Tag Archives: central banks

Forgetting Faux Stress Tests, Reclaiming Experience and Possibly Ourselves

Today was some day.  While I’m on vacation, the release of the European bank stress tests was a big enough event for me to at least keep tabs on while I was away…

And then came the leaks.  What was stressed.  What wasn’t stressed.  How much.  How little.  The reaction to the test was a given at that point.

So while I was sitting in the cottage reading “Flow,” I was struck by this sentence on Reclaiming Experience:

There is no way out of this predicament except for an individual to take things in hand personally.  If values and institutions no longer provide as supportive a framework as they once did, each person must use whatever tools are available to carve out a meaningful, enjoyable life.

This is about finding happiness wherever you are, no matter what your predicament.  There was nothing any of us could do about the construct of the stress tests, we just had to choose how to react and figure out how to trade in markets after it was announced.  There’s nothing we can do about unemployment numbers or Fed interest rate decisions or even if we get fired from our jobs.  Ours is simply to choose how we will respond.  Even sitting back and watching reactions is a reaction, after all.

To be honest, finding a sense of contentment (I won’t even go so far as to call it happiness because what is that, anyway?) and balance has been problematic for me over the past three or four years.  I don’t think I’m alone in saying that.  So I’ve been on a quest to reclaim a part of me, or perhaps a better version of me, even if it only existed for a fleeting moment.

So when my wife got this picture…

I was thrilled.  You see, I call this guy “The Dude.”  Do I know if he bowls and has an eye for carpets that pull a room together?  No.  But this is actually a formal photo of the man.  Usually he’s just in swim trunks and sunglasses, sometimes with a boogie board under an arm.  Riding around barefoot and shirtless, he epitomizes contentment.  He could spend his days shoveling poop when he’s not visiting friends and family in the hospital, nursing home or cemetery for all I know.  The point is, when you see him, whatever bad events may be going on in his life don’t get him down.  That was a choice.

We had been trying to get a picture of him for four years now.  This time we got him.  So maybe there’s hope for us. Maybe Paradise isn’t lost.  Maybe we can get back to that place in our minds we once knew and we felt good.

Before the Dark Times.  Before The Deleveraging…

At any rate, I’m choosing to believe I can get back there.

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On Gold, Guns, Bread and Cadillacs…

Well, maybe not guns.  This isn’t that kind of post.  But I am going to talk about gold briefly.  One of the more interesting ways to think about the value of gold is its value in purchasing household items.  Because back in earlier times that was exactly how you paid for things.  Gold is money, after all.  Indeed, in the book “Hedgehogging” Barton Biggs refers to gold in such a manner:

The Old Testament recounts how, in 600 B.C., one ounce of gold bought 350 loaves of bread.  As of today, one ounce will still buy 350 loaves of bread in the United States.

Barton Biggs: Hedgehogging

In my area of the country in North Carolina, one ounce of gold will get you 446 loaves of bread.  So when measured in those terms, we’re overvalued even after the action we’ve seen over the past few months:

Today I heard it referred to in another way: gold vis-a-vis Cadillacs.  So first, I have to present to you the definitive video clip on Cadillacs…

And now back to the gold/Caddy ratio.  I stumbled across this post (hat tip: @hedgefundinvest and @FinanceTrends) that looked at the fact that in 1971 with gold pegged at $35 an ounce you needed about 11 pounds of gold to buy a ’71 Eldorado.  Take away the peg and it would’ve been much less gold (at $103 an ounce you need about 5 pounds).

Now?  You can get 2 Cadillac XLR-Vs for the same 11 pounds if you’re taking the $35 per ounce as your starting point.  If you used 5 pounds, well you’re out of luck because you won’t have enough based on Friday’s close at $1193.50.  So the starting point you choose is important.

But as for the overvaluation or lack thereof currently?  At these levels it may still be overbought even though we’ve seen a pretty sharp pullback from $1,250.  But I’d be wary about how much more of a decline we see here because volume has been higher even on up days and the revolt against central banks isn’t over by any stretch.

So in my mind, we’re in for more volatility not less.

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Where the Streets Have No Names, Lights or Signs: A LIBOR Update To Remember

For reasons I’ll explain in a bit, this is going to be a critical week for Libor funding.  But before I get to that, I want to recap what has happened in the Libor markets this past week.  So let’s take a look at the usual suspects charts:

The kink between the 6mth and 1yr Dollar Libor maturities is flattening a touch.

Meanwhile, Euro Libor is shifting out.  Noticeably.

As for Yen Libor, well, just leave it alone.  It’s sleeping so soundly I don’t want to wake it.

