Dancing Fox

Dancing Fox

A foraging fox in Dulwich south west London, Sunday January 20th 2012. © Harry Dorset, 2011 #uksnow

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Fiscal Cliff vs. Fiscal Bump? Post-Election Views

Two basic cut-out-and-keep-perspectives

Taken near Dead Horse Point and Canyonlands National Park, Utah; source http://www.marketplace.org/topics/economy/us-headed-fiscal-cliff  [Creative Commons]



The glass-half-full version:

Negotiations succeed in securing a temporary extension of expiring tax provisions and spending cuts.

This is the ‘kicking-the-cliff-down-the-road-for-a-few-months’ scenario.

In that world, a short-term debt ceiling increase will have to be agreed, to get the economy to the Spring, when the real work of a deal on fiscal policy would begin.

This would require that the economy be definitively in recovery mode [arguable, but go with it for now please] and despite the prospect of market uncertainty, balance of risks to US growth projections for 2013 would be tilted upside.

Extreme outcomes feared by many today in a worst-case scenario Cliff would thus be moderated to a reasonable extent, at least. [But even in this brighter world, the Cliff doesn’t disappear; it’s just delayed for the medium term.]

The bear version:

Election results for The House of Representatives and [one third of] the Senate show that the balance of power in Washington DC post-election looks suspiciously like it did before.

The government is still regarded as divided in this world. In fact, arguably, the new House and new Senate are more polarized than before – in this more negative view, with fewer moderates all round; more right-wing right-wingers and more left-wing left-wingers.

In that world, fiscal cliff negotiations become another grown-up game of chicken, basically, in the same way the debt ceiling negotiations did.

House Republicans would probably oppose any kind of tax increase – but many commentators expect them to eventually agree to an end of the ‘payroll tax’ break.

It’s the ‘Bush tax’ cuts which would probably cause the most fireworks.

Republicans would not agree to those ending easily, if at all, even if automatic spending cuts are likely to be delayed until 2014 and maybe beyond.

All this might unsettle financial markets in November and December and put downward pressure on US Treasury yields, even if some sort of fudge is the likeliest eventual outcome as various final deadlines [late in the Spring] loom.

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The Bankia Signal

Another Friday, another wait for economic news out of Spain.

The results of the second part of an audit of Spain’s banks  – started in May and with particular reference to their funding needs – is likely to be released today [Friday] around 1600 GMT.

It’s a good time to note that in fact, Spain’s main banks are actually rather strong in capital terms and certainly relatively speaking.

This article on from Seeking Alpha from June, has some excellent data and comments which should help to differentiate such giants as BBVA and Santander from their smaller and sometimes upstart sector peers.

It’s the smaller, more regionally focused ‘cajas’ and the newer entities to which we should conclude any barbed comments in Oliver & Wyman’s report might be aimed.

Foremost amongst the struggling newer entities must be Bankia.

It takes quite a suspension of scepticism to regard this bank as sound in all respects.

It was formed at quite near the peak of the last phase of Europe’s debt crisis in December 2010, from seven regional savings banks.

It was the fourth-largest bank in Spain with 12 million customers in May 2012.

The same month, Spain failed to avoid publicly declaring it would have to provide actual financial backstops and intent of the same for Bankia.

Beyond what has publicly been disclosed though, that’s all we know.

And it might not matter much anyway, since the stock has halved from flotation levels and the only folk still interested are the daredevils and perhaps interests on the Spanish state side.

Even so, there are still ways the stock can tell us interesting things as we watch it from the sidelines. I’ve put together a few charts of Bankia’s stock price. Each bar on them represents one day of trade.

Chart 1 – Bankia stock price over three months [Bar-per-day] 

This one shows the range bound nature of what is now a relatively closely-held banking stock, over three months.

Chart 2 – Bankia stock price – zoomed to Sept. 11 to Sept. 26

Zooming in we can see the day of the most pronounced buying this month was on September 11, a day on which the stock gained more than 10%.

