Money markets on the trail of the ecbs cheap cash

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* Excess cash to keep money market rates low for long time* Peripheral bonds may be pressured by bank debt repayments* Expectations for bumper three-year funding spiralBy Kirsten DonovanLONDON, Feb 3 Even if growing expectations for a bumper take-up at the European Central Bank's next offering of long-term funds are disappointed, money market rates should stay at rock bottom as the fresh cash pours into banks' coffers. However, much of the funds could be used to repay upcoming bond redemptions and debt issued by struggling euro zone governments could eventually come under pressure. The half a trillion euros of 3-year loans handed out to banks in December has helped eased credit concerns, brought down the cost of borrowing for embattled countries such as Spain and Italy and led to a collapse in short-term rates in the secured repo and treasury bill markets. Although a vast chunk of the 500 billion euros of excess cash in the banking system is being parked back at the ECB overnight, there are clues elsewhere as to what is being done with the rest of the money. It would appear that while Northern European banks are channelling the money into safer places such as German government bonds, repos and the ECB's vaults, Southern European banks, especially in Spain, have dived back into their own countries' sovereign issuance. The euro area balance sheet compiled by the ECB shows Spanish banks' holdings of government bonds increased by around 25 billion euros in December from November. Although some of this will be accounted for by the rise in prices as peripheral debt markets rallied, Spanish banks were far and away the biggest purchasers of such bonds in the final month of the year.

Italian banks' holdings increased by around 4 billion euros but German, French and Dutch banks were net sellers. Spanish and Italian banks also increased their holdings of bank bonds by 17 billion euros. JP Morgan analyst Nikolaos Panigirtzoglou estimates that around 100 billion euros of current three-year funding will be used to invest in bonds paying higher rates of interest - the so-called carry trade. So the rise in government and bank bond holdings in December - allowing for the change in value due to the market rally - accounted for less than half of that cash. And with the rally in both government and bank bonds persisting throughout January it is likely this investment trend continued in the first weeks of 2012."The (three-year operation) was near the end of December, leaving only one week so our guess is most of the cash was deployed in January," Panigirtzoglou said.

Commerzbank strategist Christoph Rieger said he believed Northern European banks were parking cash in high quality repos and in the ECB's overnight deposit facility, fuelling the demand for safe-haven paper such as Bunds even as risk appetite in financial markets picked up. Banks currently have one more opportunity to obtain cheap three-year funding but have to repay around 550 billion euros of maturing bonds during this year, Commerzbank estimates. The Financial Times reported earlier this week that European banks were preparing to double their crisis loans to a trillion euros at the next three-year operation at the end of February although a Reuters poll on Tuesday saw an expected take-up of a more modest 325 billion euros.

"Markets are delirious with a 1 trillion euro headline popping up again," Rieger said, urging caution. And a euro zone central bank official was also sceptical about the figure."I think now the analysts are getting carried away, personally I think it is likely to be a similar level as the last one."The money being used by banks addicted to ECB funding as well as the solid peripheral banks to buy government bonds may well be used to meet bond redemptions as the year goes on."The balance sheet expansion that is taking place when banks are making use of the three-year operations supports a range of assets," Rieger said."However, unless this expansionary impulse leads to a lasting thawing of capital market funding and a recovery in risk appetite, the expansion of bank balance sheets will likely be temporary."Panigirtzoglou does see the trend of parking money in repo markets and short term T-bills as likely to continue however. Evidence that money is finding its way there is reflected by, for example, a fall in short-term Italian repo rates to 30 or 40 basis points since December's three-year operation from around 1.5 percent before, while T-bill yields have collapsed."The short-term vehicles, repo, T-bills, even unsecured overnight rates, are all being supported by this wall of cash which is going to stay for a very long time. Period," he said."There is so much cash that rates will stay low even if we assume some of the money is used to repay debt because any rise in for example repo rates will make it attractive to move cash out of the deposit facility."