Wednesday, 21 December 2011

Santa is finally coming to town?

ECB and the stock markets
The story I told on Monday appears to be gaining momentum. ECB announced new measures on 7 December and now the stock markets have finally picked it up. The combination of unlimited loans from the ECB and a “guarantee” from EU on government bonds has caused a stampede into short European short-term bonds, including those issued by Spain and Italy.

This is indeed very helpful in covering the short term financing needs of the European countries. And it gives the banks a healthy yield pickup, giving them a stealth, tax-payer financed contribution towards rebuilding their capital base. Wednesday’s opening of the ECB facility will give an important pointer. If the banks take upwards of EUR 250bn, it will be deemed a success and the current Santa rally can continue. Downwards of EUR 100bn will be interpreted as a failure.

I have for some time held the conviction that everything we know about pricing of risk is off the table for the moment. Except of course that bonds with a guarantee should trade at a lower yield than those without a “guarantee”. Go figure.

It is interesting that nobody really noticed ECB’s new initiatives when they were introduced. Instead markets took a great interest in guessing about the imminent Euro-zone breakup.

But heed this warning: If – and it is still a big IF – this re-evaluation of the risk situation continues to gain momentum, we are likely to see a major setback in the two kinds of assets that are the most overvalued or overbought or whatever: US T-bonds and German Bunds.

While gains in the stock market may be fun to look at, the sheer volume of the bond holdings of this world means that you should not take the eye off that ball.

Stocks are for show, but bonds are for dough – as we say on the golf course.

Positive data
Stock markets were helped by positive economic data. German business sentiment data came in strong and a report confirmed that the US construction sector is improving. Last week a rather dubious labour market report also told that the US economy is beginning to add jobs.

That the US economy continues to surprise to the upside is fully in line with Origo’s view that a rebound was due in Q4. The German data are not entirely in line with our rather gloomy view on the European situation. However, in all fairness, we are beginning to see indications that the downturn in Europe may be losing momentum.

US Banks
Somebody stole the punch bowl right under the nose of the US banks, just as a rally in bank stocks was about to take off yesterday. Rumours had it that even the US regulators are serious about demanding higher capital ratios.

Did this really come as a surprise to the markets?? Did market participants really believe that the influence of the banking sector on the politicians is so strong that the US banking sector could avoid completely sensible regulation when the rest of the world is moving that direction.

After 25 years in this business I can still get surprised at the sheer ignorance and credulity of many market participants.

Oil glut. WTF?
Yesterday’s Financial Times carried a story that began with the words “The boom in North American oil production has triggered a race to expand the US’s main oil storage centre, raising concerns among some industry executives of potential glut in capacity”.

Please read it again. It tells that there is a boom in oil production in North America. A couple of years ago an estimated 8bn barrels were found deep under the Mexican Gulf. Shale oil reserves in Colorado and other US states may match the reserves in OPEC. Is this the end of the story of the earth running out of oil.

Maybe oil does not come from dead algae, ferns, and dinosaurs. Maybe oil is formed deep in the mantle of the earth and slowly seeping towards the surface. At least that is a story worth following.

Monday, 19 December 2011

Crisis solved. Didn't you get the memo?

On 8 December ECB announced a new 3-year financing facility. It is UNLIMITED, and with a suitable weakening of the quality of the collateral for the loans, it could end up being a major game changer.

The LTRO will make possible a simple idea to recapitalise European banks: take 3-year loans from the ECB at 1% and place the money in southern European government bonds. EU has promised that banks no longer have to take losses if a European government goes bankrupt. Banks have again been given a "free lunch".

Apparently I am not alone in being able to see this simple idea. Spanish and Italian 2-year yields fell like a stone yesterday. The attached chart could be interpreted as indicating that:

• The market believes that Italy, Spain and Ireland no longer represent a bankruptcy risk.
• Portugal is on the verge but may hold on to dear life
• The conditions of the Greek debt restructuring is still not in place (personally I think that the haircut will end at 80% and not 50%)

ECB begins the new LTRO 3-year loan facility on 21 December. It will be very interesting to see how much this credit facility will be used. Rumours in the market say that banks in each country are buying domestic debt in the two-year segment in some volume, a  sign that demand could exceed expectations. If that happens, the new facility is as close to a Euro-QE as we can come without changing the charter of the ECB.

If we now try to put a positive spin on this development so it could read as follows: the ECB has with its new facilities taken big step towards disarming the liquidity crisis. The EU has with his "paradigm shift" given a guarantee for bonds issued by 16/17th of the euro zone. ESM and EFSF will operate at full volume in about two to three months.

The lower yields at the short end of the curve mean that it becomes easier for the troubled countries to achieve the goals of a budget surplus now that their refunding costs are falling.

Hey presto - euro crisis is solved! Well, maybe we still have a small growth problem here and there ...

This is of course the ultimate positive interpretation of things. However, amid all the end-of-the world headlines, we must also remember to keep an eye on the positive developments. ECB’s initiative is one of them.

Before we let ourselves be engulfed by a warm and fuzzy Christmas feeling over the Euro-zone’s step in the right direction, let us remember that the crisis is not completely gone. It will just move to where it was always going to end. At the banks.

We have heard more than enough lack of ethics and accountability in certain countries. The next theme will be that the private sector has contributed dramatically to the increase in debt / GDP in the OECD area and the banks have been the willing / necessary instrument in this wave of financial leverage. With Europe’s abysmal growth prospects, the ongoing deleveraging everywhere will continue to mean losses for banks.

Thursday, 8 December 2011

Sense and sensitivity

I have been ranting against Germany's ideological crusade and their (lack of) sensitivity to the need for immediate action to disarm the crisis NOW! According to a document leaked from the EU president Van Rompuy’s office, it is clear that at tomorrow's EU summit, a small number of reasonable initiatives will be on the agenda.

I have suggested that one element in getting the crisis to go away is to convert the highly indebted countries' short-term debt to long-term debt instead. If you read the leaked document (attached), it is clear that something is happening on this issue.

EU will discuss to 1) accelerate the process to get EFSF up running with gearing and everything, 2) accelerate the ratification of ESM for this new institution to get started on long-term lending and 3) make "deposits" in the IMF, which can then lend money to European countries with large short-term financing needs.

Importantly, EFSF and the ESM could be allowed to operate in parallel for a while, increasing their lending capacity.

If carried out, it is good news. And should be received by financial markets as such. If not it hurts the poor Germans on their sensitivity.

My checklist to find out if new initiatives are useful to resolve the crisis has the following five elements:

  • The ECB to act as a central bank
  • The banks to be recapitalised
  • Countries with huge short-term debt should have them converted to long term debt - very long term
  • Germany and other countries in a good situation stimulate domestic demand and growth
  • Structural development in the indebted countries (lend them money to build a bridge between some islands or similar)

This list can serve as a reality check: if new initiatives fit into one of those categories, then it is good news. If not, they are irrelevant or downright dangerous.