Notes From Underground: Together Again

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.”

Yra & Rick, October 13, 2016Click on the image to watch me and Rick discuss market volatility

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).

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12 Responses to “Notes From Underground: Together Again”

  1. GreenAB Says:

    Today I stumbled upon this chart of China´s PPI:

    Something tells me that inflation is about to turn up in the Western world once the Chinese stop weakening their currency.

    • Chicken Says:

      I can’t imagine where the incentive lies for China to stop devaluing?

      • GreenAB Says:

        Inflation. It will take a while. But once higher producer prices work trough the chain Chinese consumers will feel the pain. It also looks like commodities have bottomed. Coupled with a weakening currency it´s a recipe for sustained inflation pressure.

    • yra Says:

      Green Ab–I think the point you raise on inflation has merit .Early for sure but it also plays into the question on how the Euro is not below par .Is there something inherently weak about the Dollar?That is a question that will be answered in the post election financial environment but –China and all debt laden systems would love some inflation to lessen the debt load—Yellen’s speech from Friday was very revealing and will be covered in tonight’s blog

  2. Arthur Says:

    Via Brookings: Most Americans are better off than when President Obama took office?

  3. Rob Syp Says:

    You should have been wearing a Notes From Underground jersey last night with your number on back 2+2 = 5….. Lots of airtime directed your way! As for the strategy used on both sides in inning 8 it was as good as good as it gets (someone had to win someone had to lose) just like trading it’s either blue vs. red side of the card.

    Thinkin back to my 1st day trading in the pit an old time Member tells me the only thing I need to know is “As long as the blue side is lower then the red side you’ll do OK”

  4. ShockedToFindGambling Says:

    Yra- I think it is bearish Equities, if the yield curve (2/10) continues to sharply steepen under any scenario.

    In the case of declining rates, it would indicate a flight to quality of some magnitude…..especially worrisome in the face of expected FED tightening.

    In the case of rising rates, higher long term rates wold kick out the main support for the economy (which I believe is low long term rates…..low short term rates have probably hurt the economy).

    Sharply rising long term rates would indicate rising inflation concerns and/or fear of not being repaid (increased credit risks), both very bearish for Equities.

    I think it is very different this time……never before have we had this big an asset bubble combined with a very weak recovery and many papered-over problems.

  5. ShockedToFindGambling Says:

    Yra- Let me add one more piece of blasphemy……… this point in this cycle, I believe that a weakening economy would be bearish the long end of the curve.

    1) The Central banks would go berserk with QE, NIRP, etc., raising inflationary expectations in out years.

    2) Selling in stocks, real estate, art would lead to long end Treasury net selling to cover margin calls

    3) Many foreign investors would want to repatriate funds, leading to net selling of the long end for Treasuries.

    4) A weakening economy would lead to a general collapse of the bubble, and long end sovereign debt is the most overvalued asset class out there.

    i could be wrong.

    • AJ Says:

      Shocked – Why would someone sell real estate in a weakening economy? It seems counter-intuitive to sell an asset typically yielding a return higher than a typical blue chip dividend. I’m still very green in macro economics, please help me understand.

      • ShockedToFindGambling Says:

        AJ- Less real income makes real estate less affordable, so prices typically go down during a strong recession. Should we get high inflation, real estate might go up, even during a recession (if interest rates don’t go thru the roof).

        I’m not selling my house.

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