Tag Archives: deflation

Whether It’s Euribor or Libor, It’s All IBOR All the Time

I wanted to expand on the issue going on in Europe with respect to funding.  I’ve been contending the situation is getting worse, not better.  And as a result, we’re seeing a blow-off coming in the Euro, which in spite of the recent “strength” we’ve seen, has some very fundamental issues and it’s questionable it will continue to exist in its current form.

But first, I wanted to present a more comprehensive view of the term structure of Dollar/Euro Libor spreads:

The telling thing here is the fact that the short end has risen much higher than the long end, so this is a bear flattening in action.

I should probably explain why I look at the spread between Dollar and Euro Libor rates in this manner.  Here’s why (emphasis, mine):

In response to the reemergence of strains in U.S. dollar short-term funding markets in Europe, the Bank of Canada, the Bank of England, the European Central Bank, the Federal Reserve, and the Swiss National Bank are announcing the reestablishment of temporary U.S. dollar liquidity swap facilities. These facilities are designed to help improve liquidity conditions in U.S. dollar funding markets and to prevent the spread of strains to other markets and financial centers. The Bank of Japan will be considering similar measures soon. Central banks will continue to work together closely as needed to address pressures in funding markets.

via FRB: Press Release–FOMC statement: Federal Reserve, European Central Bank, Bank of Canada, Bank of England, and Swiss National Bank announce reestablishment of temporary U.S. dollar liquidity swap facilities–May 9, 2010.

That was all about this:

The purple circle goes back to the start of the sovereign debt crisis.  What nobody was talking about then was the sell-off in the Euro being driven by funding concerns with banks.  I wrote a post back in May where I came to the realization that these events are all about banks trying to fund themselves in the most relevant currency they can use.  To try and illustrate that, let’s take a look at the direction of those Libor spreads and the EURUSD exchange rate.

First, let’s take a look at a longer term daily EURUSD chart:

So you can see there was a bounce in early June and the Euro has been riding it ever since.  To get better visibility into what happened, here’s another EURUSD chart over a shorter timeframe:

Note the sharp break in the uptrend and change in trajectory of the rally.  But I want to focus on the beginning of the uptrend, June 8.  You can see what was happening to the spread between dollar and euro Libor:

Right around that time frame, spreads started widening.  So as funding was getting scarce,

Meanwhile, here is a look at Euribor curves going back to the beginning of the year:

One of these days I’m going to get something up and running and treat these properly by plotting them out as 3D surfaces to look at.  But that day is not today.  Regardless, you can see the curve is having some dramatic shifts out. Again, developing a 3D surface of Euribor, euro Libor and dollar Libor would probably help us in thinking this through to understand what’s going on.

But in the meantime, here’s are a couple of graphs of Euribor/Euro Libor spreads:

The humped nature of the spread curve indicates to me there are issues in the front-end of the curve out to 3mths and then they relax.

I’m curious as to why it happened, but I’m almost certain someone smarter than me is already working on it…

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Libor and the Bataan Death March for European Banks

I’m a little late in getting this out, but the charts will speak for themselves:

That was just the actual Euro Libor curve.  Here are two ways to look at Euro Libor funding relative to Dollar Libor:

The pace of widening between Euro-denominated Libor and dollar-denominated Libor has dramatically increased over the past week or two.  And if you take a look at the EURUSD chart:

You can see the Euro low was set in June which coincides with the increase in Euro-denominated Libor.  What I am sensing here is a surge both in the Euro and rates being driven by the liquidity crunch in Europe that’s building to some sort of apex at which point the true nature of the deflationary, lackluster conditions present there will be visible to everyone.  So that means you can add Europe to the list of economies that will be dealing with a significant overhang of deflation/deleveraging.

Longer term, this is setting itself up to be the Deflationary Derby: Japan, the US, Europe and other participants to be named at a later date.

But before we get there, there are some banks in Europe that are bound to be casualties of the ongoing liquidity squeeze we’re seeing.  Something like the Bataan Death March in WWII: the soliders taken prisoner by the Japanese had no food and water.  The banks have no commercial paper and little to no short-term funding. 

