STOCK MARKET WATCH -- Thursday, 19 January 2012

[Demeter]

7. $10 TRILLION Liquidity Injection Coming? Credit Suisse Hunkers Down Ahead Of The European Endgame

http://www.zerohedge.com/news/10-trillion-ltro-coming-credit-suisse-hunkers-down-ahead-european-endgame

When yesterday we presented the view from CLSA's Chris Wood that the February 29 LTRO could be €1 Trillion (compared to under €500 billion for the December 21 iteration), we snickered, although we knew quite well that the market response, in stocks and gold, today would be precisely as has transpired. However, after reading the report by Credit Suisse's William Porter, we no longer assign a trivial probability to some ridiculous amount hitting the headlines early in the morning on February 29. Why? Because from this moment on, the market will no longer be preoccupied with a €1 trillion LTRO number as the potential headline, one which in itself would be sufficient to send the Euro tumbling, the USD surging, and provoking an immediate in kind response from the Fed. Instead, the new 'possible' number is just a "little" higher, which intuitively would make sense. After all both S&P and now Fitch expect Greece to default on March 20 (just to have the event somewhat "priced in&quot . Which means that in an attempt to front-run the unprecedented liquidity scramble that will certainly result as nobody has any idea what would happen should Greece default in an orderly fashion, let alone disorderly, the only buffer is having cash. Lots of it. A shock and awe liquidity firewall that will leave everyone stunned. How much. According to Credit Suisse the new LTRO number could be up to a gargantuan, and unprecedented, €10 TRILLION!

Here is how the strawman is now put in place for what may the biggest liquidity injection in modern history in just under two months.

February’s second 3-year LTRO looks set to be extremely large. Really extravagant claims (we have heard reports of €10 tn) are probably wide of the mark because this will not be a complete collateral free-for-all (unless NCBs choose to make it so, which for some of them is admittedly an open question; again, see rational player section below). But the idea of path-finder lightning springs to mind (High-speed cameras reveal that lightning evolves “bang BANG”, essentially); the last LTRO has removed any stigma, making managements who do not exploit the value on offer arguably careless at best. This is, on the face of it, very cheap protection indeed against any possibility of a liquidity crisis for three years.
Naturally, if indeed there is anything even remotely resembling a €10 trillion expansion in the ECB's sub €3 trillion balance sheet, all bets will be off as the ratio of the ECB to the Fed assets, a correlation which would imply a sub parity level on the EURUSD would gut corporate earnings in the US, all merely to prevent the disintegration of the Eurozone. And while this event will be welcomed by the Fed initially as it will send stocks exploding to potentially all time highs (and gold to well over $2000/ounce), it will cripple the US manufacturing model unless the Fed immediately responds in kind, and prints outright, and unsterilized, a non-trivial comparable amount. In other words, the world could very well enter the final round of global coordinated currency devaluation, aka FX war, together. Yes, that means coordinated printing by the SNB, BOE, PBoC, BOJ, etc, etc. Simply in a last ditch attempt to preserve the status quo. Which, unfortunately, after the knee jerk reaction, will fail. CS explains why:

But there are many problems, particularly at the systemic level. So, although an eye-catching number may trigger a rally (to be clear: 29 February is an eternity away in the current environment), Greece is a salutary reminder that treating a solvency problem as a liquidity problem, including buying time for solvency to be addressed and other dubious concepts, is a disaster for existing creditors, who are subordinated throughout by the senior rescue funds. It also shows that three years is an eternity and that timescales (such as the possible introduction of resolution regimes) are flexible. It remains unclear to us where the new capital for the European banking system is going to come from if not from existing bondholders and that, in some cases, that must involve senior, in our view. So the LTRO is another example of reducing idiosyncratic risk at the expense of systematizing risk, in our view.

The participating bank needs a plan for refinancing the LTRO; the lack of a plan means that financing will not be forthcoming, in a death spiral. So the massive provision of official liquidity will act as a long-term triage and increases the pressure (albeit over a longer period) to raise capital. It is a free lunch only for stronger banks, in some sense, and at the systemic level is anything but. Rather, it is paid for by those with senior exposure to weaker banks.
In fact, Credit Suisse is openly hunkering down as it now see the "endgame taking shape" - "We do not expect the downgrade of France to have an immediate impact, but it highlights very clearly to us the ultimate issue that has to be tested in the euro area. Will Germany hold together the euro as, when and if France becomes part of the periphery?"

Here is how the European endgame will look, through the prism of game theory....MORE AT LINK