Wednesday, 29 February 2012

ECB's new LTRO continues the reflation wave

The European banks decided to borrow 529 bn Euros from the ECB at 1% in three years. Not quite what I had expected (600 bn), But more than last time (489 bn). Good enough.

Looking at the euro-zone money supply data shows that these loans are not channelled into lending to companies or individuals outside the banking sector. In other words, the money is either placed on deposit in the (central) bank, used to buy risk-free assets (government bonds, pfff!) or loaned out to other companies in the financial sector, who then invest in securities.

Aggregating the ECB's lending activities with QE programs in Britain and Japan and the recent relaxation of the Chinese reserve requirements, the world's central banks - minus the U.S. Fed – have added up to EUR 2200 bn to the international banking system, much of it in 2012. The U.S. QE programme amounted to USD 2360 bn, about EUR 1750 bn. While the U.S. has stopped further supply, there is no sign that the other central banks are about to stop their programs, and today's ECB loans were another big step in that direction.

I find it interesting that this topic has largely been ignored by the headlines, while the US equivalent program received a lot of attention. But there is no doubt that the monetary stance remains highly accommodative, and thus strongly supportive of financial assets of any kind.

Some fear it will lead to inflation tomorrow. That will not happen. Especially not as long as the world has a huge overcapacity.

Monday, 27 February 2012

G20. Italy. Oil

The G20 meeting did not produce anything tangible. Some of the developing countries, led by Brazil, said that they would help adding funds to the IMF if Europe would support them in getting more influence in the organisation. Since it is just a question of reinvesting the trade surpluses, countries like China and Brazil are simply trying to get maximum effect out of minor changes to their management of accumulated trade surpluses.

Not surprising that they try. But this is probably not the way to obtain an otherwise completely justified readjustment of influence in the IMF.

Perfectly justified, Germany came under pressure to show leadership. In return, Germany indicated that EFSF and ESM will be allowed to coexist for a time, temporarily increasing the “firewall” made by EU to protect the weaker countries in the EU.

In short, a major non-event.

Retail sales plummeted in December. The numbers did not look good at all. But it is too early to worry seriously. Most of Italy’s holiday shopping is early in the month (Saint Nicolaus’ day on 6 December), and that coincides with the morose sentiment right after Monti becoming PM on 13 November. We believe that there is a good chance that this is a one off.

Crude oil appears to be taking all the headlines and we are now seeing the traditional gamut of explanations that oil will go through the roof: China is growing, the world economy is growing, oil producers are running at max capacity, geopolitical problems can cause oil transports to be blockaded. And so on.

Markets are at least ignoring the fact that the threat of an Iranian blockade has anyway decreased dramatically in the past weeks, with intensive contacts between the Iran and the US.

I think there is one factor that should be taken into consideration. When the US introduced the QE2 programme in 2010, all commodities took off, as this asset class is small and illiquid compared to bonds and stocks.

The US has since then stopped adding liquidity, but ECB, BoE, BoJ, and PBoC (China) have taken over and are now flooding the money markets with liquidity. More to come from ECB tomorrow. Even if US is sidelined, reflation is still very much the talk of the town.

In the past four years, virtually all positive investment returns have been driven by the assets that reacted most strongly to the changes in the various reflation initiatives

Maybe we will have to look no further to find the true reason for oil’s price increase. But we can of course wonder why commodities, including oil, only reacts now, with a delay of several months. It will be a job for historians to find out why.

Thursday, 23 February 2012

Greece. Europe's recession. Banks.

Not unimportant, but irrelevant
I received a couple of comments from readers who felt I was not right in claiming the Greek deal is unimportant. Of course it is important. For the Greeks, who have a huge job to do, if they want to turn the country into a modern welfare state within the next generation. Scores of reports have made it abundantly clear that the country’s political system and central administration rather deserve to be classified as third world.

The deal is also important for EU, who has essentially promised to prop up Greece, for as long as Greek politicians are serious about improvement.

Of course the deal is important for the banks, who have been forced into taking a haircut. But they have again and again been asked to make sure that their balances and provisions were adjusted to the coming reality of a haircut. If they have not done so, they only have their own pigheadedness as an excuse.

A few hedge funds piled in, hoping to be able to make a killing on a legal technicality. If they disappear as a result of their wrong bets, well, that is what capitalism is about.

