First, tomorrow morning Goldman’s Lloyd Blankfein will be rolled out on CNBC to share his wisdom about the state of global markets. Maybe he will remind investors that Goldman and other banks are doing GOD’S WORK. I will write what I wrote recently: Noah and the flood were also GOD’s work so it is important for the world’s banks to signal which part of GOD’s work in which they are involved. The European bank stocks are under stress again. Deutsche Bank and many other EU money center banks continue to make new lows every day. What are investors fleeing from? Probably the huge amount of NON-PERFORMING LOANS that exist on bank balance sheet and will have to be met with NEW CAPITAL to meet the more stringent regulatory requirements from the European oversight authority, as well as increased capital requirements under Basel III. There is a great effort to initiate a FDIC-type of deposit insurance program for all of Europe–a single agency–but the Germans will not allow their CREDIT CARD TO BE USED UNTIL THE PRESENT BALANCE SHEETS OF ALL THE FINANCIALLY STRESSED INSTITUTIONS ARE PURGED OF INSOLVENT, ZOMBIE TYPE LOANS. The lack of any banking guarantee is creating an underlying tension throughout the European financial system and without a robust corporate bond market there is nothing to disintermediate the financial power of the banks. The ECB is vacuuming up all the high quality collateral so finding adequate borrowing instruments to facilitate lending is adding to the drag on the EU economy.
Things are rotten in Europe and getting worse. The ECB will have to cut rates again in March just to ensure that there will be enough sovereign debt to purchase under the rules of engagement Draghi created for the QE program. So, if this is the situation why does the EURO rally? In my opinion the euro’s recent strength is a result of the carry trade unwinding. Many investors borrowed in euros because of the interest rate differential to the DOLLAR and hoped that the FED’s policy to RAISE RATES FOUR TIMES WOULD DEPRECIATE THE EURO. Well, as Stanley Fischer moved to a new ballpark yesterday, the short euro positions are exiting. The fundamentals in Europe are atrocious but global macro is first and foremost about FLOWS and the FED‘s uncertainty is unnerving some investors. The weakness in the DOLLAR is causing a short-term adverse feedback loop in which a rise in the euro creates even more selling in the European equity markets leading to more selling in U.S. stocks. The U.S. dollar has recently been a low correlative variable for the American equity markets. This would probably change if the DOLLAR had a sizable correction but for now it is not a driving force for valuations.
The 2/10 U.S. yield curve has closed below the 115 positive sloped level for two straight session. This was the level of support that the curve had held for the past 40 months but with Japanese bonds trading at 0.08% (8 basis points) and the German bund trading at 0.30% (30 basis points), the world is in search of high-quality sovereign debt so demand increases for the U.S. 10-year note and all the other U.S. Treasury paper. It is a world in search of minuscule amounts of safe returns–1.80% is in demand–pushing the 2/10 flatter. Global demand for safety is disrupting the plans of the central banks. Don’t put the money into the banking system but purchase sovereign debt as a worthwhile alternative in an uncertain world. The more negative the rates go the more afraid investors seem to get.
Today, the BOJ announced it was cancelling tomorrow’s JGB auction for retail and municipal buyers for fear of negative rates. In Japan, most of the bonds are held by domestic buyers, far higher than any developed economy. A political backlash may emerge as Japanese investors are financially repressed by negative interest rates with inflation more than 0.5% percent. It was a different situation when JGB buyers were getting 60 BASIS POINTS and Japan was experiencing deflation or negative pricing power. If prices in Japan were dropping by 1 percent per annum and rates were 0.60%, the EFFECTIVE REAL YIELD WOULD BE 1.6%. But now the REAL YIELD EVEN ON 10-YEAR NOTES IS NEGATIVE (AS WELL AS NOMINAL). These may cause political problems for the BOJ, especially ABENOMICS.
“A Single Spark Can Start a Prairie Fire (Mao, 1930)”
Tags: Abenomics, BOJ, ECB, Euro, Fed, gold/yen, U.S. 2/10 curve, U.S. Dollar, Yen
February 2, 2016 at 9:18 pm |
DB has written the bulk of the non-recourse commercial real estate loans in the U.S.
