Category Archives: You're kidding

And So It Begins…

I asked people about a scenario like this unfolding two years ago and was looked at like I had three heads…

The financial calamity of the European Union’s sovereign debt woes has shaken the pillars of the postwar ideal of a united Europe. The debt crisis and the global downturn have left many European countries looking inward these days and viewing Brussels as increasingly irrelevant.

Germany, long a postwar champion and financier of European integration, is flexing its muscles more independently. And more of its citizens are questioning the country’s leading role in the European project.

On a recent day, Christian Gelleri buys a sandwich and a glass of Hefeweizen at a rustic, sun-filled outdoor beer garden along the Inn River in the Upper Bavarian town of Stefanskirchen.

But the 40-year-old isn’t paying with euros. The bar also accepts chiemgauer, the thriving local currency named after a region in Bavaria.

via From Stalwart To Skeptic, Germany Rethinks EU Role : NPR.

Me and my other two heads aren’t looking so out of place anymore, I gather…

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I’ve Got Some Theories About The Real Estate Tax Credit

I read this post from Jacob Roche about what has happened in housing since the tax credit expiry.  There are a couple of surprising aspects to what we’re seeing so far.  First, a look at prices (emphasis, mine)

What I found was that on both a raw and population-weighted basis, prices increased after the tax credit expired, by about 5% in both measures. Most interestingly, on a dollar basis, prices increased by a raw $9,766.77 and a population-weighted $5,280.89 — very close to the $8,000 credit. This is extremely counter intuitive. If the tax credit expiration effectively raises all home prices by $8,000, why would sellers raise their prices roughly another $8,000, and why would buyers agree to it? In some areas, like New York, DC, and San Francisco, prices increased by the tens of thousands. Also interesting is that some of the biggest price declines occurred in Texas, although removing Texas from the population-weighted data changes the average by only a small amount — the biggest percentage decliner in the list is in Texas, but it’s also the smallest city in the list.

via Real estate prices, post tax credit.

The post goes on to look at the sale data (again, emphasis is mine):

Number of sales gives the data another dimension however. Roughly three-fifths of the cities in the list saw fewer sales post tax credit, and the declines in sales were generally much steeper than any of the increases. It’s regrettable Trulia doesn’t give the exact numbers, making it difficult to estimate how much money is flowing in or out of the market, but one could at least make a rough guess that the price increases are being offset by fewer sales. Interestingly, a couple of the cities with declining prices saw increased sales.

Now I have some theories about this behavior, purely using intuition and my own read of buyer and seller psychology.  On prices, I think the sales price increase is a sign sellers know the market is not as liquid now as it was with the tax credit.  So as a result they’re looking to maximize the price paid.  I would’ve thought prices would’ve been higher under the tax credit because both buyers and sellers would treat the credit as “found money.”  What I mean by that is if you find money that you had no expectation of getting, you’re more likely to splurge – to spend on things you may not have thought of getting before, but since you have the cash you decide to get it anyway.  Apparently it didn’t quite work out that way.

As for sales volumes, that’s not a surprise.  We figured sales would be lower as the market becomes less liquid.  And Jacob’s point about money flow is a good one.  Because ultimately that’s what it’s all about.  So when pundits talk about Case-Shiller price increases, my first question is how many sales-pairs made up the estimation?  Fewer transactions at higher prices can still result in negative money flow.

Overall, I think the tax credit did more harm than good.  Prices offered and prices bid are moving further away from each other, thereby resulting in fewer housing transactions which are actually done.  The market is becoming more illiquid and the process will take that much longer to heal itself and for transactions to clear in a meaningful way.  Plus, how much money was spent on this and did it get us the outcome we wanted?

Don’t think so…

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Eurozone Banks Are in the Vise

Looking at the Libor rates day after day – and watching them rise without mercy – is starting to get well, painful.  This is a weekly view of euro Libor:

This is a classic bear steepening in the curve: short-dated rates have risen, but the long-dated rates have risen faster.  And it’s shifting out the whole curve by basis points at a time.  In fact, 3mth and 1yr euro Libor rates have been rising on the order of a basis point per day.  But you have to remember Libor rate calculations trim the data: the 4 highest and 4 lowest are thrown out, leaving the middle 8 to determine rates.  So you know there are 4 other banks that are doing much worse than the middle 8.  And since the panel is made up of sizable banks,

Meanwhile, EURUSD has also been on a tear:

I’m going to take a look at correlations between euro Libor and the euro later, because I think there’s something to that story.  In the meantime, we should probably just note that the currency is strengthening as the bear steepener in rates continues.

