Back from the spiritual cleanse and I chatted with Mr. Santelli today about volatility as the prairie fires of global politics causes great angst and HEADWINDS for markets. There was nothing new for readers of Notes From Underground as we have weighed and measured many of the issues plaguing the global markets. In this post, I want to call attention to a couple of pieces that appeared in the press Monday night and Tuesday morning. The front page of Tuesday’s Financial Times had a story, “Deutsche Received Special Treatment In The EU Stress Tests Via ECB Concession.”
In aiding the effort to help Deutsche “PASS” the test the ECB allowed Deutsche to include the proceeds from a sale of its stake in Chinese lender Hua Xia even though the sale had not been completed by the official cutoff point. The FT article noted that Spain’s Caixabank had a similar foreign sale but was not afforded the same laxity in enforcement of ECB rules. In the land of Juncker, Hollande and Merkel some animals are more equal than others. Adding to the FT story was a piece by Bloomberg’s Corina Ruhe titled, “EU Banks May Face Capital Hit in Basel Revamp, Dijsselbloem.” The Dutch finance minister and president of the European Group of Finance Ministers (in addition to president of the European Stability Mechanism) wrapped up work on the Basel Committee on Banking Supervision by noting,”… banks’ internal models, used to measure asset risk, are of ‘sufficient quality so we don’t continue to CONCEAL RISK,” (emphasis mine).
The result of Dijsselbloem’s stern statement means some banks may incur higher capital levels forcing a further dissolution of shareholders and possible pain for contingent convertible bonds (CoCos). I have raised the issue of the zero risk weightings given to all European Bonds. To quote Wallace Shawn (as Vizzini in the Princess Bride): INCONCEIVABLE. It is inconceivable that all European sovereign debt is treated as equal risk. The capriciousness of European Banking Rules results in a mistrust of all bank equity valuations regardless of what all the talking heads filling the airwaves would have us believe. In response to Dijsselbloem, Bundesbank board member Andreas Dombret pushed back against the powerful EU finance minister and said the “… revised rules, due by year-end, mustn’t disproportionately affect European banks. Also, German Finance Minister Wolfgang Schaeuble, the purveyor of austerity budgets for the profligate, “… insisted that the Basel Committee not only keep any overall increase in capital requirements to a minimum, but also ensure the rules have no particularly negative consequences for specific regions.” The political machinations of the European financial regulatory authorities OUGHT TO KEEP ALL EUROPEAN SOVEREIGN BOND buyers extremely vigilant. The largest bond purchaser, the ECB, need not worry, according to Fed Governor Jerome Powell, for Draghi has a printing press.
***In a comment to the previous BLOG post, regular contributor Shocked challenged my assertion that a steepening yield curve would act as a positive factor for equities. He raises a good point as he notes that so much of the stock market recent rally has been the ultra-low yields on car loans and mortgages, which have aided consumer demand for homes and cars. Of course he is right in this assessment. But in my historical analysis of markets steepening curves have been a signal that the FED is too easy, and bond traders and investors believe the central bank is misreading the probable inflationary impact of its policy. Shocked is right to challenge this idea because it truly may be different this time in response to negative or zero short term rates.
This is uncharted territory but if the U.S. yield curve were to dramatically steepen in response to uncertainty about Fed credibility, the hypothesis will be how dynamic the selloff in equities is and for what duration. This just raises the another element for the increase in volatility. It is also important to clarify that there are bull steepeners and bear steepeners. If the short-end–such as the two-year–goes to ZERO while the 10-year yield remains high it is a bull steepener. If the short-end holds steady while bond traders and investors sell the long end for the fear of central bank and economic uncertainty that is a bear steepener. Whichever way its goes we will analyze the process. Currently, long yields are rising but there is little movement in which to base a quality trade possibility (even though the U.S. 2/10 curve has a 200-DMA of 95.5 basis points and closed at around 89.5).