So it is not that the Greek deal is irrelevant. It is just irrelevant for investment decisions. Of course we will have a chapter 2 and 3 and 4, but increasingly it will be question between EU and Greece. The financial markets are out of that loop.

Europe’s recession will end
Instead of trying to figure out how the next Greek bust-up will unfold, headlines could focus on the two real important factors in Europe. They are intertwined. It is the ill-conceived austerity programmes (“Pain without gain”) and the situation in the region’s banks. Neither of those have anything but a passing connection with Greece.

I have tried to introduce the two time dimensions in the markets, EHT (economist hypothesis time) and RMT (real market time). I have argued that for those of us who operate in RMT, Greece is only a sideshow. Those who operate in EHT still spend their time pontificating on the precise depth and length of Europe’s recession.

Using our own indicators, we have argued that Europe’s recession would reach its depth around a month ago and that signs of a moderate recovery would abound around the end of the first quarter. Despite some minor fluctuations, we are still on track for that scenario to unfold. The residual uncertainty concerns only the strength of the recovery. Given the austerity drive, it does not look good. But there is a world of difference between a 2% growth rate in the second half and the “depression” everybody feared in late November.

Europe’s banks
I am far more concerned about the banks. The equally ill-conceived idea of forcing the banks to solidify their balances at the same time may still give some highly undesired results. In the US, the banks were given a big check. In Europe, no real decisions have been made yet - with the predictable consequence that credit is not growing. It was highly symbolical of the difference that Wells Fargo bought an 11bn loan portfolio from BNP Paribas. European banks are still shrinking.

Under normal circumstances, the combination of fiscal austerity and abundant liquidity should drive interest rates and exchange rates down. But these are not normal circumstances. We are in the biggest deleveraging drive in 80 years. It short-circuits the normal rules in the textbooks.

Europe’s monetary policy is a huge subsidy to the banks. But it may not be enough. And it is not good news that there is no common plan for solving the problems. Increasingly we see a new North-South Divide. In the north and the UK, the problems are attacked head on. In the south, the governments still cosy up to the banks. Bank lobbies are still stronger than the democracy in some countries.

But this is all in EHT. In RMT, the European banks represent the strongest possible cyclical bet on the end of Europe’s recession. Or to be more precise: The strongest possible cyclical bet on market beliefs that Europe’s recession has ended. Curious, isn’t it?

Tuesday, 21 February 2012

Greece, Euro, and risk-on

Greece and the Euro crisis
So Greece got a deal. No surprise, as the details had already been on the table for weeks. Unless you are a hedge fund and have directly speculated in a default, it is also largely irrelevant. Yes, Greece may need more money in a year’s time, but that is not important for the investment decisions taken today.

The risk-on situation that has prevailed since the October 2011 has been curious in the sense that it has taken place under very low trading volumes. This is frequently observed at cyclical turning points and last year we had two such points, leaving many investors somewhat schizophrenic. Recently, we have had the most dramatic change in relative prices of the various asset classes in more than three decades, but with no flows to support that movement.

Depending on one’s point of view, this can be blamed on the Greek crisis or the uncertainty about the global growth outlook.

As far as we see it, both of those factors are firmly off the table and that will be the situation for at least some months. USA is recovering nicely, Europe (including UK) is pouring cheap liquidity into the financial markets (new 3-year LTRO coming up in a couple of days), China has eased bank credit for a second time. German economic strength is surprising on the upside and we are past the point of maximum deflationary pressure on Europe’s economies.

We suspect that it could bring “real” money managers, i.e. those who invest important volumes, to change their mind and to begin running after the market. In practical terms this would imply that they begin to increase their holdings of risk assets and rotate out of safe haven assets.

With growth in Germany and US surprising on the upside, T-bonds and Bunds are decidedly expensive, and yields will increase as the risk premium is taken out of those markets. Risk pricing is also likely be taken out of other presumptive “safe haven assets”, Norwegian Kroner, Swedish Kronar, Danish mortgage bonds and what not. It will not look good once the asset rotation starts in earnest. Speculative Euro short positions will continue to be squeezed out.

Some weeks ago I wrote a few words about the brewing oil crisis relating to Iran’s nuclear programme. Curiously, it appears that two developments are happening at the same time. From various sources, it seems clear that there are in fact negotiations between US and Iran to defuse the stand-off. At the same time, oil market speculators are now beginning to hype the story and telling us that oil can go through the roof. Follow this story closely.

