Ten Things You Should Know about the LTRO

1. Banks that borrowed from the ECB under the Long Term Repo Operation (LTRO) can begin repaying, if they want. Banks must notify the ECB on a weekly basis about how much they want to repay. The ECB will publish amount to be paid back and the number of banks every Friday for the next few years, starting tomorrow.

2. Banks borrowed roughly 1 trillion euros in the two LTRO 3-year operations (Dec 11 and Feb 12). Italian and Spanish banks are believed to have accounted for around 60% of the use of the LTRO, German banks a little more than 10% and French banks a little less than 10%. 

3. Estimates of repayment range from 100-250 bln euros, but may come in drips and drabs.

4. Since the LTRO was designed to help with the refinancing cliff faced by European banks (and secondarily by the sovereigns), early repayment would be consistent with the easing of financial conditions. This essentially means access to market funding. Many banks have reportedly issued debt in the past few months. Bank borrowing from the ECB has fallen, so for example, Spanish bank borrowing from the ECB in Dec was the lowest since May and Portugal borrowings were at their lowest since Feb. In addition, deposits at Spanish and Greek banks have stabilized as 2012 drew to a close.

5. However, there is some fear that a two-tier banking system is crystallizing in Europe, with the large banks in the core countries having greater access to the markets than small banks and banks in the periphery. Although the ECB is not going to publish the names of individual banks, some banks may seek to announce their repayment on ideas that it will bolster investor confidence.

6. There has been some fear that the early repayment would push up short-term European rates and the implied interest rate of the March Euribor futures contract did increase by about 15 bp at the start of the year, but has since stabilized, following some calming words by an ECB official. For more than a week now the daily closing implied yield is between 26 and 28 bp. 

7. The implication of early repayment and the reduced borrowing is consistent with a reduction of the ECB's balance sheet. As of Jan 18 (most recent data), the ECB's balance sheet was the smallest since the end of last Feb. The reduction of the ECB's balance sheet comes as the US Federal Reserve is expanding its balance sheet via buying $85 bln of MBS and Treasuries a month. 

8. Some participants give a privileged place in their fx explanatory model to the monetary policy and in particular the quantity of money. While recognizing that monetary factors can influence foreign exchange prices, our experience suggests that other variables also impact. 

9. Three market segments appear to be participating in the euro's advance. Central banks, especially in the Middle East, have reportedly been buyers of euros. Real money is reportedly buying (short-end) of Spanish and Italian bonds. Equity funds investing in Europe have also reported net inflows. Lastly, momentum and trend followers in the IMM futures have been buying euro contracts. The gross longs futures contracts are near their highest level since mid-2011, while gross shorts are at their lowest level since Sept '11.

10. Although most of the other major currencies have weakened against the dollar, the euro has been resilient. After rallying from $1.30 at start of the year to $1.34 by mid-Jan, it has been trading broadly sideways in a $1.3250-$1.3400 range. The trend line going back to the July '11 lows near $1.2040 remains intact (though sterling has convincingly broken a similar trend line). It comes in now near $1.31. On the upside, a break of $1.34 could quickly see $1.35, the high from last year.