Global Investing

Sparring with Central Banks

Just one look at the whoosh higher in global markets in January and you’d be forgiven smug faith in the hoary old market adage of “Don’t fight the Fed” — or to update the phrase less pithily for the modern, globalised marketplace: “Don’t fight the world’s central banks”. (or “Don’t Battle the Banks”, maybe?)

In tandem with this month’s Federal Reserve forecast of near-zero U.S. official interest rates for the next two years, the European Central Bank provided its banking sector nearly half a trillion euros of cheap 3-year loans in late December (and may do almost as much again on Feb 29). Add to that ongoing bouts of money printing by the Bank of England, Swiss National Bank, Bank of Japan and more than 40 expected acts of monetary easing by central banks around the world in the first half of this year and that’s a lot of additional central bank support behind the market rebound.  So is betting against this firepower a mug’s game? Well, some investors caution against the chance that the Banks are firing duds.

According to giant bond fund manager Pimco, the post-credit crisis process of household, corporate and sovereign deleveraging is so intense and loaded with risk that central banks may just be keeping up with events and even then are doing so at very different speeds. What’s more the solution to the problem is not a monetary one anyway and all they can do is ease the pain.

Low interest rates and liquidity schemes can’t solve what ails the developed world. Societies must accept that in order to alter their current perilous course they must undergo great change, moving away from entitlements to which they have become accustomed. The alternative is weak economic growth, a loss of competitiveness and negative external balances — a loss of face and place in the global hierarchy.

As if to reinforce the underlying point that the developed world faces a protracted reform period that tests political, economic and social priorities, credit rating firm Standard & Poors’ — not the most popular company in corridors of power over the past year — warned on Tuesday  that it may downgrade the debt of “a number of highly-rated” Group of 20 countries from 2015 if their governments fail to enact reforms to curb rising healthcare spending and other costs related to ageing populations.

from MacroScope:

When the euro shorts take off

Currency speculators boosted bets against the euro to a record high in the latest week of data (to end December 27) and built up the biggest long dollar position since mid-2010, according to the Commodity Futures Trading Commission. Here -- courtesy of Reuters' graphics whiz Scott Barber, is what happens to the euro when shorts build up:



Contemplating Italian debt restructuring

This week’s evaporation of confidence in the euro zone’s biggest government debt market — Italy’s 1.6 trillion euros of bonds and bills and the world’s third biggest — has opened a Pandora’s Box that may now force  investors to consider the possibility of a mega sovereign debt default or writedown and, or maybe as a result of,  a euro zone collapse.

Given the dynamics and politics of the euro zone, this is a chicken-or-egg situation where it’s not clear which would necessarily come first. Greece has already shown it’s possible for a “voluntary” creditor writedown of  the country’s debts to the tune of 50 percent without — immediately at least — a euro exit. On the other hand, leaving the euro and absorbing a maxi devaluation of a newly-minted domestic currency would instantly render most country’s euro-denominated debts unpayable in full.

But if a mega government default is now a realistic risk, the numbers on the “ifs” and “buts” are being being crunched.

from Jeremy Gaunt:

Why is the euro still strong?

One of the more bizarre aspects of the euro zone crisis is that the currency in question -- the euro -- has actually not had that bad a year, certainly against the dollar. Even with Greece on the brink and Italy sending ripples of fear across financial markets, the single currency is still up  1.4 percent against the greenback for the year to date.

There are lots of reasons for this. The dollar is subject to its country's own debt crisis, negligible interest rates and various forms of quantitative easing money printing -- all of which weaken FX demand. There is also some evidence that euro investors are bring their money home, as the super-low yields on 10-year German bonds attest.

Finally -- and this is a bit of a stretch -- some investors reckon that if a hard core euro emerges from the current debacle, it could be a buy. Thanos Papasavvas, head of currency management at Investec Asset Management, says:

Are global investors slow to move on euro break-up risk?

No longer an idle “what if” game, investors are actively debating the chance of a breakup of the euro as a creditor strike  in the zone’s largest government bond market sends  Italian debt yields into the stratosphere — or at least beyond the circa 7% levels where government funding is seen as sustainable over time.  Emergency funding for Italy, along the lines of bailouts for Greece, Ireland and Portugal over the past two years, may now be needed but no one’s sure there’s enough money available — in large part due to Germany’s refusal to contemplate either a bigger bailout fund or open-ended debt purchases from the European Central Bank as a lender of last resort.

So, if Germany doesn’t move significantly on any of those issues (or at least not without protracted, soul-searching domestic debates and/or tortuous EU Treaty changes), creditor strikes can reasonably be expected to spread elsewhere in the zone until some clarity is restored. The fog surrounding the functioning and makeup of the EFSF rescue fund and now Italian and Greek elections early next year  — not to mention the precise role of the ECB in all this going forward — just thickens. Why invest/lend to these countries now with all those imponderables.

