The world is sitting on piles of tinder. Two of the potential dangers have passed in the last seven days. The Brexit vote has taken place and the Spanish elections have finished without any new disruption to the European political scene. In fact, Spain was interesting as Spanish voters seemed to be afraid of a Brexit-type market reaction and moved more support to the center-right as a vote for the known.
BUT TODAY THE ECB HAS POTENTIALLY IGNITED THE FLAMES OF GERMAN ANGER AS DRAGHI MOVED FOR THE QE PROGRAM TO BUY LOWER GRADE DEBT. THEY HAVE RUN OUT OF HIGH QUALITY BONDS TO BUY. This will not sit well with the AfD supporters in Deutschland. There were massive moves in the European sovereign spreads after the news release and more will certainly follow as the program becomes clearer.
You don’t have to be a weather man to know which way the wind is blowing, or so says Bob Dylan. As long as all things are emanating out of China it may be the time to dust off the sayings of Mao for as the talking heads are reminding us daily: “The East Wind Is Prevailing Over the West” in all things financial. THE PROBLEM FOR ME IS I DON’T ACCEPT THAT VIEW AND AM IN THE CAMP OF FORMER DALLAS FED PRESIDENT RICHARD FISHER that all roads lead to the FED and certainly the European Union for providing the tinder for a financial prairie fire. There has been so much volatility during the first six trading days of the year it is difficult to get a handle on what is algo-driven non-fundamental and what may be the commencement of a change in previous momentum trades. Today I will go through a list of POTENTIAL SPARKS TO IGNITE THE FLAMES OF A FINANCIAL FIRE so that we can be aware of what constitutes a genuine change in momentum:
1. If the U.S. 2/10 curve begins to flatten–currently holding around 117 area–the bigger test will be in the 80 BASIS POINT area to signify the initiation of the flames of deflation;
2. There’s a new break in the currency wars. On January 4, RIKSBANK of Sweden announced that it would intervene at any time to stem the appreciation of the Swedish kroner, especially against the EURO. Over the weekend Swiss National Bank (SNB) President Thomas Jordan warned about the Swiss franc still remaining overvalued against the EURO and other currencies. On Friday, a Dow Jones wire article warned that the SNB lost $23.5 billion trying to keep the Swiss weak as it purchased various currencies that dropped in value.
The SNB typically makes a profit that it turns over to the Swiss Treasury, but this lean year will not sit well with the cantonal governments. The SNB noted it will pay a dividend to the cantons out of its reserves (ah, the power of the printing press) but this will not ease the pressure by Swiss politicians who wish to curb SNB independence. There are sparks a plenty in the realm of global currencies and the Chinese yuan is a mere side-show. The dramatic fall in the some emerging market currencies have the ability to create a firestorm in global credit markets.
3. The dramatic fall in the price of OIL is significant but actually aids Europe, which has little production and benefits from a fall in the price of its energy imports. The larger problem of course if for the U.S. financial system, which has lent heavily to U.S. energy producers and is exposed via the bond markets. There is a complacency among some investors that the loan exposure of banks is minimal compared to the sub-prime crisis but as we know a single spark can ignite a large fire. The more important question: What are the Saudis up to? The last time the House of Saud drove the price of OIL dramatically lower it was 1986 and Vice President George H.W. Bush went to Saudi Arabia and convinced the Saudis to cut production because it was a disaster for U.S. producers in Texas. This time the Saudis seem to be sending a message but it’s not clear what and to whom. Given its anger at the Obama White House over its dealings with IRAN, the Saudi message my cut deeper then all previous political machinations.
There was an extraordinary meeting of the Arab states in Cairo this past weekend. The Saudis called the meeting and it seemed to signify that the Arabs would unite and the Sunni Turks were left out. By leaving out the Turks, the end result is that Russia becomes an ally of the Arabs and the price of OIL is close to its lows. Russia has proven to be a more trusted friend, as proven by Putin’s intervention to save President Assad. The U.S. 70-year support of the autocratic House of Saud is certainly being called into question by the Obama policies of the last four years. Oil and politics make for strange bedfellows and it seems that the mattress is made of straw.
4. The most dangerous spark of all is something I have warned about in this blog and on television with Rick Santelli and that is the rise of anti-euro fringe parties in Europe. More importantly, these parties are also opposed to the insular nature of the governing elites. Chancellor Merkel is under great pressure, even as she has been touted as the greatest Chancellor since Konrad Adenauer. It is amazing how quickly the winds change. Frau Merkel cancelled her trip to Davos because to leave Germany to cavort with the epitome of crony capitalists would not play well with the Burhgers of Bavaria.
