Part I

Pre-load:

• Critical series of posts about LTRO
• Facts, figures, a few fatuous opinions and a bit of fun
• Part I touches on LTROs we’ve had so far and their apparent effects

Another indecisive session for equity markets, albeit a more moderate one than we’ve had of late, during which stocks and other risky assets have slid alarmingly.

And in Spain, the epicentre of the latest euro-zone worries, the 10-year bond yield remains close to 6%, having recently peeped above that for the first time since November 2011.

Plus, the euro has been threatening another visit below the 1.30 barrier all week.

There’s no getting away from it: the crazy days last seen at the height of The Crisis, in 2011, could still be lurking not too far below the surface of euro-zone markets.

Not that I’ve met many people in this parish and beyond who would be genuinely surprised if that proves to be the case.

The idea that joint efforts by EU leaders, IMF and ECB [via SMP and latterly LTRO] have succeeded in stemming the debt crisis, is questionable, at best, in my view.

Still, it’s a notion which many market participants are happy to play along with while it suits them.

But even if we accept that view, who in the markets wouldn’t want another LTRO?

Markets do seem to be behaving as if they want another one.

After all, their apparent effect on more hazardous markets is well-known and benign.

Markets, are behaving en masse as if they seek to ‘re-live’ these apparent effects, very much like the ‘addicts to central bank funding’ which critics say markets have become.

This underlying desire for more cheap, cash [it’s difficult to imagine why markets would want such a thing] raises the issue of whether the widely held perception of what LTROs achieve is, in fact, valid.

It’s a question which the ECB is likely to consider closely.

Perhaps we should too.

I.e., apart from providing cheap money for over-privileged financial institutions, do LTROs help anyone, or anything else, in any material way?

There’s a widespread suspicion that the perceived effect of LTROs and their actual effects are quite distinct from each other.

And, if LTROs in fact don’t have enough of the effects which are desired, is it really worth chucking another EUR529.5 billion at ‘The Problem?

[EUR529.5 billion was the amount allotted at the second 3-year LTRO, held on February 29th.]

Comments from ECB President Draghi at the press conference which followed the ECB’s last interest rate announcement [rates were kept at 1%] make it clear that another flood of ECB cash has not been ruled out.

But perhaps it should be ruled out.

If it can’t be demonstrated that ECB long-term cash floods help the wider financial system [including individuals and households] that tends to weaken the case for opening the taps again.

Have the LTROs boosted European sovereign bond prices and helped credit expansion in the real economy?

Or has the credit injection just stayed in the banking system to ease the inter-bank credit squeeze and provide funding for bank debt redemptions?

I’m guessing we all already suspect what the answer is.

But fellow market-macroeconomics geeks will take a look at the next post in the series – I’ll tweet when it’s done.

 * The pun ‘LTROver’ has already been used; quoting  the source slightly obviates me from blame.

 
Meze

• JPMorgan still warning portentously of Greece’s ‘Ides of March’
• As for the rest of us, we’re almost ‘over it’ already, though no one thinks a default will be an easy option

JPMorgan has published a portentous note this morning.
 
It’s titled ‘Risk of Greek default and exit rises’.
 
Well maybe the risk is rising, especially given events over the last week.
 
Not to mention also that Greece has EUR14.4 billion worth of debt redemption payments due close enough to the fabled March 15th for headline writers [like me, I admit] to have a field day [the deadline is March 20th, actually].

Let’s be clear: without this assistance from official lenders and a restructuring of its debts, Athens will default on its payment.
 
Effectively, it would be treated by international markets as having gone bust.
 
On the other hand - take a look at the stock markets right now.
 
Most major stock markets are in the green.

Even if not by huge amounts; and even as chatter about a more serious delay of the bailout process hits the wires.
 
Greece’s potential scenarios are burned into the synapses of anyone who watches financial markets.
 
And many people who don’t are also more cognizant of Greece’s predicament than they’d like to be, given the saturation coverage of everything ‘sovereign debt crisis’ over the last couple of years.
 
Finally, the taboo of an exit from the euro zone amongst our leaders, broke some months ago.
 
