Intesa San Paolo. Photo: AFP/Giussepe Cacace

In October I called attention to work by the Bank of International Settlements about the dependency of European banks on dollar liquidity. BIS went as far as to warn that European banks might default on the $12-$13 trillion of dollar obligations that they and the Japanese incurred as part of providing currency hedges to customers buying US debt.

The collapse of SX7E after the Fed meeting evidently reflects the sensitivity of this sector to dollar liquidity. The cross-currency basis swap has come in (I would conjecture that happened because central banks made sure that interbank lending was available). Nonetheless, the sensitivity remains.

Above we see that the SX7E index can be explained by just two variables: the broad index SX5E and the 12th fed funds future.

Without the 12th fed funds futures, we have a 20% undershoot in the forecast.

Note that during the past week, the biggest losses were incurred by relatively strong banks with big balance sheets, that is, banks that are dependent on dollar liquidity:

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