Central Perk

vineri, 22 august 2014

Mish's Global Economic Trend Analysis

Spotlight on European Bank Lending: Capital Impairment to the Forefront
German Two-Year Bonds Have Negative Yield, Demand High; Euro Bond Bubble Guaranteed to Burst
Time to Short the US Dollar? Go Long Commodities?

Spotlight on European Bank Lending: Capital Impairment to the Forefront

Posted: 22 Aug 2014 01:25 PM PDT

As noted in German Two-Year Bonds Have Negative Yield, Demand High; Euro Bond Bubble Guaranteed to Burst, " Banks lend (provided they are not capital impaired), when credit-worthy borrowers want credit and banks perceive risks worth lending."

So which is it, lack of credit-worthy borrowers or capital impairment. The answer is likely both, but the spotlight goes on capital impairment, and Texas Ratios, a the ratio pf bad loans to equity.

The New York Times DealBook explains Europe Fears Banks Lack Cash Cushion to Cover Bad Loans.

When the ratio of bad loans to equity and cash set aside exceeds 100 percent, it suggests that the bank is either ready to fail or is in desperate need of new capital — as was the case with Texas banks in the 1980s.

The E.C.B. will publish the results of its half-year investigation into Europe's 128 largest banks on Oct. 17. But until then, with worries mounting that the central bank will come down hard on banks with particularly weak loan books, investors and analysts have been scrambling to determine which of these lenders are most at peril.

This spring, banking analysts for Nomura in London used the Texas ratio to highlight 11 banks in Southern Europe that were most exposed to nonperforming loans relative to cash they had on hand.

Of the 11 banks that exceeded the 100 percent threshold, three banks stood out with ratios of 150 percent and above: Piraeus Bank in Greece, Banco Popolare in Italy and Banco Popular Español in Spain.

Using the Texas ratio also underscores the ever-increasing gap that separates European banks from their American counterparts, highlighting as well the contrasting approaches taken by bank regulators here and in Europe.

According to the most recent data, the average ratio for all United States banks is 15 percent, with giants like JPMorgan Chase and Citigroup boasting very healthy metrics: 16 percent for JPMorgan and 13 percent for Citigroup.

By contrast, the largest banks in the eurozone that also pretend to have global ambitions have much higher ratios — and arguably would be considered to carry more risk. Santander and BBVA in Spain have ratios of about 70 percent; UniCredit in Italy comes in at 90 percent; BNP Paribas has a lower measure of 41 percent. Deutsche Bank in Germany has one of the lowest scores in Europe, at 14 percent, but that understates its risk because most of its assets comprise riskier traded securities like derivatives and bonds.

Problem Understated

DeelBook understates the problem, most likely by a huge amount. For starters, what about the risk or European banks being loaded up with their own sovereign bonds?

Bear in mind, eurozone sovereign bonds are all considered risk-free assets. From a capital-requirement perspective, bonds of Germany, Spain, Portugal, Italy, etc. are all treated alike.

Yet, as we found out with Greece, not all bonds are alike. That they do not yield the same is proof enough.

Via the LTRO, Draghi succeeded in suppressing yields of European government bonds, but at the expense of creating a bond bubble.

More Questions

Any banks fudging the definition of a performing loan?
What about mark-to-market valuations of loans and assets on the balance sheets of banks?
Are loan loss provisions high enough?

To date, every alleged "stress test" in Europe has been rigged. Some banks failed immediately after passing previous tests.

Texas Ratios are very useful, but banks can fail with low ratios. Why?

Look to the questions above for answers.

Whether or not banks pass stress tests, and whether or not reports say they are not capital impaired, one can look at actual lending and easily come to another conclusion.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com

German Two-Year Bonds Have Negative Yield, Demand High; Euro Bond Bubble Guaranteed to Burst

Posted: 22 Aug 2014 11:01 AM PDT

Central bank money madness continues, with market participants expecting QE to begin in Europe.

Would QE by the ECB spur European bank lending? Of course not. Banks do not lend from excess reserves. Banks lend (provided they are not capital impaired), when credit-worthy borrowers want credit and banks perceive risks worth lending.

The ECB tried to induce banks to lend by charging, rather than paying interest on excess reserves. The results are in: Yield on Two-Year German Bonds is Negative

German two-year debt yields held close to 15-month lows just below zero on Wednesday, with record low money market rates and expectations of easier ECB monetary policy underpinning demand at an auction of similarly dated bonds.

Germany sold over 4 billion euros of a new two-year bond, with demand from investors double that amount despite the average yield and the coupon both being zero.

A Reuters poll this week showed money market traders saw a 50-percent probability of QE in the next 12 months, up from a one-in-three chance in last week's survey.

"We've seen really bad growth numbers and these translate into deflation fears, which in turn fuel QE expectations," DZ Bank market strategist Felix Herrmann said, noting that risks around wars in Iraq, Ukraine and Gaza also supported demand at the German auction.

"All that argues for lower German yields for shorter and medium term maturities. There are few, if any, reasons for Bund yields to rise."

Two-year bonds yield minus 0.004 percent in the secondary market, meaning buyers will get slightly less money than they invested when the bond comes due. They first traded negative at the height of the euro zone debt crisis in 2012.

Some banks may prefer to buy such assets rather than being charged 10 basis points for keeping the money in the ECB's deposit facility - a result of the central bank's unprecedented deposit rate cut into negative territory in June.

That rate cut and the ample excess liquidity in the euro zone banking system has pushed the overnight bank-to-bank Eonia lending rate fell to a new record low of 0.005 percent.