Looking at the volume bars underneath the candles, we can see that despite the jump, that day wasn’t a day with the biggest volume — in other words a relatively few buyers were eventually willing to buy the stock at 10% higher than most of the market was willing to buy.

The stock went from a low of EUR1.26 to a close of EUR1.388.

The day before the day of determined buying, the stock looked to be on the verge of piercing the 100-Day Moving Average line.

That line, regardless of the validity of such views or not, is widely regarded by traders as one signal of strength which a stock needs to remain above in order to continue being regarded as worth buying.

Looking rightwards, we note the short candles representing relative stability in a range for several days.

We come to a couple of days ago, and note the stock had slipped beneath another signal line, the Exponential Moving Average.

Here’s Bloomberg’s delayed ticker for the stock.

Of course, since September 11th, the 100-day moving average line has collapsed.

But the stock price is today but a few cents from the point at which someone or a few parties [for the most part] thought they had to step in, earlier in September.

Hence today, being the second-most crucial news day for Spanish banks of the year, one could reason that the same parties might like to act again, so long as they had a burden of proof on their side [AKA audit results.]

Failure on their part to act in a similar way as on September 11, would imply ‘support’ being withdrawn and levels past EUR1.26 [and perhaps beyond] potentially being breached.

The stock is as I write at EUR1.286.


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Fed Decision – A Minority Report

The analogy sort of fits; and what put me in mind of it was the news this week that the FBI has commenced a project to create a hi-tech facial recognition database.

We of course, are concerned about a different set of ‘Feds’ right now.

The Federal Reserve’s interest rate decision will come at 1630 GMT, and will be followed by Chairman Ben Bernanke’s press briefing.

Watch it here. [That’s the Fed’s official www.ustream.tv/ channel.]

I don’t know what Ben Bernanke will say. I know what I think it would be logical and prudent for him to say.

I’m not alone either.

Whilst we know that a majority of professional economists polled by Bloomberg [paragraph 5] and Reuters [paragraph 3], expect a third round of quantitative easing, a minority disagrees.

I’m with that minority.

The logic of those who disagree goes, a-little-something, like, this:

  • In theory, quantitative easing is meant to impact the real economy through a two major channels.
  • Via the interest rate channel, QE is meant to lower borrowing costs and consequently increase borrowing activity and then real investment in property, plant and equipment.
  • However it’s clear that QE’s most important channel is not a formal one. Rather it can be argued that sentiment is at least as powerful a channel as interest rates.
  • We know that the QE has lifted 5Y US Treasury yields ~35bp from the first mention in Bernanke’s Jackson Hole speech in late August 2010 through to its formal end on June 30, 2011).
  • Over that same period S&P 500 rallied 27% and DXY fell by about 15%.
  • Right now SPX is around 14% higher on the year, 10-year yields are well off the highs of earlier in the year and 5-year yields much lower than in 2010.
  • The ‘real’ trade-weighted dollar is ~3% lower than before QE2.
  • You know where I’m going don’t you? The question of whether the financial markets really need a QE3 arises.
  • I’m afraid I am going to have to skirt the question of whether the real economy needs [another] one – maybe our experience of the extent of the efficacy of the last two is implicit enough of an answer.
  • There would clearly be an element of protection in any decision in going full-on QE tonight.
  • However, given the Fed’s robotic drumbeat of readiness to act if needed over the last year, it seems a stretch to think that any market upset resulting from a failure to announce QE today would be akin to semi-catastrophic meltdown.
  • The market reaction might certainly be cheaper than the QE option.


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ECB Floats Yield Target Idea; U-Boats Launched

Late this morning the markets seem to have sobered up a bit following earlier barely fettered optimism about a Der Spiegel article over the weekend.

It said: “The European Central Bank is considering setting limits on yields of euro area sovereign debt by pledging unlimited bond purchases” and that “the policy will be decided at the September meeting of the ECB’s governing council.”

For the person who managed to avoid all versions of this story over the weekend, here it is in German [you can use Google Translate if necessary.]

Yield limits would mean the central bank could intervene in the secondary markets when yields go above a certain level.

The inevitable parade of Bundesbank officials saying they’re not into the idea has also started

Bundesbank headquarters, Frankfurt  Wikimedia Commons
Even without that, the realization was already spreading that implementing that idea would present obvious problems.

Here are the basic problems the ECB would face in trying to establish a yield/price target:

  • impossible to determine exactly where such a fair level ought to be
  • putting a number to such a level would leave ECB in a position where it would be required to explain how it arrived at such a number
  • Potentially, ECB would need to explain why a number for one country might differ from that for another. 
  • If ECB sacked all the above off and did not set a yield target, it might have to follow a quantitative target

Even if quantity=“unlimited”: key questions would be:

  • what assets will be eligible?
  • how long the programme will be in place?
  • How it will even be executed? 

All this of course doesn’t even try to guess how effective any such intervention would be,
Remember the main objectives are:

  • Raise the share of non-domestic funding/foreign exposure to Italy/Spain
  • Repair monetary transmission; get credit flowing again, specifically demand.

So, we wait till the ECB’s next announcements on September 6.

Just remember that in recent years officials often [not always] find it difficult to provide a sufficient amount of detail in time to satisfy markets.


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ECB Bullets To Shoot Down High Hopes [Sorry]

The views below are based on my soundings, readings and common sense. Responsibility my own:

  • ESM banking licence: crisis would need to deteriorate significantly (threaten the core) before such a politically contentious and legally complex policy change is considered.
  • Bear in mind German constitutional court ruling regarding ESM, continued disagreement regarding the necessary prerequisite of prudential banking supervision before another Spanish bail-out. And the increasing likelihood of a Greek exit from the EMU.
  • Note the German finance ministry’s unambiguous reiteration of its resistance to ESM-related policy yesterday.

What will happen then:

  • Draghi seems likelier to “talk” about an ESM banking licence at the press conference, but no more.
  • Expect him to “stick to the script” staying within the ECB’s narrow mandate.
  • Given the significant hurdles involved regarding the ESM, a “re-loading” of the SMP seems the most realistic short-term policy option available to the ECB.

But it needs a tweak.

  •  I’m sticking with the idea that LTROs are dead. We may see a further loosening of collateral conditions (e.g. through lower haircuts).


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What Will The Fed Do? – Predictions from The Mile [and beyond]

There’s half an hour to go before the FOMC policy announcement, which will be followed by ‘The Ben Bernanke Show’ from 1815 GMT.

You can Watch the Federal Reserve press conference with chairman Bernanke here:  http://www.ustream.tv/embed/4944768

Live video for mobile from Ustream

Predictions and polls have been cast; the vast majority of positions taken and wise bears would have capitulated, for now.

It’s rather too late for ‘clever’ predictions.

Still, it’s interesting to take a gander at forecasts and views of the Major Houses, for whom the Federal Reserve’s decisions are likely to create a lot of work this evening and beyond, whatever the Fed does.

I’ve pasted a few of these views below.

[Remember, details will be released on the NY Fed website 10 minutes after the announcement at 1630 GMT.]


Greg Anderson, Foreign Exchange Strategist, CitiFX – Citigroup Inc.

“Based on our own private opinion polls and those we have seen in the public domain (WSJ June 15), we would now say that market expectations today are roughly the following: 60% – twist extension, 20% – QE3 and 20% – Nothing. We believe that expectations have coalesced in the direction of a Twist Extension over the past week or so. The higher expectation for Twist has taken away some of the expectation for Nothing as well as for QE3, with the benign outcome of the Greek election and subsequent risk rally being key factors in pushing QE3 believers toward the Twist camp.”