But let’s take a look at some weekly snapshots of the Dollar and Euro Libor curves:

Dollar Libor is relaxing some.  Not that it’s relaxing that much, but the acute funding pressure we had seen building has softened a bit.  This shouldn’t surprise us as this move coincides with the Euro move to the upside.  Here I show the hourly chart going back two weeks.  This should tell the story well enough:

Which also shows up in Euro Libor:

What we’re starting to see is a kink formed at the one month point on the curve.  Mid-dated Euro funding is getting bid up while overnight funding remains dormant.  This next chart shows that:

Outside of the two hiccups 35 days apart, that is.

But now, things get interesting.  While I was on the road, zero hedge ran this post about funding conditions in Europe.  I took this screen capture of the ECB’s OMO page:

I circled those two transactions because they settle within a day of each other.  This week.  So within 2 days, we’ll see almost €600bn in ECB reverse transactions settle. What is a reverse transaction?  From the ECB’s General Documentation on Eurosystem Monetary Policy Instruments and Procedures:

Reverse transactions refer to operations where the Eurosystem buys or sells eligible assets under repurchase agreements or conducts credit operations against eligible assets as collateral.

So you can either structure these to take liquidity out of the system, or put it in.  Trust me, these were injecting liquidity in to the system.  But now they’re coming due, and I want to use this to show how inflation is not the issue to worry about and hasn’t been for a while.

How?  Well, take a look at how much is now owed to the ECB:

For the small facility on 6/30:

(€151.5114bn)[1+((7/360)(1%))]  = €151.5409bn

For the large facility due on 7/1:

(€442.2405bn)[1+((371/360)(1%))] = €446.7980bn

In a world where credit costs are minimal (extremely low default rates, good recoveries on collateral, charge-offs almost nil, etc.), this wouldn’t be an issue.  Heck, the facilities wouldn’t have been this well-bid in a good credit environment.  But we’re not in that kind of environment now and the credit cycle still has a ways to go before we can see a true recovery there.  Plus, other assets like sovereign debt securities are having their own issues.  Banks might hold some of these notes, so now you’re talking about a hit on the balance sheet again with the recent credit market action, in addition to the rising credit costs. Oh, and I forgot to mention falling loan demand.  So amidst this backdrop, banks are going to have to come up with this cash.

And to make matters worse?  Consider Spain:

Spain faces a confluence of events in July, whereby it will need to finance 21.7 billion euros within a single month. This combines shortfalls in its budget and a wave of scheduled government debt redemptions.

via Spain’s Debt Maturity Wave Hits Next Month And It’s Already Obvious They Don’t Have Enough Cash.

The problem here is two-fold: first, there are the questions about what the cost will be – i.e. how much will the spread to German bunds be.  Second, consider this (emphasis mine):

It goes without saying that the government’s priority will be smooth and well-bid auctions (see calendar below), with local banks playing a crucial role.

So Goldman obviously expects banks to be bidding on these notes.  Below is the Spanish debt auction calendar in question:

The 5yr bond auction takes place the same day the monster ECB facility expires. Can this get any crazier, or what?

Looks like the Euro Libor market is becoming less and less certain, of well, a lot.  Take a look at the spread term structure:

Dollar/Euro Libor spreads are widening a bit, but not for the right reasons.  It seems now that the increases in the term structure of Dollar/Euro Libor spreads are being driven by uncertainty over the June 30/July 1 settlements.  Given the nature of the activtiy in the funding markets, I’ll probably write something before next week on this (i.e. look for a post later in the week as we approach month end).

Because as of right now, this like driving in a foreign country where no streets are named, numbered and there are no traffic lights or signs.

But the sad thing is, we’re not driving.  We’re standing in the middle of the intersection while everyone converges from all 4 directions at death-defying speed.

There’s only one way I can see this ending “well.”  The ECB will have to announce a new facility to roll all of the collateral that has been pledged and the banks can keep the Euros the ECB lent them.  For now, anyway.  But there has been no indicator they’re working on this.

Better find something to hold on to and brace for impact…

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Greece Gets an Uber-Coordinated Lifeline (Sort Of) While the ECB Finds Space on the Failboat

Wow.  Who missed out on getting involved in this one?  From the WSJ:

FRANKFURT—The European Union’s agreement Thursday to set up a safety net for Greece as it weathers its debt crisis boosted the country’s government bond prices Friday, paving the way for a new bond issue as early as next week.

The rescue plan, which will involve assistance from the International Monetary Fund and provides Greece with a system of standby credits to guard against threatened insolvency, also brought down the cost of insuring Greek debt against default.

So we have the IMF and the Eurozone working together to provide what exactly?  Let’s look at the draft of the release (hat-tip: alea):

As part of a package involving substantial International Monetary Fund financing and a majority of European financing, euro area member states are ready to contribute to coordinated bilateral loans.

This mechanism, complementing International Monetary Fund financing, has to be considered ultima ratio, meaning in particular that market financing is insufficient. Any disbursement on the bilateral loans would be decided by the euro area member states by unanimity subject to strong conditionality and based on an assessment by the European Commission and the European Central Bank. We expect euro member states to participate on the basis of their respective ECB capital key.