EU leaders openly musing about Greece not being in the euro zone is almost de rigeur nowadays, having been something few would countenance publicly just half a year ago.
 
So let the penny drop to the ‘Cassandras’ amongst us - at least in terms of their disingenuousness.
 
Of course, we know, that ‘they’ know - privately, that we know, that they know. Etc.
 
A reminder that JPMorgan and others have massive bets against Greece and would profit big if Greece were judged to have defaulted.
 
Perspective rocks. But only ever so gently when it comes to markets nowadays!
 
ThSM

At this point, the ECB seems unlikely to produce any material changes in policy with its announcements on Thursday.

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T&C reminders:

• please see disclaimer at head of this blog.
• please note the peculiarities of my discursive style: I try to make it empirical, but this isn’t the place for an excess of references and data
• If you require such references/data, please note they are widely and publicly available

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Additional conventional easing seems improbable.
 
In December the decision to cut by 25bp was taken by consensus.
 
Also, note one governing council member let it be known they were opposed to consecutive rate moves.
 
On the other hand the ECB is very likely to keep its easing bias - signalled by some of the words it used in its statement following December’s meeting: “substantial downside risks” to growth.
 
As for the ECB’s ‘unconventional options’, it still looks premature to try to assess the effectiveness of the latest round of the ECB’s non-standard measures.
 
Note most of the liquidity taken on by banks at Autumn’s 3-year LTRO has since been parked overnight at the ECB, with deposits regularly continuing to hit new historical highs.
 
Banks are hoarding cash, unsurprisingly.
 
On the SMP side, the ECB as The Man From del Monte is still saying ‘no’, quite emphatically.
 
But many continue to wonder if at some point the ECB might fudge some form of wider accommodation than we’ve seen so far via the SMP.
 
My view: it seems reasonable that the European authorities would try to get a closer look at how distressed sovereign debt fares in response to the entire zone moving toward a tighter fiscal compact.
 
For instance we can see that Italian and Spanish curves have benefited from the enormous 3-year cash injections at the quarterly LTROs, but the long end is still a battle field.
 
This reflects the fact that the weakest euro-zone states are still facing tougher financial conditions than the rest of the euro zone, even after suffering harsher fiscal adjustment.
 
However if by February’s scheduled 3Y LTRO there does not appear to be any appreciable cool-down in yields, this surely increases the chances that the ECB will crack in some way.
 
[Even if it does not guarantee that the central bank in fact will.]
 
Last but not least the so-called Real Economy.
 
Since the December meeting, it’s probably fair to say leading indicators have signalled some economic stabilisation.
 
Additionally, composite PMI and Ifo expectations have now been stronger for two-consecutive months.
 
Anecdotally economists appear mostly of the view that data for 4Q11 point to a minor euro-zone GDP contraction.
 
Also we can note the ECB expects CPI to move towards 2%, judging by its latest set of forecasts.
 
Finally of course, it’s always worth reminding ourselves that euro weakness is probably the most effective stimulus to the euro-zone economy at the present time.

It may be an unintended side effect, but it does buy some time.

ThSM

Espresso

• 7% rate on all debt would cost just EUR140B
• Italy projects it will collect c. EUR500 bln taxes in 2012
• Italy’s Total Debt Scenario Relatively Tame
• Italian household debt is about 40% of GDP
• Risk/Scope for Financial Repression

Some factors for seekers of ‘alpha’ to bear in mind about Italy, where newly-installed techno-warrior Super Mario works to form a government.

[Alpha. From bond yields.]
 
Italy’s average debt maturity is a little above 7 years and that’s among the longest in the euro zone. This coupled with its large stock of existing debt suggests that the rise in average yields will take some time to filter into Italy’s real debt burden.
 
7% rate on all debt would cost just EUR140B
The 2012 budget assumes Italy’s debt servicing costs of about EUR85 bln.
In theory, if Italy were to pay 7% on all its circa 2 trillion euro debt, that would cost about EUR140 bln.

Italy projects it will collect c. EUR500 bln taxes in 2012.
That still leaves quite a cushion if the debt servicing estimate is too low and tax collection were to be high.