Sebastian Galy, Senior FX Strategist at Societe Generale

“We expect about $600bn of bond buying. Split 40/60 MBS/Treasuries, and sterilized through depos and reverse repos. The economic impact will be limited – the economy’s on a slow growth flight path whatever – but if they deliver I can go on being a yield-hungry, dollar-selling, carry-monkey for the rest of the month.”


Dennis Gartman, Editor/Publisher, The Gartman Letter, LC

“Do we expect to see the FOMC make another momentous decision at today’s meeting? The answer is, ‘No we do not.’ We expect, however, that the Fed will move to extend Operation Twist out for another year perhaps, although it may choose to lengthen it by an amorphous period. It may also choose to lengthen the maturities of the securities ‘twisted’ and it is possible that the Fed may increase the types of securities it will accept including agencies rather than merely choosing Treasury debt only.”

Ed Yardeni, President & Chief Investment Strategist, Yardeni Research, Inc.

“In any event, whatever the Fed does, it will be very lame. That’s because the raison d’être of the previous unconventional easing programs was to bring bond yields closer to zero. They are already there (Fig. 1). So what exactly would be the point of OT2 or QE3? If the FOMC votes for another round of easing today, the justification will be that the labor market remains weak, as evidenced by the latest JOLTS report. However, that begs the question of why another round of easing would work if the previous ones did not.”


Rabobank Financial Markets Research Strategists

“After the April meeting, we learned that employment growth has slowed down further, to below 100K per month. However, in his testimony to Congress on June 7, Bernanke did not appear to be very concerned. [Mr. Bernanke] acknowledged that there is an alternative, more troubling hypothesis. “But it may also be the case that the larger gains … were associated with some catch-up in hiring on the part of employers who had pared their workforces aggressively during and just after the recession. If so, the deceleration in employment in recent months may indicate that this catch-up has largely been completed”. So the Fed has two hypotheses about the recent deterioration in economic data and probably prefers to wait and see how data evolve in the coming months to decide which hypothesis it believes to be true. Therefore, we do not expect the FOMC to announce a new asset purchase program tomorrow.”

Steven Ricchiuto, Chief Economist, Mizuho SUSA

“The combination of “Twist” and the Fed’s forward short-term rate guidance was intended to push rates down in the belly of the curve, while keeping long rates from backing up. Now the Fed will be looking for ways to push long rates down further in an attempt to boost housings. As such, QE3 has surfaced again. So has the speculation that the Fed will buy mortgages to directly help drive down the cost of housing. The possibility of lowering the interest paid on excess reserves has also resurfaced, as has the possibility of extending the forward guidance. This means that the Street will probably be disappointed by the results of the meeting, since aggressive speculation has replaced a cautious approach.”


Brown Brothers Harriman Economists

“While there continue to be calls from notable participants for QE3, it appears that most have come to the same conclusion we have. That is simply: an extension of Operation Twist, in some form or fashion, is more likely than renewed expansion of the Fed’s balance sheet by QE3.  The roughly 7.7% increase in the S&P 500 since the June 1 report of weak US employment data, was arguably helped by anticipation of Fed action.  Anticipation of Fed action may have also encouraged some dollar-negative position adjusting in the foreign exchange market.  There is some scope for a reversal of these actions after the FOMC decision.”

 Independent Strategy economists

“Our forecast is [that The Fed] will inch towards more quantitative easing (QE), but limit its comments to the potential for it down the road and more rhetoric about keeping interest rates lower for longer. However, assuming, as we expect, that the US labour market continues to disappoint, the Fed’s choice down the road is between ‘Operation Twist’ and unsterilized or sterilised QE. Given that the Fed’s holdings of short-term assets for use in Operation Twist are much diminished, it makes QE more likely. That is why it is worth understanding the difference between sterilised and unsterilized QE.”

Compiled by ThSM

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Negative Benchmark Omens – How Imminent is the Doom For Yields?