The objective of this mechanism will not be to provide financing at average euro area interest rates, but to set incentives to return to market financing as soon as possible by risk adequate pricing. Interest rates will be non-concessional, i.e. not contain any subsidy element. Decisions under this mechanism will be taken in full consistency with the treaty framework and national laws.

So let me get this straight.  Not only is the IMF going to come to the table with financing that they can’t specify, but the Europeans will finance a part (my guess will be banks buying debt on the open market), but also bilateral loans to Greece from the EU with some sort of  sovereign wrap guarantee.  This is a Keystone Cops deal if I’ve ever heard of one.

To me, the real issues are what’s going on beneath the surface.  The Euro, ECB liquidity, and the use of Greek bonds as collateral.

From a structural/macro point of view, this does very little to shore up the Euro.  Greece is a small economy that has lived on borrowed money for way too long.  It’s not like anything has fundamentally changed the issues I’ve pointed out already here, here, and here.  I remain very skeptical of the forecasts they’ve baked into their austerity measures, and I’m very skeptical of their accounting/reporting of official statistics.  The FT calls Greece the “sovereign Lehman,” but I’m sticking with my “sovereign Enron” moniker.  It has 80% more snarkiness and just like the company it pokes fun of, it’s completely synthetic.  So while we saw a relief rally in the EUR/USD rate, I just don’t see how this can be viewed as a sustainable move especially given Portugal’s downgrade (the bonds fared better since they were issued in dollars – not Euros) and the forward debt calendar of European debt scheduled to roll from Spain and Italy as well.

The last two are intertwined together and, in my view, reinforce my overall Euro bearishness.  On one hand, we saw Euribor rates move a bit higher across the curve.  The common view was that the Greek situation made the ECB’s plan to withdraw liquidity problematic.  That part makes sense.  What’s odd is that the ECB also postponed normalizing its A- collateral requirement until 2011.  This was obviously done to signal to the market they will still take Greek debt as collateral for ECB loans, even while banks in the Eurozone will not.  So while you have normalizing liquidity conditions on one hand, you have unorthodox collateral/credit conditions being extended on the other.    And so with Spain, Portugal and Italy on deck for a possible ratings downgrade, you’re looking at a less liquid central bank balance sheet that is taking on more credit risk.

So while the ECB suffers a setback because the IMF ended up getting involved in this ordeal, the kicker comes from a quote in the FT article from ECB Executive board member Bini Smaghi:

“Those who continue to bet on Greece exiting the euro will lose money.”

But those who bet on the Euro getting clubbed like a baby seal seem to be doing just fine.

So, Messrs. Trichet, Bini Smaghi, we have your reservations confirmed for the Failboat.  Thank you for your reservations.

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RBA: Media Release-Statement by Glenn Stevens, Governor: Monetary Policy Decision

As the immortal Frank Vitchard said before his arm got chopped off, “I did not see that coming!!” Indeed, Frank. Neither did anyone else:

At its meeting today, the Board decided to leave the cash rate unchanged at 3.75 per cent.

via RBA: Media Release-Statement by Glenn Stevens, Governor: Monetary Policy Decision.

Skip down to paragraphs 3 & 4 and you find the real reasons why the Reserve Bank of Australia left rates unchanged. And shocked everyone in the process:

Inflation has, as expected, declined in underlying terms from its peak in 2008, helped by the fall in commodity prices at the end of 2008, a noticeable slowing in private‑sector labour costs during 2009, the recent rise in the exchange rate and a period of slower growth in demand. CPI inflation has risen somewhat recently as temporary factors that had been holding it down are now abating. Inflation is expected to be consistent with the target in 2010.

Given that Australia is a commodities exporter, the price declines probably haven’t helped. And a stronger Aussie dollar would’ve been the equivalent of shooting off half your right foot, after the left foot is already missing a toe from the commodities price declines we’ve already seen going back to 2008.

Credit for housing has been expanding at a solid pace, and dwelling prices have risen significantly over the past year. Business credit, in contrast, has continued to fall, as companies have sought to reduce leverage, and lenders have imposed tighter lending standards and in some cases sought to scale back their balance sheets. The decline in credit has been concentrated among large firms, which generally have had good access to equity capital and, more recently, to debt markets; credit conditions remain difficult for many smaller businesses.

Two of the three conditions here are the same as we see here and other parts of the world as well. The one item to watch of course, is housing. Credit is contracting, partly from a lack of borrowers but also a lack of willingness – or propensity – to borrow. So in their judgment, there’s no need to raise rates and incent the carry traders any more than they already are.

We’ll see how this plays out, but this seems to be a counter-cyclical move when you compare this to the moves underway by China and the US. I’ll have more on those two in my next post.

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