After the fall somebody will bottom feed these assets
February 2, 2016 at 9:26 pm |
Yra,
Great post, and nice piece yesterday with Rick. Both are very fitting this 2+2=5 world we live in. The age of central bank omnipotence is beginning to unravel, and central bankers are the last to recognize it. Kuroda’s pledge of no negative rates (until Friday) is a classic! In less than a week, they now cancel a JGB auction for retail and municipal buyers, a clear “unintended consequence” unforeseen until it bites them in the hind end. With financial repression now providing Mrs. Watanabe negative nominal and negative real yields, one wonders how long the torture can go on. I remember the words of Sister Mary Cecil (OP) in 8th grade; “What a tangled web we weave when we practice to deceive” I don’t think she was talking about central bankers, but she sure should have been!
February 3, 2016 at 4:46 am |
Professor—Kurod’a speech last night in Japan on BOJ monetary policy was astounding.for its HUBRIS–that speech on QQE in Tokyo showed how the central banks have assumed absolute control over the global economy—I don’t know who is more scared ,Kuroda or me—but read it.
February 2, 2016 at 9:27 pm |
Just a comment on bank insurance guarantees in Europe, looking for an FDIC type fund to solve their problem.
Anyone ever look at the FDIC reserve funds and the total deposits insured? It is about 1%, so it is more psychological than real. Of course the full faith and credit of the US government is behind it, but what would happen to the dollar if the government had to inject tens or hundreds of billions into the fund?
The most frightening thing today is not the breakdown of the price of crude oil (that is a problem) but the financial condition of the banks worldwide. When Germany, Europe’s most solvent nation’s money center bank (DB) is breaking the 2008 lows, you can bet the problem extends from China and Japan through Europe and the US banks. Derivative exposure is enormous and Dodd Frank never began to solve the problem. Abolishing Glass Steagall was a major error and the repercussions lie ahead of us. Blankfein’s firm was in deep trouble in 2008. The reason’s for it then exist again today.
The Big Short should get an Oscar for letting the public know what happened then and what can happen again.
February 2, 2016 at 9:54 pm |
“what would happen to the dollar if the government had to inject tens or hundreds of billions into the fund?”
Sounds like a debt bailout to me, like turning water into wine.
February 3, 2016 at 4:27 am |
Asherz–yes of course you are correct.Can you imagine if there is a bailin of American depositors in the next three months—Bernie will come to rise from the ashes of the public burn
February 2, 2016 at 9:58 pm |
“In my opinion the euro’s recent strength is a result of the carry trade unwinding. Many investors borrowed in euros because of the interest rate differential to the DOLLAR and hoped that the FED’s policy to RAISE RATES FOUR TIMES WOULD DEPRECIATE THE EURO. Well, as Stanley Fischer moved to a new ballpark yesterday, the short euro positions are exiting. ”
OUTSTANDING! tick VG. I will spend some time working through this BUT really, OUTSTANDING! Thank you Trotsky
February 3, 2016 at 1:29 am |
Love the “Noah and the flood”, but that it’s not Goldman and company that are going that job, it’s the Central Banks! The flood is coming and no one will be able to stop it. Perhaps in the near future the CBs will be the ones who enforce digital currencies so that they can then directly manipulate the public…
February 3, 2016 at 6:44 am |
Soph–no but Goldman and the others anti Glass-Steagallers certainly direct the waters flow
February 3, 2016 at 3:41 am |
“If I were to shut off my web and shut off the TV…I wouldn’t know there was any economic issue at all in China.” – Tim Cook, CEO Apple
February 3, 2016 at 4:25 am |
Arthur–i know what he means .Although now that alphabet is in the “lead” we will have google in our ears all day–let the genuflecting begin—and Google doesn’t operate there so by Spockian logic of course they rise to the top.
February 3, 2016 at 8:49 am |
“The constraint of the ‘zero lower bound’ on a nominal interest rate, which was believed to be impossible to conquer, has been almost overcome by the wisdom and practice of central banks, including those of the Bank of Japan,” said Mr Kuroda.
“It is no exaggeration that [ours] is the most powerful monetary policy framework in the history of modern central banking,” he said.
Yra, You are so correct. Mirriam Webster now has a new definition of “Hubris”.
February 3, 2016 at 5:21 pm |
professor–his hubris still has me shaking or very bothered to say the least
February 3, 2016 at 9:42 am |
Looks like the FED needs to raise rates, for some reason I cannot understand the logic but no doubt higher rates are the way to go, they (the FED) say.
February 3, 2016 at 1:03 pm |
Yra,
Your call on GOLD looks prescient.
What is your target?
And where do you see resistance?
February 3, 2016 at 5:20 pm |
Frank C.–at this stage trading it tactically as it as broken more hearts then marlene dietrich—closing above the 200 day ma. today is a plus but again will trad cautiously into this area of resistance—still waiting on the GOLD/YEN to break thru its 200 day