Wednesday, December 28, 2011

How the markets get spooked by old news

A sudden selloff in EUR makes everyone ask the question - what happened?

EUR/USD (Bloomberg)

In these thinly traded markets it could be a number of things (including some year-end corporate repatriation), but the focus seems to be on a sudden spike in the ECB balance sheet.
Bloomberg: The euro dropped against the yen to the lowest level since 2001 as the European Central Bank’s balance sheet soared to a record after it lent regional banks more money last week to keep credit flowing.
Total Assets at the ECB (Bloomberg)

Of course the next question should be - what caused this spike? The component responsible for the increase is of course the lending to the eurozone financial institutions.

ECB loans to EZ financial institutions (Bloomberg)
The reason for this spike is the additional liquidity provided via Long Term Refinancing Operation (LTRO). The fact that LTRO was tapped quite extensively was well known a week ago.  We also knew that a slug of LTRO will be used to pay down the existing short-term loans from the ECB, but according to Barclays about 200 billion euros would be "new money" into the system.
Bloomberg (Dec 21st): Barclays estimates the loans will inject 193 billion euros of new money into the system, with 296 billion euros accounted for by maturing loans.
This is entirely consistent with the chart above showing roughly a 200bn increase in new loans to the eurozone banks. So where is the surprise that caused the euro to sell off? It seems that market participants are so confused and uncertain about news out of Europe that even information that is well known in advance spooks the markets when it shows up on a chart. It is more about "reminders" than "news" these days.  And with poor liquidity this week, it doesn't take much.
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