Italy’s Total Debt Scenario Relatively Tame
Let’s also think about the complete debt picture - not just sovereign debt. Public and private debt do have an interface, especially in Italy.
If both broad debts were combined, Italy’s overall debt would still be amongst the lowest in the OECD.
 
Further, Italian household debt is about 40% of GDP.
This compares with a European average of closer to 75%.
In the US, household debt is near 90% of GDP, having peaked close to 100% in 1Q09.
Italy’s government debt is about a quarter of household net wealth.
 
Finally, the term and implications are horrible, but we need to also touch on Financial Repression
 
Arguably, the fact that US nominal yields are said to have pushed real yields well below zero, is a form of FP.
 
However in Italy, financial repression could hypothetically, cut much deeper.

Domestic accounts own about 55% of Italy’s government debt.
That affords, for instance, such measures as bond swaps being foisted on ‘domestic institutions.’
Similarly, domestically-focused institutions [for instance pension funds] could be required to hold more government bonds in pension portfolios.

OK, one more thing - a side issue really, as the following isn’t really an option in my opinion, but recently, there’s been something of a hum coming from pundits asking: should Italy sell it’s gold reserves?
 
The ‘Red Herring’ aspect of that is largely centered on the facts that European central banks officially own their state’s gold and are independent; and additionally use of reserves is governed by EU treaties.
 
Yes, we’ve learned of late that treaties are made to be ‘voluntarily’ broken.
But it seems likely some will be relinquished less easily and with graver consequences than others.
 
ThSM

With the world beset by all manner of crises right now, the Swiss franc is most likely on the closest to a vertical trajectory as we’ll ever see in our time. (We hope.)
 
And during such times, there there’s often speculation that parity with the euro will occur.

But how likely is it?

Let’s look at indicative pricing in the options market for a clue.
Using spot and implied volatility, options market friends suggest odds that the euro falls to CHF1.0 before the end of the year are about 14%.
 
Odds over the next 12 months are almost 35%.
That means CHF is not the odds-on favorite for euro parity.
 
But that’s still rather too close for comfort.
 
For investors in Swiss-listed equities, all this can mean only more pain.
 
Year-to-date the SMI is off 7.3%, while Dow Jones Stoxx 600 is off less than 3% and DAX is up 4.4%.                 
 
Plus, SMI is inversely correlated with CHF’s strength against the euro. 
On a 60-day percentage change basis, inverse correlation is near -0.5.
Only five times over that period the inverse correlation has been -0.6 or beyond.
 
Further, by OECD calculations, CHF is the most over-valued currency in its universe at nearly 45% over-valued vs USD and 37.5% over-valued vs euro.
 
Today, Wednesday July 20th, we’ve had talk of a Swiss sovereign wealth fund, but that might obviously raise more problems than it solves.
 
The same goes for a temporary peg with the euro, also subject of recent talk.
 
Most likely, most of the above talk will remain just that, but in the meantime, keeping an eye on the correlations is wise, naturally.

After all, you can be sure this article was already old news for the big volume players who are sitting on EUR/CHF and feeding CHF/EUR.

Schwimmen Sie mit den Gezeiten.

 
ThSM

Are you ready for the sequel?

Yes, even if it feels somewhat surreal, the EU does indeed appear to be verging on throwing more bad money in the direction of Greece, after having last year thrown reasonably good money in that direction, which subsequently went bad.

Using latest press reports in conjunction with earlier models, thinking in The Square Mile is basically shaping up as follows:

• Official part of bailout will account for around half the funding gap or EUR32B
• Other half to be funded through expected privatisation receipts and roll-over of debt mostly expedited by Greek bank bill issuance
• People seem keen to emphasize: voluntary rolling over doesn’t change terms
• On that basis, there would be no private sector participation haircuts or changes in any terms of the bonds - however this does not preclude some form of NPV ‘bleed’ for non-government holders, even if not contractual
• Execution risks are plain and ongoing: capacity to raise revenues from privatisation is questionable at best; fiscal/global economics not 100% visible naturally; likelihood of further social and political unrest are clear and present dangers
• Good luck with that EU