Where it all pans out is now anyone’s guess, but an eventual collapse of the single currency can’t be ruled out now as at least one possible if not likely outcome. The global consequences, according to many economists, are almost incalculable. HSBC, for example, said in September that a euro break-up would lead to a shocking global depression.

Euro exit-ology

Whether or not it’s likely or even a good idea, talk of Greece leaving the euro is no longer taboo in either financial or political circles.  What is more, anxiety over the future of the  single currency has reached such a pitch since the infection of the giant Italian bond market that there are many investors talking openly of an unraveling of the entire bloc. But against such an amplified “tail risk”,  it’s remarkable how stable world financial markets have been over the past few turbulent weeks — at least outside the ailing sovereign debt markets in question.

Yet, focussing on the possible consequences for Greece of bankruptcy and euro exit has now become an inevitable part of investment reseach and analysis. In a note to clients on Tuesday entitled “Breaking Up is Hard to Do“, Bank of New York Mellon strategist Simon Derrick sketched some of the issues.

One issue he pointed out,  and one raised in the September Spiegel online report, was the chance of invoking Article 143 of the Treaty on the Functioning of the European Union, which permits certain countries to “take protective measures” and which could be used to allow restrictions on the movement of capital in order to prevent a flight of capital abroad.

from Jeremy Gaunt:

Democracy and Chaos are both Greek

It seems as if almost everyone was surprised by Prime Minister George Papandreou's decision to hold a referendum on the euro zone's bailout package for his country. At the very least, it can probably be said that he is weary of being hammered from all sides --  his own party, the opposition, the people on the street, Germany, the tabloid press, you name it.

A lot will obviously depend on what question is asked. Do you want an end to austerity, would get a clear yes vote. Do you want to leave the euro zone -- perhaps not.

Financial markets, however, do not initially appear content to wait.  Talk of an end-of-year rally is off the table (at least for now).  It's not exactly χάος (chaos) out there, but Papandreou's  experiment  in δημοκρατία (democracy) has sent the whole euro zone project into a new, risky phase.

Trash heap for sovereign CDS?

For all the ifs and buts about the latest euro rescue agreement, one of its most profound market legacies may be to sound the death knell for sovereign credit default swaps — at least those covering richer developed economies. In short, the agreement reached in Brussels last night outlined a haircut on Greek government bonds of some 50 percent as a way to keep the country’s debt mountain sustainable over time. But anyone who had bought default insurance on the debt in the form of CDS would not get compensated as long as the “restructuring” was voluntary, or so says a top lawyer for the International Swaps and Derivatives Association — the arbiter of CDS contracts.

ISDA general counsel  David Geen said there would be no change in the ruling to account for the size of the haircut:

As far we can see it’s still a voluntary arrangement and therefore we are in the same position as we were with the 21 percent when that was agreed (in July)

from MacroScope:

New twist in Hungary’s Swiss debt saga. Banks beware.

A fresh twist in Hungary's Swiss franc debt saga. The ruling party, Fidesz, is proposing to offer mortgage holders the opportunity to repay their franc-denominated loans in one fell swoop at an exchange rate to be  fixed well below the market rate.  This is a deviation from the existing plan, agreed in June, which allows households to repay mortgage installments at a fixed rate of 180 forints per Swiss franc (well below the current 230 rate). Households would repay the difference, with interest, after 2015.

If this step is implemented and many loan holders take up the offer, it would be terrible news for Hungary's banks. The biggest local lender OTP could face a loss of $2 billion forints, analysts at Budapest-based brokerage Equilor calculate.  Not surprisingly, OTP shares plunged 10 percent on Friday after the news, forcing regulators to suspend trade in the stock. Shares in another bank FHB are down 8 percent.

But Fidesz' message is unequivocal.  "The financial consequences should be borne by the banks,"  Janos Lazar, the Fidesz official behind the plan says. The government is to debate the proposal on Sunday.

Jean-Claude Trichet, EM c.bankers’ new friend

What a friend emerging central bankers have in Jean-Claude Trichet. Last month the ECB boss stopped euro bears in their tracks by unexpectedly signalling concern over inflation in the euro zone. Since then the euro has pushed steadily higher  — against the dollar of course, but also against emerging currencies. The bet now is that interest rates – and the yield on euro investments — will start rising some time this year, possibly as early as this summer.

That’s ptrichetrovided some relief to central banks in the developing world who have struggled for months to stem the relentless rise in their currencies.

Being short euro versus emerging currencies was a popular investment theme at the start of 2011, partly because of EM strength but also because of the euro zone debt crisis. “What that also means is that people who were short euro against emerging currencies had to get out of those positions really fast,” says Manik Narain, a strategist at investment bank UBS. Check out the Turkish lira — that’s fallen around 5 percent against the euro since Trichet’s Jan 13 comments and is at the highest in over a year. South Africa’s rand is down 6 percent too. Moves in other crosses have been less dramatic but the euro’s star is definitely in the ascendant. The short EM trade versus the euro  has more room to run, Narain reckons.