Just to make sure, oil could see quite a rapid increase before it derails our indicators that the risk-on situation is intact.

Wednesday, 15 February 2012

Three AAAs and an AA+

Some weeks ago we had a storm in a nice cuppa as French politicians attacked the UK in frustration over Frances’s downgrade. They claimed that the British economy in all important aspects was worse off than the French economy. Rather unsurprising, the British government found the attacks unfounded. Back then I commented that there was something correct in the French criticism.

One big difference between the two countries is obviously that the UK has its own central bank and its own currency. Back then, the BoE had just announced a massive QE programme, and has later expanded the initiative further.

The problem is just that it has not worked. Moody’s is now on the prowl and has placed UK on a watch list for a downgrade. Apart from an outsized banking sector, UK has the quite dubious honour of belonging among the countries who saw the strongest growth in household debt in the past 15 years. UK consumers are busy repairing their balance sheets, curbing consumption as a necessary consequence.

This is the reason that well-intended expansionary policies from the BoE does not work. With slow growth it becomes a problem to curb the budget deficits. Again the rating companies are only pointing it out long after it became visible to the naked eye.

Another AAA country with a failing sense of reality took a couple of punches to the chin. Denmark is now on EU’s new watch list together with Bulgaria, Slovenia and 9 others. EU points to the fact that Denmark’s massive loss in competitiveness has led to significant loss of export market shares. At the same time, Danish household debt has grown strongly as consumers eagerly participated in the housing boom. Hence, the current deleveraging of household balance sheets handicaps economic growth. And that in turn creates problems in controlling the budget deficit.

Danske Bank’s outgoing CEO Straarup confirmed this situation in an exit interview. Danske sees strongly increasing losses on consumer loans as the housing bubble deflates. A shame that Straarup did not point this out earlier. But of course – once burned, twice shy. Straarup had to ask for emergency government assistance to save Danske in 2008, and he has kept a discrete profile ever since.

Nothing of all this should come as a surprise to the regular readers of this missive. I will venture into claiming that the only reason for Denmark not to be on a watch list for a downgrade is the massive improvement in public finances that happened before 2005. However, Denmark’s growth problem can end up becoming a serious problem of government balances.

Norway also holds the coveted AAA rating. It always helps a bit when you have no accumulated government debt. But all is not well in this country of oil and expensive vegetables. 

Recently several voices have pointed out that the country is in the grip of a major property price bubble. Most recently the head of the Norwegian FSA, Baltzersen, pointed out that the combination of a strong Krone and a property bubble creates a very difficult policy problem. Robert Schiller, the author of the Case-Schiller housing prise index for the US, pointed to the bubble in January.

The governor of Norway’s central bank, Øystein Olsen will speak on 16 February. He will likely concentrate on his area of responsibility, which includes the NOK, but not the house prices.

The situation becomes progressively more difficult for the government. The bubble is conflated by highly distorting tax rules. It makes it easy to deflate the bubble. It also makes it very easy to become highly unpopular among property owners. It is easier if one can blame the disaster on somebody else. But in this case, the government fully owns the problem.

The goings-on in the Republican race to nominate a challenger to President Obama make people say things that could otherwise create suspicions of use of controlled substances.

Romney has recently stated that the big 3 US carmakers would have been better off today without federal help in 2008/9. Let us just remember that two of the companies were in Chapter 11 and only survived because of capital injections from Washington.

One of the elements in the rescue plan was a dramatic reduction in pension liabilities. Pension funds received a large number of shares in the recapitalised companies as a compensation. Romney also criticised that one.

If he is to continue down that road, it would only be logical that he gets critical regarding the capital injections to the banks PLUS the fact that the federal government bought some 800 bn USD worth of “troubled assets”. 

The timing of that criticism is easy to get right. It will come when pigs fly.

Monday, 6 February 2012

Risk-on. Greek default. US Jobs

Risk-on vs Risk Rally
Since November I have claimed that we were in a risk-on situation in the markets and at the turn of the year I believed that it could turn into a market rally. The distinction is crucial. A risk-on situation prevails when the markets are getting less fearful and the asset prices adjust accordingly. A risk-on situation may turn into a rally if the price adjustment leads to increasing volumes and that in turn leads to added asset price momentum. It certainly looks like we are there now. Last week’s raft of Market Strategists turning positive is just another proof that consensus is now following the markets (and not the other way round!).

