Resolving the emergency of investors

The ECB decision yesterday, to offer unlimited (!) access to funds in July, August and September through its refinancing operations, is a big plus for risky assets and could lead to another round of liquidity driven buying.

At the beginning of 2010, investors were worried about a possible liquidity drag end of June, when the latest big refinancing operation from June 2009 will expire. Now, not only the payback of the outstanding amount of € 371 Mrd. is assured, but also the huge sum of about € 350 Mrd., waiting in a parking position at the ECB (deposits, see graph below, blue line) is ready to be invested in the markets again, for at least the next months.

ECB Deposits (blue) and ESX50 (orange)

Where will the money flow? One obvious beneficiary will be the stock market. The graph shows, that when the money is flowing from deposits back to work, the stock market advances.

But even the bond markets may benefit as the monetary policy of the ECB devalues the parking position in an extremely fashion. This has to do with the shape of the current yield curve. If you put your money on an ECB account, you receive only 0,25% p.a., if you invest in a fixed-term deposit you may receive up to 1% for 12 month (but that includes taking an exposure against the banking sector).

But take a look on German government bonds. For a 4 year bond you receive 0,98% p.a. and for 5yr an equally low yield of only 1,5% p.a. What could an investor expect for the rest of the year 2010 if he decides to invest in Bobls? You have to calculate! If the yield curve remains unchanged, you may earn an abolute yield of 2% in 6,5 months for your investment in Bobls, more than the coupon for a full year, and double the value you earn in the monetary market for a full year!

Why that? Because the 4yr bonds have a yield of only 0,98% and an investment today in 5yr Bobls will be at the end of the year an investment with a remaining duration of 4,5 yr, a bond with a yield of about 1,2%! The rolldown yield of the investment is about 1,2% in absolut terms (not p.a.) compared with a coupon yield of only 0,8%. Even if the curve will face a parallel shift up of 50bp, the 5yr Bobls will lose "only" 0,2%.

So investors should not be surprised that the bond markets still look attractive from this point of view. Now think about an investment in Portuguese or even Greece bonds.

3yr bonds of Portugal offer a per anum yield of 3,42%, much higher than the 1,5% for Bobls. But the "buy & hold" return until year end will be only 2,4%, if nothing happens. Bobls offer still a meaningful alternative! Surprise, surprise.

Another story is Greece. 2yr Greece governments bonds offer yield of 7,56% and a buy&hold return of 5,2%, if nothing happens until end of year, what looks much more attractive if you believe in the EU bureaucrats.

Conclusion of all said above: the massive liquidity offered by the ECB will find its way into the markets because the pessimist (5yr Bobl), the conservative player ("good" stocks") and the aggressive buyer (2yr Greece bonds) all have investment opportunities. There is a chance, notwithstanding the current uncertainties, that we may see a replay of the "summer of 2009" when the massive liquidity injections of the ECB lead to a nice rally in risky assets.

Für deutsche Leser: eine interessante Lektüre zum Auftakt der Fussball-WM auf der Seite unseres geschätzten Kollegen Robert Rethfeld von Wellenreiter-Invest.