The recent scandal of the rapes in Cologne over New Year’s Eve have lit the fires of the AfD and its anti-refugee platform. But the real spark to German political pressure on Merkel is the RAPE of German savers by the ECB-imposed negative interest rates that are condoned by the German Chancellor (yet vehemently opposed by Bundesbank President Jens Weidmann). It is this potential conflagration that can cause the greatest problem for the EU and global financial markets. The ECB’s swollen balance sheet has caused the sovereign debt of Spain, Portugal, Italy, France, Greece and others to be absurdly priced risk. The world is a tinder box.
***If the central banks lose control, meaning that investors grow fearful of their ability to control outcomes, GOLD will become a haven (also factor in concerns about currency wars). The GOLD has been in a medium-term bear market but in the long-term it’s still corrective. The GOLD held the important $1048 price level (of the IMF 200-ton sale to the Bank of India in November 2009). Currently, the GOLD/YUAN spread has rallied above its 200-day moving average but the other gold currency crosses have not reflected any such strength. The GOLD/EURO cross remains rangebound. The ultimate haven spread, GOLD/SWISS has held at the 200-day m.a. and failed to continue last week’s rally of the fearful. (The Gold/Swiss 200-day is 1097.33 on the CQG daily continuation.) This is an important signal because the world’s speculators are short gold. Remember, last year GOLD outperformed BERKSHIRE. In the realm of GLOBAL MACRO all values are relative. Gold reflects the lack of global leadership and no GREAT HELMSMAN steering the ship.
June 30, 2016 at 4:40 pm |
Add this to the list of ECB and Merkels problems – Italian Bank bailout
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More tinder for the AfD.
Here is a late WSJ report on ECB bailout of 150 Billion euro liquidity injection into Italy banks.
========================================
European Commission Authorized Italian Government to Support Banks
Program approved under the bloc’s ‘extraordinary crisis rules for state aid’
By VALENTINA POP and GABRIELE STEINHAUSER in Brussels and GIOVANNI LEGORANO in Milan
Updated June 30, 2016 12:56 p.m. ET
BRUSSELS—The European Commission on Sunday authorized Italy to use government guarantees to provide liquidity support to its banks, a spokeswoman said, disclosing the first intervention by a European Union government into its banking system following the U.K. vote to leave the EU.
The June 23 referendum sparked a steep sell-off in banking stocks followed by intense volatility this week. That has exacerbated already existing troubles in the Italian banking sector, which is suffering from high levels of bad loans and poor profitability amid super-low interest rates.
The Italian liquidity-support program includes up to EUR150 billion in government guarantees, said an EU official. Several other European countries with weak financial systems already have similar support systems in place.
The commission spokeswoman declined to comment on the amount of guarantees that were authorized, but said that the budget requested by the Italian government had been found to be proportionate. The Italian economy ministry declined to comment.
Only solvent banks would qualify for the liquidity support, which will run until the end of the year. “There is no expectation that the need to use this scheme should arise,” the commission spokeswoman said.
The guarantees, which could be used to guarantee debt issued by banks, are separate from an Italian government blueprint to recapitalize weak lenders. Italian officials have said that the government hopes to inject up to EUR40 billion in fresh capital into domestic banks.
In contrast to liquidity support, which the commission can approve during times of market turmoil, capital injections fall under the EU’s new strict rules on bank bailouts. Those rules would require private investors, including bondholders, in the bailed-out bank to take losses.
“As this decision and other precedents demonstrate there are a number of solutions that can be put in place in full compliance with EU rules to address market turbulence,” the commission spokeswoman said. She said the support program was approved under the commission’s “extraordinary crisis rules for state aid to banks,” and that guarantee programs such as the one for Italy were generally approved for six months so they could be adjusted for new developments.
Diego Valiante, head of the financial-markets and institutions unit at the Centre for European Policy Studies, said the decision to allow extra support was a clear reaction to the market turbulence that has followed the Brexit vote.
“This is good news for the Italian banks,” he said, adding that similar programs could be set up for other countries with battered financial systems.
The victory of the “Leave” vote in the British referendum has triggered political turmoil in the U.K., where Prime Minister David Cameron has said he would step down after the summer. Questions remain about when—and if—a new government will trigger formal exit talks with the EU and what kind of relationship it would seek with the bloc.
“There will be a long period of uncertainty around this,” he said.
The post-referendum market moves have exacerbated preexisting problems in the Italian banking system, even though banks in other countries, such as Spain, have a bigger exposure to the U.K. market and have seen their shares drop even more.