Elsewhere in the euro zone, ECB easing expectations pushed other euro zone yields lower on Wednesday. Spanish and Italian 10-year yields hit new record lows earlier in the session, falling 6 and 3 bps respectively to 2.38 and 2.56 percent, before reversing some of those gains in the afternoon.

Portuguese and Greek equivalents dropped 12 and 10 bps respectively to two-month lows of 3.31 and 5.80 percent.

Bubble Guaranteed to Burst

The calls pour in for the ECB to "do something". The ECB did, and the results speak for themselves.

There is no demand for loans and/or willingness of banks to lend. Credit-worthy customers simply do not want loans in this environment. And no fundamental flaws with the euro have been fixed after all these can-kicking years.

Meanwhile, Spanish banks gorge on low-yielding Spanish bonds, Italian banks on low-yielding Italian bonds, Portuguese banks on low-yielding Portuguese bonds, etc., all with massive leverage.

The ECB's expectation was to spur lending, instead it created a bond bubble. It's a bubble guaranteed to burst.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com

Time to Short the US Dollar? Go Long Commodities?

Posted: 22 Aug 2014 01:51 AM PDT

Is it time to short the dollar?

Saxo bank chief economist Steen Jakobsen thinks so. Via email from Steen ...

What is wrong with changing your mind because the facts changed? But you have to be able to say why you changed your mind and how the facts changed. Lee Iacocca

My biggest call all year has been for global lower rates, and in particular lower core country (Germany, Denmark, and US) yields led by this magic trinity of factors:

1. China and Asia rebalancing growth away from nominal to quality growth
2. US current account deficit reduced by 50% (see chart below)
3. A Europe where Germany will pay the price for the first two factors with a lag of six to nine months.

The headline call was and remains that Germany will be close to recession by Q4-2014 or Q1-2015 setting up a desperate ECB and a Europe once again close to zero growth instead of the "escape velocity" everyone and their dog promised you and me in December and January.

This past week we went through the important floor of 1% on ten year German Bund yield and I took profit on my long held position.

A position I established back in Q4-2013. Feeling "naked" I did some additional work and heavily supported by our Saxo JABA model we have changed the asset mix-up and also our yield call:

• Highest conviction call remains for lower global yields (Low in Q1-2015), but for rest of 2014 I see US yields falling more than European equivalent – this will lead to Bunds underperforming Ten year Treasury and set up the second call:

• US Dollar will significantly weaken from mid-Q3 into Q1-2015. Market remains overexposed to US dollar and US equities relative to norm – Furthermore with mid-term election on November 4th the coming budget talks will have a hard time producing convincing and long-term results needed. Bunds will not be able to follow the re-pricing of Fed (away from early 2015 hike) and growth in the US (It's not the weather) as Q2 gets revised back down to 2.25-2.50% and geo-political risk and lag of global earnings for S&P-500 companies reduces margin and cash-flow. The US average GDP the last five years has been 2.0%......

I am presently almost square in fixed income – alpha model – from very long, but will use a any correction in US bonds to activate medium term long. (Again Bunds yields will continue to fall but less than US rates remains the new call…) hedging any US dollar exposure back into JPY and EUR. EUR/USD could trade 1.4000+ and USDJPY below 97.00.

Global growth is slowing down – World Growth in 2014 was in January expected to be higher than 3.1% - Today my learned colleagues have revised their "guess-estimates" down to 2.53% - a "small" drop of 0.6% - which is not only concerning but also put at risk the coming budget talks – certainly in Europe but also in the US.

This is of course relatively bold calls considering the market and consensus have short EUR/USD, long USDJPY and overweight US stocks as their main risk vehicles when VaR (value at risk) is allocated. It's important to underline that major US investment houses, and certainly every single sales person I talk to, believe US is about to accelerate in growth not slow-down. Q3 could be ok but the real damage will come in Q4 as the lead-lag factor of geopolitical risk, lack of reforms and excess global supply leads to low inflation and despite Fed recent optimism about an exit strategy the fact remains few institutions is worse than the FED in projections even their simple target goals:

Fed is simply terrible in predicting. Why would they be right this time?

They will not be – Q2 will be revised down to 2.5-ish by third correction – the standard correction is 1.5% from 1st to 3rd reading:

… And largely ignored, the US consumer remains on strike despite "lower" unemployment:

No, hope and lack of alternatives is ruling the markets…..the major call is:

Short US Dollar Index and soon also long commodities as the weak US dollar and soon lower US yield sets up great value trade.

Yes, it's time to be defensive … very defensive.

Safe travels,

Steen Jakobsen

Short the Dollar?

I think so. Rate hikes are priced in that I do not believe will happen. And if they don't, it would be dollar negative.

Of course the ECB could go ape with QE, and that would be negative for the euro (thus dollar supportive). On balance, I think Steen has this correct.

Long commodities?

Not so sure. If global growth is slowing why shouldn't oil, copper, and base metals do poorly?

Yet, I do like gold here. It's priced as if the Fed will hike and QE will never start again.

Those are likely bad assumptions.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com

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West Wing Week: The Summer Social Media Mailbag Edition

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West Wing Week: The Summer Social Media Mailbag Edition

Welcome to a special edition of West Wing Week, featuring a Summer Social Media Mailbag Q&A session with White House staffers. But before we get to your questions, we've got a couple scenes from the President's week.

Watch this week's West Wing Week for a special Q&A featuring answers to your questions: