Thursday, June 17, 2010

Does Liquidity Reduce Risk Premia?

I was recently looking at liquidity versus solvency, and Jim Reid at Deutsche Bank was still wondering about the credit matters in the European periphery on Wednesday. The credit strategists at BNP Paribas had an interesting take on divergences in credit and equity markets today, my emphasis:

The inconsistency between credit and equity markets can only be explained by the discrepancy in confidence levels being expressed by the markets with regards to the various liquidity measures announced by the ECB, EU Commission and IMF in assisting the PIIGS. We believe the ECB will be forced to expand their quantitative easing measures or the sovereigns may have to go directly to either the EFSF facility or the IMF to overcome medium term refinancing risk, a factor that is spooking credit markets but being ignored by equities. For once, we believe, equities may be telegraphing the right message, as in more liquidity from the authorities to reduce risk premia and hence painting a glass half full picture.

Click on charts to enlarge, courtesy of BNP Paribas.

Inspired by Battle Royale Between Fundamentals & Technicals at Trader's Narrative, I would rather say that the "Battle" is won, as stupid as it may be, by ECB' s "Unlimited Liquidity", that is Resolving The Emergency Of Investors, err, Banks ...

If need for additional liquidity and low interest rates are signs of tight money, does liquidity then reduce the risk premia?

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