A strengthening currency and inter-bank interest rates that are rising by a basis point per day?  Sounds like a real-life stress test to me.  So forget about the stress tests the Europeans did.  And if they think the European banks will have the same rebound that the US banks had, maybe they’d better think twice:

“The question is whether governments can shoulder their sovereign debt if they had to bail out half their financial system on top of it,” said Lothar Mentel, chief investment officer at Octopus Investments Ltd. in London “That is the real worry.”

via European Banks’ Hidden Losses Threaten EU Stress Test – BusinessWeek.

Indeed.  A number of those countries are in worse fiscal shape than we are, with economies that are less dynamic and have poorer growth prospects.  I don’t see how their policies are supposed to inspire confidence.

I think it’s just a matter of time before we see “Bank Fail Friday – Euro edition” unless we get something more than just a bunch of concocted stress tests (again from the Bloomberg Businessweek article):

“You can’t just have stress tests, you’d better prescribe some medicine as well, which is going be more capital-raising,” said Hank Calenti, a credit analyst at Royal Bank of Canada in London. “If some institutions need access to government recapitalization or other improvements, the market needs to know how that’s going to happen.”

Meanwhile, the cost of capital is going up…

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A Bip A Day Keeps The Counterparties Away: LIBOR Update

Let’s get straight to the charts:

The Euro Libor curve steepened a touch with overnight Euro Libor/Dollar Libor spreads coming in, but the rest of the curve saw another basis point added, resulting in a bit of bear steepening.  We’re seeing 3mth and 1yr Euro Libor rising the most, which makes sense.  As a result, I’m inclined to believe the Euro rally may have a ways to go.  But if you look closely, there may be a top in the process of forming.  It would be interesting to see what DeMark indicators can tell us about that:

I also went ahead and analyzed the daily changes in Euro Libor rates:

In every instance there was a flat trend line you could plot until the past two weeks where you can see rates have shot up.  To see these changes moving in this manner is bothersome.  Rates are moving higher, faster.  Part of it can be attributed to rate convexity; as rates increase, they become less sensitive to subsequent rate increases.  Having said that, I think we’re seeing the early innings of a  liquidity crunch unfold in Europe.  Having worked in the Treasury department in a bank, I can say definitively this is why having a solid deposit base is so important.  Because if you rely on external funding to get cash to lend, you can – and will – get whipsawed on occasion.

The flip side of the coin is if you have excess deposits and are looking to deploy them.  Lending in the interbank market is looking precarious now.  It had been precarious before this, with the dollar Libor funding pressures we saw earlier this year telling me you have – as FT Alphaville put it – a two-tiered banking system in Europe.  But frankly, I think even the strong banks are running into funding problems and the stresses in both dollar and euro Libor show me a lot of banks have probably been leaning too much on external/brokered funding.

So here we are, three years later, still talking about counterparties, liquidity runs, and bad credit fundamentals in spite of massive central bank intervention.  With talk of European banks still being too weak to fund themselves without ECB assistance, a quote from St. Augustine comes to mind:

Habit, if not resisted, soon becomes necessity.

St. Augustine
more famous quotes

I think banks in Europe are starting to find out just how true that saying is…

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Obscure Rates Update

Because Libor rates aren’t obscure enough, I’m taking a quick look at EONIA swap rates and the EONIA swap curve.  This first chart is really busy since I put all the maturities on one chart going back to January, 2008.

I then took the data and tried to boil it down in terms of just looking at relatively recent experience with fewer maturities.  You’ll see over the past few weeks all maturities have seen an increase in rates.

This next chart takes a look at the EONIA swap curve.  I took daily snapshots for the past several weeks.  Again, it’s a little busy:

But why is EONIA important?  It’s important because it is used as the reference rate for interest rate swaps throughout the Eurozone.  So banks, insurance companies, multinational companies and others use it to either fix or float their borrowing costs, depending on their capital structure, how they want to achieve their weighted average cost of capital (WACC) objectives, etc.

Note the arrow I put in the chart.  You should see a kink where the longer dated rates widened from previous fixings and look to steepen.  Since most swaps are done in annual increments, I tend to focus more on longer dated curves  so the 1 yr and 2 yr swap rates are what I’m interested in the most.  Another sign Euro-denominated funding is getting more expensive.

Here’s another obscure rate to keep track of.  It’s actually a spread instead of a rate, but it’s still important: it’s the spread between 2yr Treasuries and 3mth Libor:

This one is interesting because of what it infers.  From David Goldman:

If LIBOR continues to creep up and reaches, say, 75 bps, it no longer will be economical for banks to own US 2-year notes. In that case the US Treasury market will be in trouble. That’s when you head for the bomb shelter.

via Inner Workings » Blog Archive » …unless LIBOR hits 75 bps, in which case head for the shelter.

