There is not much news that needed to be dissected so I think it is time for a quick look at yield curves. For simplicities sake I will keep the analysis to the generic 2/10 curves in the countries that have sophisticated capital markets. Why are the curves important? In looking back at the crisis that forced the ECB‘s Mario Draghi to announce “there will be no TABOOS and we will do whatever it takes” to sustain the euro currency and the entire European project. It was the 2/10 curves in Europe that were providing so much of the problem. The talking heads in the media continue to point to the 10-year debt instruments in Europe as being the most significant element. The Italian auction did this. The Spanish auction did that. I urge us to be more attentive to the shorter end of the curve and especially the two-year note.
Remember, the only real QE program that was initiated by the ECB was the LTRO (Long Term Repo Operation) that allowed European banks to repo sovereign debt and other lower-grade collateral for a period of three years, not 10 years but three years. President Draghi is well aware that ensuring a liquidity injection without fear of recalling the REPO for three years will give the sovereign lending authority and problem banks the most important element they need … TIME. This is what former Fed Governor Kevin Warsh meant when he said, “A central banker’s job is to buy time.” Watching the slope of the yield curve will alert us to how effective the central bank is being in buying time. The Spanish and Italian ten year notes may have rallied as long rates declined by over 2%, but the TWO-YEAR instruments fell in yield by more than 4.5%, meaning that Mario Draghi was very effective in buying time. Just what policymakers do with the time … there in lies the problem.
If you look at the charts you will see that as the 2/10 yield curves were flattening as investors were worried about the ability of banks and sovereigns meeting their financing needs. Once the ECB promised to meet the whatever credit was needed, the 2/10 reversed and steepened out to a very positive slope where they have remained since. Italian and Spanish curves went from +80 pips to more than 250 pips positive. The fear gone from a credit implosion, the same day that the 2/10s reversed, the developed world equity markets made their lows. The DAX, FOOTSIE and S&Ps all made lows on July 24 or 25, 2012. For some, a mere coincidence.
***A new POPE is named, POPE FRANCIS I. It may mean little for the markets that an Argentinian was named to be the head of the Catholic Church but this blog is Noted From Underground where 2+2=5. The naming of a Pope from Latin America MAY HAVE DEEPER MEANING. The Liberation Theology has been a big part of the Latin American Catholic Church for several decades and its anti-colonial basis has caused agita for the Catholic establishment. Those espousing liberation theology have had a very harsh view on the enslavement of emerging market sovereigns to global banks and lending institutions. (Especially with Argentina suffering under recent U.S. court decisions it will be interesting to see if the Pontiff lends his moral authority to the issue of debt relief and restructuring.) Just something to be attuned to.
***This afternoon the Reserve Bank of New Zealand held its meeting and left the overnight lending rate at 2.5%. The KIWI came under pressure though as the RBNZ statement said: “The overvalued N.Z. dollar is undermining profitability in export and import competing industries and worsening drought conditions are creating difficulty in much of the country. Ongoing fiscal consolidation will also act to slow overall demand.” Again, another country complaining about an overvalued currency but merely wants to talk about it. When everybody is trying to push their “overvalued currencies” lower, I am suffering the pains of Harry Neilson: Everybody is talking at me, I can’t hear a word they’re saying. RBNZ Governor Graeme Wheeler is going to have to make a real decision. Either cut your interest rates or put on foreign exchange controls. The ECB and the BOJ have louder voices.