But both have one thing in common: they happened under the hot, sweltering sun…

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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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Paul McCulley does Modern Monetary Theory | Credit Writedowns – And My Thoughts

I’ve been trying to make sense of the macro landscape since, well, that’s just what I do.  One of the frameworks I’ve been trying to learn more about is Modern Monetary Theory, but I have to admit it has been a bit of a mind-bending experience and I’ve not always had the greatest success getting my head around it.

Having said that, when I read about Paul McCulley of PIMCO doing MMT, I wanted to see what I could find out.  So I wrote up a question for Edward Harrison at Credit Writedowns, who I have a great deal of respect for:

Interesting stuff. Edward, I have two questions for you:

1) I agree with you about this being a secular change in aggregate demand instead of a cyclical change. So in your mind, will the MMT approach work? Maybe you said it already, but perhaps you could re-state.

2) China taking on the consumer of last resort makes sense given their surpluses. Do you think the news regarding the Dagong’s rating of the US vis-a-vis China is about getting cheaper costs of funds to take this role on or is about capital inflows because credit and real estate are facing headwinds there now?

Thanks as always.

via Paul McCulley does Modern Monetary Theory | Credit Writedowns.

Here’s Edward’s response:

Yes, MMT works. But, remember MMT is just a framework -a lens – through which to view actual economic events. It is a very useful framework though because it forces one to look at all individual transactions or any aggregate shift as having two parties with balance sheet effects.

If I reduce my purchases from you that has implications not just for me but for you too. A lot of politicians try to talk about the budget deficit in a unitary way without working through the numbers.

This still doesn’t get away from the longer term problems regarding the (mis)allocation of real resources (monetary and physical). But it doesn’t allow people to cheat intellectually and act like austerity will be positive for the economy.

I was actually in bed when I saw this via my friend Scott and got up just to write a quick blurb on it. So I am headed back there now! More in the morning.

Looking forward to what he has to say on this…

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What to Do With All That Cash…

This is an extension of some discussions I’ve been having and some blogs I had recently written on inflation and bonds.  Because as you think about inflation and investment returns, you inevitably come to a point where the discussion turns to the cash on corporate balance sheets.  I was going to put up some charts based on the Federal Reserve’s Flow of Funds data but thanks to Google, the Trader’s Narrative and the good folks at the Financial Times, I don’t have to (click here for the video).  But let’s take a look at some of these charts to tee this up:

Indeed, this view shows there’s a record amount of cash available. But when you look at it on a debt-adjusted basis…

Not so massive a pile now, is it?

Share buybacks seem to be the most obvious use of the excess cash at the moment.  And with good reason.  The prospects for future growth don’t look particularly good at the moment.  So if you were going to do fundamental analysis of equities right now via a dividend discounting model (let’s use the Gordon Growth Model as an example):

Your denominator gets larger as the spread between required rates of return and growth rates expand.  And as a result, the valuation for the stock is lower. If this sounds like a bearish case based on fundamental analysis, it is.  How do you boost the price in this event?  Simple: demand a lower rate of return.  Good luck in getting your investors to go along with that.

But let’s try to take this train of thought and think strategically.  If you’re a corporate Treasurer or CFO and view the economy and your business the same way, that means you would be expecting P/E multiple compression: prices fall while earnings level off and growth rates turn anemic.  All of which leads to an interesting question: why do a buyback now if you can get more bang for the buck later?  The case could be made for saving some dry powder.

As always, feel free to leave a well-reasoned, on point comment.


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While Euro Libor Gently Weeps

In my mind there’s not much else to say about Libor in the Eurozone.  The charts do all the talking for me:

The curve is shifting out at a rapid pace, in a bear steepening fashion.  Looks like liquidity situation in Europe is getting worse, which keeps the Libor rates moving upward rapidly. And the Euro has followed suit:

This brings up an interesting point about the risk-on/risk-off trade: it depends on who you’re talking about.  For most people in the world, the risk-on trade is to hold anything except dollars.  Risk-off is to convert those holdings into dollars. For European banks, however, they have to convert everything back into Euros.  So with the removal of Euro-denominated liquidity facilities, “risk-off” takes on a different meaning.

Regardless, the funding squeeze continues…


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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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