That was written a little while back when dollar Libor was moving higher, almost unabated.  Now, it’s not moving much at all but the issues is still the same: it’s one of potential yield curve flattening/inversion and counterparty credit risk.  A quick check of rates as of July 1 shows the spread at about 10bps.  Precariously close to parity.  The green circle is from July ’05 and it was the first time the spread went negative – right around the same time housing peaked. So this can be a good tell regarding overall market conditions, but it’s not watched that frequently.

So bottom line: counterparty issues are taking center stage again, and as a series of fundamental macro metrics, they don’t look that good to me.  Growth looks like it has stagnated and is possibly contracting, job growth is weak at best and other metrics aren’t looking so cheery.  As this backdrop has really lingered since ’07 – with the conditions that set all of this up occurring beforehand – it’s probably time to think about what to do about it.

Yes, that means I’m going to look at the inflation/deflation, austerity/stimulus debate.

You’ve been warned…

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The 6.30 Libor Earthquake, Aftershocks and Tsunamis

First, let’s update our Dollar/Euro Libor spread chart.  That’s the one that really matters now because looking at the Libor curves in isolation won’t help us understand what’s going on:

Across all maturities, we saw rates increase about 1bp from Wednesday into Thursday.  Not a healthy sign.  Indeed, I along with others were wondering about the €310bn that didn’t settle and it’s looking more and more like the liquidity it provided is gone and now there’s a mad scramble – a tsunami of buying, if you will – for Euros:

But if you’re watching the Euro-Yen cross like I am, you still need to use the Dollar-Yen as a crossing pair to get a Euro-Yen quote. The last time I checked, the Euro-Yen cross was at 110.039. In a word, ugly.  That cross has been the great carry trade cross for years, so any movements in this cross should be noted and heeded.

But I also wanted to take a look at some other trading activities in futures:

Surely with the correlations we’ve grown accustomed to, a rise in the EURUSD should mean stocks, commodities and well, everything that is not cash is headed higher.  But right now, it doesn’t because of the banking issues in Europe.  Gold collapsing the way it did was rather stunning, frankly.  And the fact that crude oil, in the midst of the summer vacation/driving season coupled with a natural disaster of epic proportions, couldn’t maintain the trend line on the daily chart that would imply $80/bbl, is telling.  And the message seems rather ominous and foreboding:

Meanwhile, two Treasury ETFs, SHY (iShares 1-3 yr Treasuries) and TLT (iShares 20+ yr Treasuries) have benefited from the safe haven bid.  If you executed a bear flattener by shorting the SHY and going long  the TLT, you would’ve had a very nice 6 months, in spite of the gains in the SHY:

My point in showing all of these charts?  It’s to try and present/describe a macro level picture that shows one simple message: the problems in Europe can’t – and shouldn’t – be underestimated and the spillover/contagion/whatever buzzword you want to use that means “spreading” are the worst kinds of scenarios you can think of: higher probability and high severity.  I characterize them as “higher probability” for two reasons:

  1. Never underestimate people’s ability to underestimate tail events.
  2. The probability of a spooky tail event occurring  is increasing.

I don’t know how long the EURUSD “rally” lasts.  It will last as long as banks in Europe are afraid their balance sheets are too illiquid.  It could be over in days, weeks or months.  I don’t know.  But I do know that trade is not acting the same way it would have in the past for a reason.

This will be an interesting month…

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A 6.30 Earthquake in Libor

Well that didn’t take long.  Yesterday I was speculating rates would go up, and here it is:

You can see my note on the chart.  Now let’s take a look at the term structure of spreads between Dollar and Euro Libor:

The curve is flattening, in a big way.  With ECB open market operations results in now, the liquidity picture is, well, unclear.  Folks cheered yesterday’s 3mth LTRO, saying it wasn’t as big as expected, but results of today’s 6 day operation and yesterday’s weekly MRO suggest to me there are definitely a bunch of banks in a world of hurt.  Why else would you borrow money for 6/7 days at 1% when the Libor market allows you to lock up 6mth Euro Libor funding at the same rate?

I think FT Alphaville put it best (emphasis, mine):

And now that we know we’re looking at a two-tiered existence for eurozone banks — those that can fund themselves in the interbank market and those that still have to rely on the ECB — we can guess that a rapid rise in rates could be difficult for some to take. In which case, we could still see rates like Eonia and Libor rise on fears of bank counterparty risk. It’s a tough job, this weaning-off-liquidity thing.

And, some might say, still a highly-improbable outcome.

via FT Alphaville » More please … the 12-month LTRO roll-over ain’t over yet.

In other words, this may be just the beginning.

The ECB is just trying to use methadone on heroin addicts at this point.  We’ll see how this goes…

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