ECB JOINS THE PARTY – IMPLICATION FOR RATES AND SPREADS
The global liquidity spigot got a large new source of funds from the ECB last week when the EZ decided it was tired of missing out on the party. The details of the ECB’s plans have been infinitely dissected by both the media and analyst community (ourselves included) so we won’t repeat them here. Our view is that while the negative depo rate grabbed all the headlines, the targeted longer-term refinancing operation (TLTRO) has the greatest potential to influence global asset values. While the targeted approach is intended to kick start lending to EZ businesses, we are more skeptical on this front, and think that cheap funding will likely revitalize the carry trade once funds start flowing in the fall. We have already seen strong moves into higher yielding Euro periphery debt, as previous incarnations of the ECB’s term repo operations pushed the carry trade into weaker sovereign credits. For instance, yields on Spanish and Italian bonds have fallen by 20 bps each since the ECB’s announcement, while yields on Portuguese and Greek bonds are down 40bps and 80 bps, respectively. As the chart below indicates, certain parts of the Spanish curve have traded through UST rates, which from a credit perspective make little sense, although we think that the periphery relationships to Bunds are a more important metric. From this perspective, the +123 bps of the Spanish 10-year to the German 10-year sits squarely at the level they were at just before Spanish yields began to spike in 2010, which also corresponded closely to the start of the Greek debt crisis. Given how low the yield on core Eurozone bonds are already, we find it difficult to envision much more compression on that front, while getting to pre-2010 spreads on periphery debt is difficult to justify from a fundamental perspective.