TLTRO: One for the road – Natixis

Jean-François Robin, Research Analyst at Natixis, points out that the fourth and final Targeted Longer-Term Refinancing Operation (TLTRO) will be staged today and will be in the focus.

Key Quotes

“During the last meeting of the European Central Bank (ECB), Mario Draghi suggested that a new TLTRO was not planned. Nevertheless, one can imagine that this was also (perhaps mainly) to ensure there would be a good take-up at the last scheduled TLTRO. For the banks, more was to be gained from waiting for the last TLTRO, which has the longest maturity. Given the risk there will be a normalisation of key monetary policy rates in coming years, this final refinancing operation offers the best risk/reward ratio, especially for banks entitled to the 40bp bonus. Had Mario Draghi left the door open to another TLTRO later this year, the incentive to take part in the March operation would, of course, have been much less.”

“The ECB as a whole, including Germany, is not in the least opposed to TLTRO, which are a more “standard” measure in its monetary arsenal, less exceptional and less controversial than the purchase of sovereign bonds at negative yields. Previously, a number of governors had hinted that another TLTRO could be envisaged. This could happen, but probably only when previous LTRO and TLTRO reach maturity, to avoid a refinancing wall...”

“More short term, targeted longer-term refinancing operations could, in our view, be used to blunt the impact of an eventual tapering (which we expect to be announced in September), notably if spreads come under excessive strains.”

“Were one slightly more cynical, Ewald Nowotny’s announcement that the deposit rate could be raised could not have been timed better in encouraging banks to participate in the final operation. Irrespective of Ewald Nowotny’s assessment, it is likely if not certain that during the course of the final TLTRO (which matures in March 2021), the ECB will end up raising its deposit rate and repo rate. Our view is that the first hike in the repo rate will occur at the start of 2019, possibly earlier in the case of the deposit rate (but not until the end of 2018, however). The incentive to obtain free liquidity at four years is therefore very strong.”

“There follows that demand could be greater than for the two previous TLTRO. While it is not known exactly what banks could be most active, some have already indicated that they would take part in the final TLTRO.”

“While an ersatz QE, if demands exceeds say €150bn, the final TLTRO would lead to a compression of spreads, drive down Eonia, weaken market interest rates (notably past 4 years, with the risk therefore that there will be a steepening from 5 to 10 years but a flattening from 2 to 5 years) and weigh on the euro. The greater the amount borrowed by the banks, the more negative the balance between supply and demand for securities.”

“All in all, everything suggests demand will be strong. For this last TLTRO, we expect demand to reach around €100bn. Bear in mind that banks have no real need for cash, are reluctant to be over dependent on the ECB, need to retain collateral to preserve market access post-ECB, etc. There are therefore also reasons why demand will not be huge.”

“As expectations are for rather strong demand, if it were less than €100bn, this could lead to a widening of spreads, while the current pricing of a monetary policy normalisation (which is a touch optimist) in the Eurozone, in the wake of the US, would resume.... and conversely.”