Italian banks have lost more than half of their market capitalization since the beginning of the year, as investors fret about some EUR360 billion in bad loans still logged on their balance sheets. That drop in market value compares to an average decline of less than one third for European lenders.
Some Italian banks have seen their shares plummet by some 75% in the first half of the year.
A person familiar with the Italian government’s plans said the cabinet of Prime Minister Matteo Renzi hoped to use a liquidity backstop to contain investor panic, which could result in a run on deposit and affect banks’ liquidity.
The liquidity support provides a temporary cushion for Italian banks. But it doesn’t solve the broader issue of how to raise sufficient capital to sustain writedowns of loan portfolios gone bad.
The commission’s decision also comes ahead of several important supervisory announcements for European banks. The European Banking Authority will publish the results of its latest stress tests by the end of July. Although these stress tests aren’t designed to fail specific lenders, the European Central Bank could ask banks to raise more capital in their wake.
Later this summer, the ECB plans to publish draft guidance on how banks should deal with nonperforming loans, or NPLs.
July 1, 2016 at 4:40 pm |
Frank–Draghi in a hurry to bury the Germans under subprime debt–remember Bronx Tales—-now you can’t leave
June 30, 2016 at 6:55 pm |
Gee, I missed this in Jan, but feel as though I haven’t missed anything?
Thanks to Frank C. for the additional Euro Comedy sketch. Good Grief.
June 30, 2016 at 7:08 pm |
Why do solvent banks require liquidity support?
Barclay’s is liquidating non-core (growth) assets.
July 1, 2016 at 6:50 am |
Happy birthday, Yra!
July 1, 2016 at 12:24 pm |
Bonnie–thank you for the great wishes—-what a memory –regards to Broadway Joe
July 1, 2016 at 8:58 pm |
Can’t imagine what Germans are thinking, they appear to say one thing and deny reality?
The Brits simply said no thanks, they can plainly smell something’s rotten in Denmark.
July 4, 2016 at 10:13 pm |
Yra,
While the Germans may think Draghi is trying to bury them with Italian debts the situation gets more dire and more press.
See tomorrows 7/5/ 16 WSJ on the Italian bank problem.
What the article neglects to say is two critical factors
1) Draghi was head of Bank of Italy (I believe from 2005-2010) and failed to over see the recapitalization of the Italian banks and write off of the bad loans. He went from there to the ECB. The Italians, especially Renzi think they have been neglected by Draghi.
2) Their is an upcoming October 2016 referendum to redo the Constitution. It also includes some EU provisions.
Perhaps Draghi wants to use his new corporate debt mantra to buy Italian Bank debt.
I have seen Bronx Tale and understand your thoughts that Draghi will bale our his old neighbor hood. I am not so sure that the Italian bankers have the same confidence.
In any event the 360 Billion Euro bad debt Italian situation will continue to deteriorate and capital will seek a safer haven and risk off.
July 5, 2016 at 10:53 am |
Yra- Good Santelli interview today.
You wrote……. BUT TODAY THE ECB HAS POTENTIALLY IGNITED THE FLAMES OF GERMAN ANGER AS DRAGHI MOVED FOR THE QE PROGRAM TO BUY LOWER GRADE DEBT. THEY HAVE RUN OUT OF HIGH QUALITY BONDS TO BUY.
Agree, but this makes me think of something I have been pondering (or to steal from Woody Allen……. Right now it’s only a notion, but I think I can get the money to make it into a concept, and later turn it into an idea.)
The current debt bubble is huge, dwarfing that of 2008. When it pops, a lot of lower quality debt will become worthless.
As much as I am against Central Bank intervention, we are really past the point of no return on low quality debt……when most of it goes to pennies on the dollar, the results for the world economy will be disastrous.
Therefore, the Treasury and Central Banks need to set up some type of facility for an orderly retiring this low quality debt….some ideas:
1) Forced debt swap for equity
2) Retire debt at 50 cents on the dollar ( bond investor loses half his investment, and borrower saves 50% on his loan)
3) Defaulting low quality debt bought by Treasury (financed by FED) and exchanged for special Treasury debt issues.
This is all totally against my economic philosophy, but the Central banks have created such a huge debt bubble, that when it pops, we could easily see a Depression..
July 5, 2016 at 5:24 pm |
Shocked–I know the dilemma you are in—wait for tonight’s blog post and hit with Santelli—I believe you will appreciate it
July 5, 2016 at 5:25 pm
Shocked–but also remain aware that a central bank taking on a haircut on the assets it owns would be in violation the the Karlsruhe’s Court ruling on OMT
November 30, 2016 at 6:08 pm |
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