Discussion of whether [or when] there is likely to be a collapse in ‘core’ government debt prices appears to be increasing.

One example

Specifically in Europe, the question of when Bunds in general [and perhaps the Euro Bund Future contract in particular] will end their run of the last year or so, is also exercising investors.

The idea that the bull market in bonds can be safely linked to the travails of economic prospects around the world [including developments in the economic crises in Europe] does not appear to be providing complete solace to core bond investors anymore.

The worry, on the eve of the FOMC’s QE decision day, is shown in persistent talk in the market that some real money investors are switching weight out of the German benchmark and into the US one, fearing that US rates might correct first, for whatever reason.

There’s certainly no corroboration of this rumour, but the fact that the talk is out there does underline the market’s anxiety.

Clearly there is no easy solution for core sovereign investors’ worries. But still, I got to thinking…

One interesting experiment is to look at recent instances of negative spreads between the benchmarks of the two countries and compare them with what we know about strong yield spread corrections.

We know that the inverted spreads are widely postulated to be anomalous and are meant to presage all sorts of severe corrections.

We could take the 10-year UST as a basis [i.e. ‘zero’] and calculate spread values against the 10-year German benchmark .

Immediately I must caution that the idea that there’s a relationship between the inception of negative spreads and the beginning of recessions is far from straightforward and is often contested.  [‘European Central Bank Working Paper – ‘Does the Yield Spread Predict Recessions in the Euro Area?’ Fabio Moneta, 2003]

 Additionally, the ‘negative yield spread thesis’ is primarily intra-economic and not inter-economic.

There do not seem to be many precedents in attempts to draw conclusions from spread patterns between economies in different [albeit symbiotically tied] regions.

Provisos aside, let’s still have a look.

1-Year Yield Spread Comparison: 10-yr UST [Base] / 10-yr Germany

Data from FactSet Research Systems

As you can see, the spread has been negative again since February this year.

The spread was negative by 16.56bp yesterday.

But the deepest inversion this year was marked on April 3rd at -46.69bp.

Even so, compare that with May 31st 2006 when it marked -112.72bp.

It took more than a year for the spread to re-enter positive territory and it did so around mid-to-late November 2007, judging by data and the graph below.

And it took two years for the spread to correct from its depth to a peak  of +88.82bp by March 31st 2008.

10-Year Yield Spread Comparison: 10-yr UST [Base] / 10-yr Germany

Data from FactSet Research Systems

There is of course a further ‘basis’ component to consider nowadays – the base could be said to have lowered compared with the heights of the last decade.

So, if you can permit me to get ”quick and dirty”:

No one doubts that core Western benchmarks need a correction….

However, the extent to which the current ‘distortion’ is predictive of a correction [if at all] is debatable.

In other words, we may not be able to draw very close conclusions from this exercise.

What we can say with a greater degree of certainty is that the inverted 10yr UST/DE spread is unlikely to be evidence in itself of an imminent correction in yields.


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The Cherubs at Ludgate

We continue our Square Mile Photo series of specially commissioned photographs by Harry Dorset.

Photograph of a sculpture depicting two cherubs at Ludgate Circus, near Fleet Street, London EC4. © Harry Dorset, 2011 

Taken in October 2011

Cherubs watching over Ludgate Circus

 This one shows one of the dozens of sculptures of cherubs installed at or on various places in The City.

There’s scant information available about the origins of this particular sculpture, however the cherubs watch over an historically important section of the City which has been well documented.

You can read more about the area surrounding the sculpture here.

You can ‘visit’ the area with Google Maps’s interactive wide-angle photo here.


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Spain: the Pain the Bailout Forgot

EU leaders hailed it.

Merkel & Co. gave their blessing to it.

UK leaders nodded in mild approval to it.

The IMF applauded it [from the sidelines.]

And markets, of course, ‘sold’ it.

It’s not that frequent for the political discourse at key points in Europe’s financial crisis to be ‘called out’ by public opinion so quickly.

