Creaky credit markets
It’s not a snap or even a pop – but there’s definitely a crackle. Rumblings emerging from key credit markets bare a frightening resemblance to the early days of the 2008 credit crunch.
Take commercial paper, a widely used instrument for short-term funding in the corporate world. Financial sector issuance of commercial paper fell steadily in the second half of last year, from around $556.5 billion in July to $434.4 brillion in December. The final month of the year saw the downward trend spilling over into other industries.
Paul Ashworth at Capital Economics:
The contraction in commercial paper issued by the financial sector is now being compounded by a dramatic drop off in commercial paper loans to the non-financial sector.
Despite the European Central Bank’s renewed effort to keep bank liquidity ample, money markets have shown some signs of strain. The London Interbank Offer Rate or LIBOR, used for loans between banks, more than doubled in the last six months of the year to its current 0.55 percent as worries mounted about the health of European institutions.
Anthony Crescenzi, portfolio manager at PIMCO:
Liquidity risks by no means have been eliminated because liquidity provisions are no substitute for private capital nor the transference of risk to either the private-sector or the central bank.
For inter-bank rates, this means that while rates might be capped by the cost of borrowing from the Fed and the ECB, no substantial decline in rates is yet likely either until an external balance sheet is drawn into the mix or there is a miraculous endogenous recovery in the wholesale funding market and Europe’s banks therefore regain market access.
ECB stuck feeding southern Europe’s cash addiction
Commercial banks in southern Europe are increasingly addicted to cheap central bank money after dealers shut them out of money markets. Due to this dependency, the European Central Bank will have little option but to keep offering banks cold hard cash for almost nothing – currently it prices its loans at 1.0 percent.
Economic growth in the euro-zone core has been robust lately, but southern Europe has been hit hard on several fronts recently and is falling badly behind. First, the sovereign debt crisis hit Greece and other southern periphery countries, then bank stress tests showed 6 out of 7 failing banks were in Spain or Greece, and then the region posted only tepid economic growth.
Bank borrowing from the ECB shows increasing strains in southern euro-zone’s financial sector while banks elsewhere are getting back on their feet, but the fear of contagion from country to country will keep the ECB on its toes. Banks in Greece borrowed twice as much last month as they did in July 2009, even though outstanding central bank lending fell 18 percent over the same time. Banks in Portugal borrowed five times as much in July 2010 as they did a year earlier, and borrowing also rose in Spain and Italy.
“The full-allotment fixed-rate repos will stay well into next year,” said Michala Marcussen, Societe General chief economist. “Beyond the first quarter of next year, the overall economic environment will be the key determinant in how much longer it gets carried. In all likelihood it could get carried further ahead.”
The ECB tried to reintroduce limits to borrowing in April but was forced into a U-turn by the sovereign debt crisis, returning to its full allotment policy in May. Fourth-quarter plans are due to be revealed in September, with markets expecting full allotment to continue.
Among the ECB’s 22 Governing Council members, Cyprus’s Athanasios Orphanides and Ireland’s Patrick Honohan have indicated the unlimited funding should continue, and on Friday Germany’s Axel Weber made clear exit discussions should not resume until early next year. His dovish tone got analysts’ attention.
