When 500 billion euros no longer pops eyes

February 28, 2012

There was a time when 500 billion euros in cash was truly spectacular.

But investors and speculators hoping for an even more eye-popping cash injection at the European Central Bank’s second and most likely last three-year money operation on Wednesday are likely to be disappointed, based on past Reuters polls of expectations.

"Here, have some cash"

Ever since the ECB started offering cheap, long-term loans to keep cash flowing through banks during the financial crisis, a clear pattern has emerged in the forecasts of money market traders attempting to gauge their size.

They have consistently underestimated the size of a given new loan tender the first time it is offered, only to overshoot on subsequent operations of the same maturity.

It is already widely understood on many trading desks that Wednesday’s sale, which the ECB is not likely to repeat, is an offer that is too good to refuse rather than a vital lifeline to keep the financial system afloat.

“Free lunch” is a common phrase that money market traders contacted by Reuters have used over the past month when providing views on how big Wednesday’s long-term refinancing offer (LTRO), currently expected to be 500 billion euros, is likely to be.

As early as the first one-year tender the ECB offered in 2009 when the credit crisis was gripping the financial system by the jugular and threatening to bring it crashing down, traders were overwhelmed by the wall of cash that hit them. 

That operation provided a 442 billion euro firehose, which at the time helped preventing flames raging in the money markets from spreading into a total inferno in the harrowing months following the collapse of U.S. investment bank Lehman Brothers.

Fast forward to late last year, when the ensuing sovereign debt crisis in Europe had pushed yields on benchmark Italian and Spanish debt to danger rates above 7 percent, and the ECB again was forced to step in to ward off catastrophe.

The Reuters consensus was 310 billion euros, far undershooting the 489 billion they actually hosed out to 523 banks who lined up at the trough for the cash.

That December 21 cash injection helped bring down Spanish and Italian bond yields as banks were coerced into reinvesting the money. It also just happened to trigger a rally in global equity markets, sending key indexes racing up to multi-year highs.

Sure enough, traders starting ramping up expectations there would be oodles more cash to play with. One went from predicting just 30 billion in take-up in Wednesday’s auction when polled on Jan. 16 to 650 billion in a poll taken a week ago.

But even he cut his prediction back to 500 billion in the latest survey.

There have been several figures bandied about that are even more eye-wateringly high, 1 trillion euros or more. But the highest an actual money market trader got was 800 billion euros before he trimmed that back in the latest poll to 700 billion.

Polls conducted by investment banks of their clientele not suprisingly have pointed to another staggering sum, in most cases higher than the traders. 

But with asset prices rallying and hedge funds having a banner start to the year after a decidedly bad 2011, who wouldn’t want to provide a dealer with a forecast for another ton of free money? Bring it on.

But the Reuters poll of money market traders suggests a bit of caution wouldn’t be such a bad idea. After all, these are the people who actually trade the market and who consistently have been saying no more liquidity is needed.

While the median forecast for Wednesday’s LTRO is 500 billion, the bulk of responses have been concentrated between 251 and 500 billion euros in all six polls conducted over the past month and a half.

The rising euphoria since the start of the year, clear from this graph, appears to have levelled off.

(Reporting and analysis by Yati Himatsingka and Sumanta Dey)

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