Classic Buy Rumor Sell Fact after LTRO

The euro extended its rally to a six day high, just shy of $1.32 before the results of the ECB's allotment.  The results were at the upper end of expectations and the euro was returned to session  lows.  A classic buy the rumor of a strong demand and sell the fact.  Expectations seemed to have crept higher.    The larger short squeeze in the euro may not be over.   The key seems to be $1.3050 area.  It should now be support for this corrective advance to remain intact. 

Almost 490 bln euros was taken in 3-year money by some 523 banks.  The sheer number of banks ensures limited stigma.  This is the upper end of the range that had been anticipated, which seems more important that a median guess.  In addition, almost another 30 bln euro was taken in 3-month month.  And on top of that,. $33 bln was taken at 14-day auction compared with $5.1 bln of 7-day dollars that were expiring.  

European banks have an estimated 230 bln bond maturing in Q1.  There will be another 3-year auction in Febuary after the new and lower reserve requirements are implemented.   

The rally in periphery bonds ahead of the LTRO has also been reversed.  While it may indication that the market sees through the liquidity provisions and is concerned about the underlying solvency issues. but it is also thin markets that could be reversed quickly.   The chief concern was that banks were running out of collateral and access to liquidity.  That immediate problem has been addressed.

To be sure, the crisis is not over.  My "muddling through" hypothesis includes the ECB providing a backstop for banks (not sovereigns) in terms of liquidity.  This would seem to reduce the extreme tail risks.  The hypothesis is also consistent with a continued decline of the euro.  My immediate concern is market positioning and participation.  

The other noteworthy development today is from Japan.  The BOJ lowered its economic assessment for the second consecutive month, noting that it was stalling.  Separately, but not unrelated, Japan reported a larger than expected trade deficit in November, the second consecutive deficit.  The shortfall was JPY695 bln in November after a JPY273 bln deficit in October. 

Exports fell the most since May, off 4.5% year-over-year.  Imports, boosted by fuel and post-quake demand, rose 11.4% year-over-year.  Exports to the US rose 2%, but Asian exports fell 8% year-over-year.  Asia is the destination of half Japan's exports.  However, that decline may not only reflect slower Asian growth, but given its role in assembly, it may also reflect expected weaker European demand.