ECB Lightenings Up The Markets

It is getting darker in the Northern hemisphere, but after the winter solstice next week the days will start to get brighter – albeit slowly. Whether the same can be said about the financial markets is a big question and by no means can we rule out the possibility of prolonged and denser darkness before the markets eventually lighten up. One thing that could lighten up the holiday season is the ECB three-year liquidity programme that banks can tap using a wider base of eligible collateral. We think this programme is quite significant as it offers long-term liquidity at very reasonable conditions and makes it easier for banks to lower their funding costs and make more investments (securities and loans) profitable. More importantly, the programme could help short-circuit the brutal selling of sovereign debt that banks have been doing – however, most likely not before year-end as we doubt banks would see strong reason to show big investment positions in GIIPS in their annual reports. Note that the ECB programme does not materially change the prospects for banks that are constrained by their capitalisation. For these banks, the incentive to de-lever is unchanged.

So far the credit market has not warmed particularly to the ECB liquidity programme – in our view, most likely due to it being overshadowed by the disappointment that the ECB has not stepped up its buying of sovereign bonds. Furthermore, the newsflow following the EU summit last week shows that implementation risks of a potential new EU treaty are likely to be significant. In a shallow ‘end of year’ market this is enough to cause a widening of CDS indices. Compared with last week, the investment grade index, iTraxx Europe, has widened some 12bp to 188bp while the high yield index has widened by 40bp to 800bp.

On another note, Fitch has downgraded a number of European banks including Danske Bank and Pohjola Bank in the Nordic region. The downgrades come as a consequence of a general review of the bank ratings amid the sovereign debt crisis. Furthermore, Vattenfall was downgraded and Fortum was put on negative outlook by S&P following a more pessimistic view on the Nordic utili ties market due to lower demand.

At the beginning of the week, we saw a few corporate issuers approaching the bond market. Vinci and Akzo Nobel both came to the market with benchmark deals. Despite the difficult market environment, both bonds have performed well subsequently in the secondary market, illustrating why it is often a good idea for investors to dip their toes into the primary markets when times are rough as the new issue premiums are substantial in order to ensure a ‘successful’ transaction. We do not anticipate any primary market activity next week as books are in the process of being closed.