Friday, 27 January 2012

Fed. Data. Restructuring

Slow recovery in the US – and elsewhere
Federal Reserve’s decision to announce that short term interest rates would be kept low until at least mid 2014 took many, including me, by surprise. But it makes sense. The current recovery was never going to be a strong one, since the deleveraging of the household sector will put a lid on private consumption. Such deleveraging historically takes 5-8 years, and if we take mid-2008 to be the starting point, it makes sense that growth will return to normal in 2014-15. The same goes for three other economies hit by similar consumer leveraging: UK, Spain, and Denmark.

But the interesting thing is of course the investment consequences. Since 2008 money has been earned in reflation trades. Fed’s announcement was a statement that reflation is still very much on the table and it should feed the current risk rally further. It will weaken the USD at least until we see the second tranche of ECB’s 3-year LTRO in March. US T-bonds were flirting with calamity, but have now pulled back. We need to study our indicators, but at the end of the day, I believe that this will give investors one more chance to get out at very attractive prices.

No matter what Fed did, it is not a negative for the current return to risk willingness in the markets. Since the main reason T-bonds and Bunds are trading at too low yields is risk aversion, a correction is due as the risk willingness returns.

The German IFO index of the business climate for January came out better than forecast. Together with the PMI numbers from earlier this week, it confirms the possibility that Germany will avoid a recession for this time. Next week we will have a raft of data for the US but nothing really indicative of the European situation. Today we will have US GDP. It could come out lower than expected, given what we have seen from Fed.

Auctions – again
Italy sold 4.5bn EUR of 2 year notes at a yield of 3.7 per cent and 10 year yields fell below 6%. It did not draw any headlines, proving that the coverage of the Euro crisis is still biased towards the negative. But it does not matter. It was yet another step away from the Euro-Armageddon.

Discussions about the Greek restructuring have stalled, and there is a lot of bluffing going on. The banks have made their “final offer” and Merkel has threatened the banks that if they do not accept a bigger de facto haircut, there is always the possibility of just declaring a default. And so on.

The most entertaining statement came from outgoing CEO of Deutsche, Josef Ackermann. He claimed that if Greece/EU did not accept the final offer it would mean that fears of “contagion would come back in the markets”. Hmmm. He admits that contagion fears have reduced significantly – which is good, as it rhymes with my perception of the risk-on situation in the markets. He also indicates that the situation around Greece could lead to a new round of “contagion”.

Using my definition of contagion – a panic-like reassessment of risk in an investment – Ackermann is off the wall. The next possible source of contagion is Portugal, which has been priced out of the market. But of course, Ackermann is trying to bluff us into minimising the banks’ losses. It is his job, and his statements should be seen in that light.

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