Some Thoughts About LTRO II Prepayment

Two big events tomorrow. One is the EC updated forecasts, which may have policy implications. However, the second event may be more immediately important for prices.
Tomorrow is the first opportunity for European banks to declare how much of LTRO 2 they want to pay back early. Based on the same percentage that LTRO was repaid, it would suggest something near 150 bln euros. Our understanding is that core banks were larger participants in LTRO II than LTRO I. On ideas the stronger banks are more likely to return the funds, it suggests some upside, or larger prepayment.

Some disagree. It is reported that Danske Bank, is saying the market may exaggerating the repayment. It says the market is pricing in ~125 bln euro announcement tomorrow, and 7 bln on average per week thereafter. JP Morgan sees 100-125 bln payback announcement tomorrow.

The Bloomberg survey is for total LTRO II prepayment of 138 bln median and 165 bln ave. In the survey for initial prepayment of the first LTRO the median and average were near half of what actually was announced.

Generally speaking, the larger the repayment the more upward pressure on short-term European rates. Looking at the June Euribor futures contract, the implied interest rate rose from about 9 bp in near mid-December to 45 bp in late January. Since implied rate has trended lower (prices higher), and reached 27 bp earlier this week. This is roughly a 50% retracement. The next retracement target is near 23 bp.

This is also reflected in the 2-year spread between the US and Germany. After trending away from the US from mid-December, as the implied yield on Euribor rose an the euro appreciated, it reversed in late January. The US had fallen to an almost 3 bp discount to Germany and earlier this week was at a 10 bp premium, and the dollar is firmer.