To TLTRO or not?

The European Central Bank is likely to decide soon whether to launch a new targeted long-term refinancing operation (TLTRO III) for banks. The market may already be forcing its hand, but the EU’s fight with Italy means the choice has wide-reaching implications.

  • By Jasper Cox
  • 27 Nov 2018
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Can you make something reality just by stating it?

It is what philosophers call performativity: the most obvious example is saying “I do…” when getting married. The phrase is not just describing intent but effecting the marriage itself.

The importance of feedback loops, bubbles and herd mentality means something similar happens in finance all the time. Market movers’ prophecies fulfil themselves.

This extends to monetary policy, too. Now analysts are saying that TLTRO funding will be extended, this in itself makes it more probable.

“In the short term, we expect outstanding TLTROs to be extended,” said UniCreditresearchers earlier this month. “Given that there is value in providing banks with timely guidance on liquidity policy, we predict the ECB’s announcement will come soon, possibly as early as at the December 13 governing council meeting.”

Analysts at Barclays concurred on Monday: “We believe there are compelling macro- and micro-economic reasons for a new TLTRO, and now expect the ECB to announce a round of TLTRO funding in December or early 2019.”

Predictions like these, echoed elsewhere, mean that TLTRO extension becomes priced in, and so it would become more and more shocking if it does not happen.

No extension would hike up bank borrowing costs, as well as impairing liquidity coverage and net stable funding ratios (LCR and NSFR), and jacking up lending rates in the real economy, according to the Barclays analysts.

And the coming months could be particularly turbulent, giving the decision extra importance.

The next monetary policy meeting will occur just two days after the UK parliament may vote down prime minister Theresa May’s Brexit deal, leaving the UK staring down the barrel of a no-deal Brexit.

And that is without mentioning Italy — which brings its own complications (more on that below).

We may be getting into “Gone Girl” territory. In 2014, the Financial Times compared the relationship between the Federal Reserve and investors to the novel and film of that name. 

A wife fakes her own murder to frame the cheating husband, then returns and claims she wants to stay with him after all.

Both are continuously questioning and speculating about each other’s motives and actions — just as investors and the Fed were trying to suss each other out over QE tapering.

Around that time, the markets would dive on hints of the stimulus unwinding; after years of easy money, investors suddenly panicked that the central bank would not always be there for them. As for the Fed, it had to predict how bad a crash would be when it pulled away.

TLTRO is not as systemic, but right now, it is vital funding for the small, peripheral banks. And Mario Draghi and co will be wondering how the market would react if it is not extended.

The Italian dilemma

It is Italy where the effect of the decision will be felt most.

Lenders from the country had taken €250bn of TLTRO funds as of May this year, according to Moody’s, the highest volume of any country and a third of the overall outstanding amount.

ECB funding exceeded 10% of total assets for most medium-sized banks in Italy at the end of 2017, according to the ratings agency.

In the ECB’s last monetary policy meeting, one member mentioned tightening credit conditions in what one must assume is Italy.

“Reference was made to the recent increase in sovereign bond spreads… where it was noted that lending rates for firms and households had increased,” the account of the meeting stated. “Some tightening in lending conditions was also visible for that economy in the recent results of the bank lending survey.”

But there are wider considerations beyond the simple financial facts on the ground.

European authorities will be viewing TLTRO through the lens of their ongoing spat with the country.

The European Commission wants Italy to revise its budget, and looks unwilling to give much ground. Matteo Salvini, deputy prime minster and League politician, has little incentive to dampen the flames either, given that the League are riding high in the polls ahead of next May’s European Parliament elections on the back of the conflict.

So how does the Commission stick the boot into the Boot?

Allowing bond vigilantes to pile on the pressure seems to be the best way. And with QE ending as the deficit rises, BTPs will enjoy less ECB support.

But causing a full-blown financial crisis is not in anyone’s interest. One big step towards preventing this is to offer Italian banks cheap liquidity through a TLTRO extension.

How much TLTRO helps Italy is in the detail. One technicality that would stop it recovering too much would be to restrict how banks can use the ECB funding. 

Much of the liquidity so far has been directed towards government bonds — in Italy’s case helping to keep a lid on BTP spreads.

“A new operation should be strictly targeted to deliver new loans to the private sector rather than to bond investment or carry trades,” said the Barclays analysts.

Again, expectations of a TLTRO extension could affect how Europe and Italy act — whether they feel they can get closer the cliff edge before falling.

The three-dimensional chess game involving investors’ expectations and Italy greatly complicates the TLTRO decision. Time to strap ourselves in for the December meeting.

  • By Jasper Cox
  • 27 Nov 2018

All International Bonds

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • Today
1 JPMorgan 161,597.45 701 8.06%
2 Citi 158,100.45 638 7.89%
3 Bank of America Merrill Lynch 131,322.73 520 6.55%
4 Barclays 126,396.71 489 6.30%
5 HSBC 104,257.54 522 5.20%

Bookrunners of All Syndicated Loans EMEA

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • Today
1 Bank of America Merrill Lynch 12,900.23 34 6.65%
2 BNP Paribas 12,334.48 61 6.36%
3 UniCredit 11,196.47 58 5.77%
4 Citi 9,580.75 37 4.94%
5 Deutsche Bank 8,953.95 35 4.62%

Bookrunners of all EMEA ECM Issuance

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • Today
1 Morgan Stanley 5,454.13 25 10.64%
2 JPMorgan 4,766.13 27 9.30%
3 Goldman Sachs 4,280.20 20 8.35%
4 Citi 3,649.88 23 7.12%
5 UBS 3,602.23 16 7.03%