The global reaction to the first round of the French presidential election was not confusing. Capital was sitting on the sidelines as the polls reflected a possibility of a second round Le Pen/Melenchon faceoff, which would have been devastating for global investors because fear of an EU break-up would have led to a massive repricing of risk premia. The avoidance of such an outcome led to a rush of capital into European markets, which provided support to Asia and the U.S. The German/French 10-year spread reacted as expected. The yield differential narrowed by a significant 20 basis points. The BUND yields rose against all European sovereign debt as Berlin’s haven status was rendered null and void for at least another two weeks. The GOLD and YEN also performed as expected as money rushed to purchase a risk on profile in a global zero interest environment. The EURO rallied by 2% as global capital flows into European stocks forced previous short euro positions to the sidelines. There’s nothing confusing about any of these outcomes. But let me throw some confusion onto some of the other geopolitical events making the front pages:
Posts Tagged ‘Bunds’
Time it was
and what a time it was, it was
a time of innocence
a time of confidences
long ago it must be
i have a photograph
preserve your memories
they’re all that’s left you [Simon & Garfunkel]
(Will the Collapse In Energy Prices Grease a Cut In Rates Or the Introduction of QE?)
Just some tidying up and refocus on things besides China, Iran and the debt of ingratitude to the fracking revolution. Tomorrow at 9:00 a.m. CST the Bank of Canada announces its overnight interest rate. The bank rate in Canada is currently 0.5% and consensus is calling for a rate cut of 25 basis points to 0.25%. Other market participants are suggesting that BOC Governor Poloz will announce a large-scale asset purchase program (better known as QE). I doubt the BOC will change policy at this time even as the Canadian economy suffers from the severe drop in fossil fuel prices and other commodities.
As Poloz articulated in a speech in Ottawa at a BIS BREAKFAST SERIES January 7 (regarding monetary policy divergence): “It is very important that we understand the reasons for these policy divergences. On one level, they simply reflect actions taken by central banks tailored to their own economies. But the underlying forces acting on the global economy are powerful, slow-moving and affect various economies differently. This means that the theme of divergence – both financial and economic – is likely to remain with us for some time to come.”
The Canadian real-estate market has run hot for too long and even though Canadian banks are not of the sub-prime model lenders, Mr. Poloz will not wish to just continue to inflate property values. It would behoove the BOC Governor to wait to see what the newly elected Prime Minister Trudeau puts on offer from a fiscal stimulus perspective before racing down the monetary stimulus track that many other central banks have followed with no proven success (except for counter-factual arguments).
Financial repression was not the ultimate weapon in central bankers’ armories. The light saber was symbolic of market-driven levels of interest rates allowing for a genuine return on capital. The Darth Vader PUT was relegated to the outer rings of the galaxy while the VOLCKER RULE provided the rule of law and prevention of over leverage. Planet Mario was under assault as its storm troopers were defeated by the battalions of the financially repressed. All banking DOVES from the Dark Side were driven off by the foresight and power of the Millennium FALCON. A mechanical droid was given the power over all financial decisions and order was restored to the financial galaxy … in a realm far, far away. The world is calm as the DROID runs off an ALGO relying on the intelligence of an unseen oracle, devoid of emotion (or Yoda). Okay, enjoy the fantasy.
Six months ago the world woke up to learn that the Syriza Party had been elected in Greece. It was a dream for some and a nightmare for the European ruling elite. Yes, there is a ruling elite that is very similar to what C. Wright Mills wrote about America in the 1950s. This is not conspiratorial but rather a sociological commentary and the ruling elite is not beholden to an electorate but operates with a sense of noblesse oblige. The Brussels eurocrats are in the image of Plato’s Philospher King, only there are too many Kings all believing themselves to be the most capable ruler. For two years I have written about that the European leaders feared REFERENDA more than anything for direct democracy was an affront to the wisdom of the self-anointed elite. The European project was too important to be left to the capricious voters.
In late April I wrote a blog post titled, “Why Bill Gross Is Right and Wrong.” I noted that Bill Gross’s call on selling German bunds was inherently correct but the French OATS–the French 10-year note, would be the more profitable sale. The yield differential at the time was 23 basis points but with the news out of Europe on Friday, the differential widened to 38 basis points. The area of concern for me is that with Germany maintaining twin surpluses–trade and budget–the ECB QE program would enhance the demand for German assets in a world of diminishing supply. The French budget and current account deficits, as well as a trade deficit, means the underlying fundamentals of the French economy are much weaker than Germany’s.
Last Wednesday, ECB President Mario Draghi warned the traders and investors in sovereign debt and other credit markets that great volatility would be the cornerstone of activity and the market would have to learn to deal with it. The problem with this scenario is, I believe, that the ECB is the progenitor of most of the violent price movement. Remember, the ECB QE program means that the Frankfurt bank has a great deal of fire power to move markets–to the tune of 60 billion euros ($72 billion) a month, which was close to what the FED was purchasing at the height of its QE program. Traders and investors have no heads-up as to when the ECB will be buying and therefore subject to being stopped out of trades at any time.
The markets are playing with ECB President Mario Draghi. Just a few short weeks ago the suave performer of the ECB press conference only had to be concerned about being doused with paper confetti from an anarchist demonstrator decrying the dictatorial powers of the central bank. Post-ECB meeting, the BUNDS, OATS and BTPs made all-time highs in the futures and yields on German and French 10-year notes touched extreme lows. As the ECB paraded the success of QE the EURO currency was also trading at multi-year lows, 1.06 euros to the U.S. dollar.