By: Christopher Lewis

On Wednesday the European Central Bank released funds into the banking sector to the tune of 489 billion Euros. The markets had expected only 293 billion to be needed, and the higher need simply underlines that the situation in Europe is bigger than many people understand. The ECB also stated that a total of 523 banks asked for the funds, which are set to be lent at the benchmark rate of 1% for the term of the three year loans. The funding operations begin on Thursday, and the hope is that some of the banks will use this money in order to purchase sovereign debt that is currently offering over 5% in many of the countries around the EU.

The biggest fear is that the banks simply won’t buy what the ECB is hoping they will. After all, there was the situation in the United States after the credit crunch where the extra liquidity was supposed to be used to help lending, although the practice simply didn’t happen. The US banks would simply borrow money for next to nothing, and then buy Treasury notes. Ironically, this is exactly what the ECB would like to see, but in the periphery. The biggest issue is that these banks may simply decide to use it to shore up balance sheets, buy German Bunds (Which aren’t in trouble), or even worse – US Treasuries.

The markets sold off on this news as it was a larger draw of funds than most people believed. The severity of the economic issues continues to be brought to the forefront by such actions, and as such – the markets remain extremely volatile. The reactions in this ongoing situation will continue to be exaggerated by the low volume in the holiday trading as most of the larger players are simply away from their desks until January. The risks of large and extremely exaggerated moves will continue to increase on headlines news during the holiday season as the low liquidity won’t provide the backstop that you normally see in these markets. The professionals are more than likely keeping an eye on the news flow, but are unlikely to trade with size until after the New Year.