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Friday, 16 September 2011 08:26

ECB To Offer Liquidity With 3-Month Dollar Loans, Forex In Risk Rally Mode

The main story behind today's trading, which included a 'risk on' rally in New York trading session, was a move by the ECB to offer 3-month US dollar loans to commercial banks, which have been facing funding pressures as US money markets have stopped lending to European banks. The move, with 5 central banks participating, will in essence try and backstop Europe's banking system while ushering in a new era of global financial coordination. The idea is to make sure that companies have liquidity and access to dollars through the end of the year.

The ECB move to offer these loans will be done in coordination with the US Federal Reserve, the Bank of England, the Bank of Japan and the Swiss National Bank.

From Reuters: 'The British and Swiss central banks said they would conduct three-month dollar lending operations simultaneously with the ECB on October 12, November 9 and December 7. The Bank of Japan, which already holds three-month dollar tenders, will add one on October 18.

The Fed, which in the past has faced criticism from lawmakers in Washington for its role in rescue efforts for European banks, will not itself offer three-month loans to banks in the United States. But it maintains dollar swap lines with the ECB and other central banks to ensure they can obtain additional supplies of dollars when needed.'

Why is the ECB lending Dollars and not Euros?

This step by the ECB is an attempt to get ahead of this funding issue - which is that European banks are struggling to access Dollars. US money market funds have been withdrawing from Europe, and two unidentified banks tapped the ECB's 7-day dollar loans last week. The two unidentified banks borrowed a total of $575 million. Today's action would give banks time to adjust their dollar businesses through the crucial end of year period and therefore help ease the pressure in the European banking system.

The ECB has helped three months dollar operations before, especially at the height of the global financial crisis in 2008-09. It also held a one-off three month dollar loan operations in May 2010 around the time of Greece's first international bailout.

Therefore it's a weapon the ECB has used successfully before, though this time it seems they are using it preemptively, rather than reactively. The move therefore should stabilize European banking shares - with an eye on sovereign debt fears.

The move had a positive effect on risk sentiment today, especially in Europe, with European bank shares rallying strongly.

Forex Markets See Risk-On Rally from ECB Developments, But Will it Last?

While this news helped increase 'risk on' trades - meaning higher-yielding currencies linked to global trade rallied at the expense of traditional safe haven currencies - the move by the ECB does not eliminate the threat surrounding the European banking sector. While near-term dollar liquidity crisis may have been alleviated, the longer-term problems stem from the sovereign debt crisis - and that remains firmly with us still.

Therefore, today's events still be taken within the context of the correction to the risk aversion we had seen prior few weeks, and that underlying problems regarding Greece - despite the positive developments of late - will resume pressuring both bank stocks and the euro as you move through the weeks ahead.

For today, currency markets were in a risk on mode, meaning traders and investors were searching for higher yields in'riskier' currencies. The EUR/USD surged higher but was beaten back at the 1.3925 resistance level. Commodity currencies like the AUD and CAD followed the EUR higher and manged to hold their gains, while the GBP (also a 'risk' currency) was stronger during the NY trading session, but receded from its highs.

While we remain cautious of the recent risk rally, we'll have to see how equities and sentiment develops during the final trading session of the week. The fear of an imminent Greek default may have eased, the problems of weak economic growth in the euro zone and in the US continue (and in the US case was reinforced by today's data) and will weigh on any risk rallies

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