additional easing measures. Growth seems to be back on track (albeit in a modest manner) and US equity markets are performing solidly. Barring a massive selloff in US equities or a change in the aforementioned factors, the Fed can continue the status quo without the need of expanding their balance sheet.
What this means is that positive data and growth related stories out of the US will continue to dampen the need for additional easing and this should continue to keep the US Dollar buoyant in the interim.
Gold see largest one-day loss since 2008
It was a rough week for Gold bulls, who saw their precious metal drop 3.50% in the week.
Staff
