Recap 9-28-11

Main Items

  • US DGO ex Transportation declined to -0.1% MoM in Aug vs -0.2% exp and 0.7% prev.
  • US Capital Goods Orders Nondef Ex Air improved sharply to 1.1% MoM in Aug vs 0.4% exp, and July’s figure was revised up to -0.2% from -1.5%.


  • German CPI increased to 2.8% YoY in Sept vs 2.6% exp and 2.5% prev


Several members of the ECB have discussed the idea of reinstituting 1yr unlimited LTRO’s. This makes sense because the 3m Euribor-EONIA basis has increased to late 2007 / early 2008 levels again:

Readers may recall that following Lehman, the ECB’s use of unlimited LTRO’s was very successful in tightening that basis. As long as the ECB was willing to lend for 3m against eligible collateral at the refi rate, there was no incentive for EU banks to continually set Euribor above that level. I think the expectation for 1yr LTRO’s is one reason Euribor has not set higher in the past few months.

This is interesting because there is now an apparent soft ceiling for Euribor settings. As a result, buying ERZ1 below 98.75 looks attractive because in most scenarios, 3m Euribor will set below 1.25%. Either the implementation of unlimited LTRO’s or a refi rate cut could do the trick. However, there is still the possibility of a disorderly Greek default that could make insane things happen. My guess is that the troika will want to avoid any disasters during the holiday period, and given the small amount due in December, March is more likely as the default date. However, in the interest of cutting tail risk, buying the ERZ1 98.25 puts for 3bps will limit your loss to 50bps. Note that the maximum loss amount is highly unlikely because a Greek default will almost certainly occur in conjunction with both LTRO’s AND sharp refi rate cuts. Finally, ERZ1 has been range bound between 98.65 / 98.95 for a couple months now. There is a good chance that we’ll be able to ‘trade around’ the position as volatility continues.

Finally, the high German CPI print today suggests that the ECB could delay rate cuts until inflation convincingly falls. But the ECB, as well as the market, are seeing through the rise, especially given that energy appears to have been a big contributor. 2yr inflation swaps, for example, barely moved and remains well below the ECB target.