Observing a risk rally is quite obvious and does not require a lot of rocket science. Defining the beginning of a risk-on situation is a bit more complicated, as the signs are often weak at the beginning. Looking back, we believe that the risk-on situation began in late September and accelerated in late November (even if the stock markets actually fell a bit) and again in December. The market rally only kicked in later.

At Origo we devote considerable energy to time these turning points. Now, in the fifth month of the risk-on situation, we are becoming a bit concerned. The market optimism may still developing further. But there are some not-so-healthy factors in the European economy, including credit. We still need decisive action to recapitalise banks.

The good news is that when a risk-off situation begins, it is usually clearly visible in advance and the signs are unmistakable once it hits the markets. If you have forgotten what it feels like, think back to 2 August.

A Greek default is increasingly likely
The Greek drama continues to develop, but now with a quite different twist. Over the weekend, Euro-group Chairman Jean-Claude Juncker piled the pressure on the Greek government to be serious about implementing reform as a condition for the disbursement of further help. Some days ago I sent a couple of links to documents that amply demonstrate the point: The Greek government faces a serious job in reforming the public sector and that goes way beyond just reducing costs. OECD has pointed out that the public administration is largely dysfunctional, that there is no follow-up on policies and their effects, that public collection and use of data is disastrous. I quote from OECD:

“For now, it is not clear how existing and new entities of the Centre of Government will work together in order to secure the leadership needed for reform, including the necessary strategic vision, accountability, strategic planning, policy coherence and collective commitment, and communication. Fundamentally, there is no obvious ownership of the reform agenda either with specific entities at the Centre of Government, or shared by these entities.  The capacity to co-ordinate with key ministries is also weak.” (OECD’s emphasis)

And so on. Again it appears that the conservative Nea Demokratia party at the same time tries to present themselves as defenders of the country and an even stronger defender of vested interests that are dead against any kind of meaningful reform.

Meanwhile, the negotiations with the private bondholders appear to have taken a back seat, at least in the newspaper headline space. But we certainly are on the final straight: On Wednesday the EU Council meets, and the Greek negotiations are on the agenda. On 13 February a formal offer for the “voluntary” debt swap must be presented in order for the Greece’s large coupon payment on 20 March to actually be paid.

But at this moment, any losses ought to be fully discounted by the markets. I guess it is only the distribution of the losses that remains to be seen.

US Jobs report
The US labour market data released on Friday gave the stock markets a good boost. The headline unemployment number fell from 8.3 to 8.1 per cent in January. That number is one of the most suspicious numbers in the entire cycle of US monthly data releases. Since Reagan’s days, this number is an estimation, based on panel data, and not on any kind of national records. In particular the number of job seekers is dodgy and fluctuates significantly. As a result the unemployment rate can fall if unemployed persons drop out of the labour force. In the US definition you can fall out of the job-seeking category if a job offered is turned down, eg. because of a too low pay.

There is more substance in the data for actual jobs creation. And those data showed that job creation is getting broader and more dispersed. Anyway, it is a lagging indicator. US data have exceeded expectations since October of last year.

Friday, 3 February 2012

Greece, Geithner, GS

Time to worry about Greece?
Apparently (well, we have been wrong on this one before), the negotiations about the Greek  restructuring are inching towards a resolution and the private bond holders appear ready to accept a coupon of some 3.6% on the newly issued bonds. That corresponds to a haircut of 70%. You may call that a default or not, depending on your preferences.

But what worries me is the steady stream of reports out of Greece that the public sector is falling apart and essentially unable to implement radical policy changes. This is amply chronicled, even by such staid institutions as the OECD back in November. It begins to look eerily like Argentina.

In a telltale sign, Steve Hanke has publicly stated that Greece will fall apart. Hanke was the intellectual force behind Argentina’s disastrous “currency board ”in the late 1990s that led to the country’s default in 2002. He still does not see any responsibility for the failure but blames the fiasco squarely on the implementation.

Anyway, he has seen up close what happened, and he believes he now sees the same happen in Greece. It is not often you will see me reference Telegraph, but in all of their euro-hostility, they have made a listing of what could happen to Greece if not something is done to stop the downward spiral. Not funny at all.

The US Secretary of the Treasury may well be sacrificed by Obama in order to obtain re-election. Geither is widely seen as an ambassador of Wall Street inside the US Administration (I tend to agree), and it is likely that Obama will try to tap into the public exasperation with the financial sector excesses. Geithner’s position may stand in the way of the re-election strategy.

