On 8 December the European Central Bank (ECB) launched its LTRO (Longer-Term Refinancing Operations) emergency funding scheme, providing the banking sector with a much needed boost to liquidity. The scheme contributed towards financial sector strength in January with no negative stigma attached to the participating banks.
The next tranche comes on 29 February; with estimates on how much the banks will take varying between €400bn and €1tn. Evidence suggests that the first LTRO was used to cover refinancing, with the second tranche there is significant pressure on the banks to use the funds to buy sovereign bonds in the carry trade to borrow cheaply and invest at higher yields.
The size of this next tranche has significant implications for the market. A larger amount suggests greater profits from the carry trade as they reinvest in sovereigns, but also higher risk should the sovereigns in question deteriorate as austerity bites. A lower take-up with existing assets used as collateral means outstanding and future issuance of senior debt is effectively subordinate (to the ECB) and may cause analysts to look less favourably at banks, who will still need to issue debt. Finally, for sovereigns with questionable fundamentals, no amount of liquidity will solve what is in affect a solvency issue.