See sell-off, if LTRO is below 500bn euro: Citi Pvt Bank

In an interview to CNBC-TV18, John Woods, managing director and chief investment strategist, APAC of Citi Private Bank says, too much of a provision of liquidity will split the market. “It will make people think that the banking system is perhaps little more distressed than otherwise thought,” he asserts.

On the other hand, he says, too less is not going to provide the liquidity for the risk rally to continue. People are expecting around 500 billion euro. “If we do see around 300-400 billion euro, my sense is that the market will sell-off,” he adds.

Also read: LTROs will only provide short-term boosts to markets, says Nomura

Below is the edited transcript of his interview on CNBC-TV18. Also watch the accompanying video.

Q: What you expected to see from the potential size of the LTRO? How you think global equity markets may react to it?

A: I guess those are the two main questions that we are asking. Too much of a provision of liquidity will split the market. It will make people think that the banking system is perhaps little more distressed than otherwise thought. Obviously too less is not going to provide the liquidity we need for the risk rally to continue.

The sweet spot people are talking around 500 billion euro. If we do see less, if we do see around 300-400 billion euro, my sense is that the market will either sell-off or shortly thereafter sell into strength.

We are seeing quite a lot of client activity now actually looking to take profit and lock in these extraordinary gains that we have had for the past six to eight weeks.

Q: Do you think the ECB will be cognizant of this risk, given expectations in the market and they would want to actually deliver something, which is more confidence bolstering rather than something, which leads to a sell off because that’s their purpose in a sense to begin with?

A: My sense is that the LTRO will be over shaped and sized by underlying demand from the banks rather than market expectations. It is worthwhile pointing out that the only reason this liquidity exists is because of this appalling state the banks have got themselves into in terms of funding pressures in the last quarter of last year. Indeed many smaller financial institutions would actually be insolvent had it not been for this very cheap liquidity. So, the demands of the financial institutions are paramount.

Again, it is worth bearing in mind that the larger the amount they receive, the more capital they have to put behind it. So, I think that’s an important aspect. You just can’t take too much free liquidity; there is a capital cost as well.

Q: What do you think would trigger a global correction at this point because liquidity has been ample and after today will probably get even better? In that situation, aside of profit taking, do you see any more powerful motive for a deep correction for global equities?

A: If the 500 billion LTRO II is in the price then ofcourse there is limited upside. I think that’s one important aspect. The second ofcourse is oil. If we start to see further price pressure on oil, particularly emerging markets will start to falter somewhat. I wouldn’t at all be surprised to see a correction.

If you look at a whole range of equity market performance over the last two weeks, you will see that higher prices are being achieved on lower volumes. Typically that’s a sort of a technical indicator suggesting that conviction is weak, investors are reluctant to participate in the prices of these sorts of levels. That tends to lay the groundwork for a short-term correction in the markets.

Q: Some people have argued though that a large sized LTRO will not be seen as negatively as people fear. In fact the more money that’s thrown, it is solving this economic problem the better. How would you tactically position yourself for an announcement that could potentially be higher than that 500 figure? Do you think it is more likely markets correct or that in the short term at least we see a big bounce?

A: If it is anything above 500 to 750, I think we will see a short-term bounce. Clearly, Asia will benefit most from this, all emerging markets in general. I would expect to see the most liquid, typically North Asian markets benefiting the most.

But again it is worth bearing in mind that the message that this funding is actually communicating if banks are that dependent on this incredibly cheap liquidity that they need for their underlying solvency then ofcourse it sends a rather difficult message. It will be interesting to see how the market behaves on the news.

Q: You reckon that any potential liquidity announcement would see the money being routed to emerging markets because we have seen fairly large sized performances both from emerging markets and asset classes like crude as well.

A: The emerging markets generally have, not particularly demand in valuations. In fact I think they are pretty compelling versus some developed markets. So, I do think there is an opportunity for liquidity to continue to flow over here. As I mentioned, it has been attracted to the large liquid markets of North Asia, but quite possibly and probably we will that distributed across the broader and perhaps more equitable base in South and South East Asia.

In general, the liquidity is going to be reflected initially in equities, obviously in currencies. My sense us that the bond markets won’t really pick up on this liquidity, it tends to be a lot more domestic focused. Certainly, we haven’t seen a huge amount of yields. That is in itself somewhat troubling.

If bond yields were rising alongside or coincident with Asia’s equity markets, you would get a sense that from an underlying perspective fundamentals were improving, but actually the opposite is happening. Yields are either flat or actually falling. I suspect that is a more insightful message from the bond markets as to this very difficult growth inflation trade off now that higher oil suggests for Asia going forward.