But this time the general wider opinion got in step with the oft’ skeptical markets PDQ.

The European Union’s €100 billion solution for Spain’s banking crises is arguably that inadequate, it’s obvious to all.

Even so, there are a number of key figures and details about Spain’s finances and the EU’s latest bailout which are important but not so readily apparent.

I’ve tried to distill the major ones into a few main points below.

[NB: as usual, I’ve had a lot of help from ‘economists’ spam’, but the responsibility for the following is my own.]

Spanish Debt to the Markets vs. €100 Billion

Spain’s government needs to refinance about €82.5 billion worth of bonds this year, with a concentration of maturities in early in 4Q. Plus, the regions also have to refinance almost €16 billion in 2H. Additionally, the central government and regions will have to fund a €52 billion deficit this year.

Before the EU agreed to provide the neat, round-numbered €100 billion to Spain’s banks late last weekend, a 77-page IMF report, released a little earlier, claimed Spain’s banks were suffering a crisis that was “unprecedented in modern history.”

It said Spanish banks would need at least €37 billion to withstand a sharper economic contraction.

The figure is similar to the one Fitch gave when it recently slashed Spain’s rating by three notches.

Additionally Banco de España [this is the bank’s English page]: recently estimated that €180 billion worth of the known €300 billion in real estate related loans outstanding “in Spain are “troubled.”

That’s not including a €655 billion-sized overall mortgage ‘portfolio’ owned by Spanish banks.

It’s interesting that Spain’s central bank judged less than 3% of the ‘portfolio’ to be in “non-performing” loans and carried at full value.

That’s even though house prices in Spain are down by a quarter since the 2007 peak and one in four Spanish workers are unemployed.

Independent auditors’ report expected by or on June 21.

The Role of Credit Agencies and their Ratings


It’s been easy to dismiss the role of the credit rating agencies during this crisis.

I’ve been just as guilty in getting a cheap laugh at their expense as anyone else.

However, as we know, the agencies have a serious role with respect to collateral valuations which could have all of us laughing on the other side of our faces.

We know that the ECB takes the highest of the three ratings from the main agencies when determining the size of the discount to apply to different collateral.

We also know that Moody’s still rates Spain at A3.

That’s out of step with the other main agencies:


Fitch: BBB

If [OK, when] Moody’s cuts Spain, Spanish bonds will fall into a new collateral category and an additional 5% discount is likely to be applied across the curve.

Some say the ECB could change the rules, but it seems unlikely – especially with Ireland muttering and Greece already complaining about ‘one rule for one and another for Spain…’

A bigger discount would require Spanish bonds used as collateral (Hello, again, Spanish banks) to be repaid more or less immediately or a haircut to be taken.

ESM. Or EFSF. [Not that it particularly matters at this point]

That’s just one detail which has yet to be decided.


Another question is what will happen to Spain’s planned share of contributions to the likely source of its bailout, the ESM, not to mention the rest of its share of guarantees for residual EFSF?

Spain’s agreed share is about 12%.

€60 billion of the ESM could therefore be kyboshed.

And if indeed the EFSF really did have €248 billion in as yet uncommitted EFSF funds in March, Spain’s €24 billion share might not be there either.

Early indications are that Spain will go ahead with its plan to be a guarantor.

Later indications during the crises have underlined the fact that few things are as guaranteed as they appear.

The remaining countries not receiving aid will have to increase their commitments or the firewall will be marginally smaller.

I’ve decided to largely leave Cyprus out for the moment.

Obviously its contribution to the crises is more on the left hand of the ledger than the right.

The latest.

But because the EU offered Spain funds, prior to Cyprus’ request, we’re left with the dark comedy of Cyprus facing the prospect of having to share the cost of Spain’s aid before seeking its own.

It’s, yes, another detail which has yet to be decided.

As is the political dimension, involving the already bailed-out and their EU state creditors and any resulting political pressure thereof.


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