Last week, the ECB cut its deposit rate to zero. This means banks will receive no interest for leaving their money at the central bank. The amount of money parked at the ECB has remained elevated throughout the debt crisis, and has generally hovered between 700 billion and 800 billion euros since March when the central bank implemented the second version of its long-term refinancing operation (LTRO). The fact that ECB deposit facility usage spiked immediately after the second LTRO was both ironic and discouraging as it indicated that, rather than loan the cheap money out, the receiving banks simply took the cheap loans and parked them in the very same place they came from.
On Wednesday (the first day the zero policy went into effect), banks pulled a record 484 billion euros from the ECB, bringing the total parked there overnight to just 325 billion euros. That's down dramatically from the 800 billion euros deposited there just 24 hours earlier. The intention of the deposit rate cut was, of course, to encourage banks to begin circulating money into the system. For his part, ECB President Mario Draghi opined that he expected the rate cut to have a minimal effect on what banks chose to do with their cash, but the intention of the move certainly was to stimulate interbank lending across Europe.
The key question, of course, is not one of intention but one of results. The market wants to know what the banks will do with the hundreds of billions of euros they pull from the ECB. If not channeled in the right direction, the capital flow could serve only to perpetuate existing trends. To the discerning observer, it appears as if banks are putting the cash right where it is not needed: into safe havens.
For instance, yesterday's 10-year Treasury auction was "ridiculously well bid" as the bid-to-cover was the second highest ever at 3.61, and direct bidders took down an incredible (and a record) 45.4% of the auction in an indication of a massive rush to safety. Similarly, Germany's borrowing costs fell to a record low at a 10-year auction yesterday on strong demand as the bid-to-cover exceeded that from a sale of comparable notes last month. Yields on Swiss two-year notes fell 3 basis points to a fresh record low of negative 38 bps Thursday, while yields on German two-year bonds are hitting fresh record lows almost daily and stand at negative 4 bps as of Thursday. In another example of the midweek safe haven bid, the U.S. dollar index hit a two-year high Wednesday.
The takeaway from this is that the ECB's decision to cut the deposit rate to zero seems to be having the effect of driving capital into the next-safest haven after the ECB. This will only serve to exacerbate the divide between distressed assets (such as Spanish and Italian debt) and those assets perceived as safe havens. Nonetheless, it provides a set of clear cues to investors: go long Treasury bonds, long German bunds, long the U.S. dollar, and short the euro.