In a statement to reporters Geithner made a comment that gives away a lot of the thinking inside the Administration. “We are working to discourage other nations from applying softer rules to their institutions in order to try to attract financial activity away from the U.S. market and U.S. institutions”, he said. One can only assume that governments elsewhere have the same attitudes, and that explains why international agreements are so hard to come by.

But what about the European politicians who want to introduce tougher rules on their banks?

It must be official by now
Goldman Sachs, one of the leading consensus makers in the English-speaking part of the financial sector, has finally given in to the positive mood. Jim O’Neill, chairman of GS Asset Management offered the following gem:  “just the cessation of bad news itself has sort of appeared (to be) a bit of a positive”. It must mean that GS agrees with me about the (feeble) economic recovery and its influence on the market. I am sure he will receive a huge bonus for this rigorous analysis. Predictably others followed in his wake.

Should we worry?
In recent days there have been some disturbing reports about the trends in Europe’s broad money supply. Overall it can be taken as an indicator of the amount of credit given - but not a precise one. In the last months of 2011, the EU-zone money supply fell by a few per cent (in Greece it actually collapsed). We need to see this trend reverse in the first quarter in order for the region’s recovery to continue.

Wednesday, 1 February 2012

25/27 EU. Portugal. RBS.

25/27 EU
So 25 of 27 EU member states decided to sign up to the new fiscal policy agreement, and the Czech Republic may sign up later due to democratic procedure. The UK decided to remain on the sidelines – again.

I have nothing new to add. The agreement is asymmetrical and will always have a deflationary bias. Unless, that is, it is completed by a solidarity agreement whereby the surplus countries agree to stimulate growth when other countries are forced into budget cuts. It is not on the agenda and the German understanding is that they have no such responsibility.

President Carter’s security advisor Zbigniew Brzezinski gave this description of the UK: “Its ambivalence regarding European unification and its attachment to a waning special relationship with America have made Great Britain increasingly irrelevant insofar the major choices confronting Europe’s future are concerned. London has largely dealt itself out of the game”. It cannot be said any clearer.

There was some flowery talk about creating more jobs for the young unemployed and for making some initiatives to help small and medium-sized companies. It will not improve the economic growth.

I continue my focus on European bond auctions. European nations including Italy, Belgium and Spain plan to sell more than 33 bn euros this week. Italy sold 5.5 bn euros out of a target of 6 bn euros of five- and 10-year bonds on Monday, and issued 1.9 bn euros out of a maximum goal of 2 bn euros of 4-year and 9-year bonds. Belgium sold 2.58 bn euros of bills, with Spain, Portugal, Germany and France issuing 13 different maturities in coming days. Italy’s auction did not go down as well as hoped and there will be some focus on that issue in the coming weeks. But overall the results point to continued improvement.

The country’s 10 year yields now stand at a sky-high 16.40% after having been higher than 18% last week. Predictably, it has led some to believe that Portugal’s refinancing costs have increased just as much, and that the country is about to be insolvent.

I am surprised some people still have not realised that the purpose of the bail-out from May 2011 was to allow Portugal to stay out of the markets for something like three years. The country steadily makes some auctions but they are small enough not to imply an imminent insolvency. Contrary to the case of Greece, nobody has accused Portugal of lying about the true situation of the public finances.

It does not imply that Portugal is safe yet. The government has embarked upon a major labour market reform. About time to clean up after the dictatorship imploded in 1974. But that kind of initiatives only work slowly, however well-intended they may be.

The fall-out from the RBS story continues. Sir Fred Goodwin, the ex-CEO of RBS is now ex-Sir Fred. He was stripped of his knighthood, just because the government had to step in with a modest GBP 45bn to save the bank. He must feel that he is being treated very harshly.

As a small compensation, I guess that Fred will keep his bonuses, contrary to the current CEO, who was brought in to clean up. Steven Hester waived his bonus of less than 1mn GBP after a public outcry that had nothing to do with his actual results.

We still need a serious discussion about how to device bonus systems for bank CEO’s. I still believe that looking at the returns created on the balance is better than the current obsession with return on equity. Using the RoE creates a strong incentive for the likes of Fred Goodwin to gamble. And as we see, again a ruthless and greedy bank CEO privatised the gains and socialised the losses.