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.

If Wednesday’s market moves in Europe are just half as volatile as they were in the relatively illiquid overnight conditions, it’ll be an ‘interesting’ day.

Just after London’s close, the euro spiked circa 80 pts to 1.3760/65, as did other risky assets amid headlines quoting an unnamed source who suggested the Prime Minister of Greece’s referendum bid was “basically dead.”

Gains were subsequently unwound after headlines indicating Papandreou  told his Cabinet that he would hold the referendum after all.


S&P closed 2.8% lower.

Then, whilst we were sleeping; a headline early in the Asian session said Greece would “vote on EURO membership in the referendum” This knocked EUR lower again (c. 70pts to 1.36301/35).

Finally [it’s probably healthy to end around here] a meeting of Greece’s Cabinet concluded still early in Asia and officials unanimously agreed to hold the referendum; and to hold it before Christmas.

Initially the expectation was to have it in January: the small surprise provided a small risk on tone.

EUR is moderately bid.

Strap in.

ThSM

Quick expectation points from 3 economists at large investment banks whom we expect to be attending the Jackson Hole, Wyoming Symposium:

“We suspect that the Fed is likely to outline a range of potential policy actions that may include the extension of the Fed’s treasury holding maturities, a potential cut in the excess reserves held by member banks at the Fed and changing the composition of the its balance sheet through MBS purchases and Treasury sales.”

“Investors will focus on potential markers and triggers for additional stimulus, in particular regarding the potential launch of a new large scale asset purchase programme (QE3), which we do not expect to be announced at Jackson Hole, or any other policy response such as a lengthening in the maturity of its current portfolio of securities.”

Whilst we do not expect out-right QE3 we think that the Fed has the headroom to “sell short-term securities and buy long term securities in equal amounts. This could lower long-term rates and flatten the yield curve without increasing the absolute size of the Fed’s holdings. But like many such policies, the devil is in the details.”

QuickJPYbullets:

• scope for USD/JPY to plumb/set historic lows with the most recent being 76.37.
• Overnight the pair reversed from a peak around 76.88 and is now at a weakly looking 76.53
• triangle on hourly chart suggests 73.50 target!
• More sensible targets are 76.37 and 75.46

Ahead of the Democratic Party of Japan’s leadership election on August 29, the likelihood of Bank of Japan intervention [on behalf of the Ministry of Finance] looks very limited. 

This comes after the overnight news of Finance Minister Noda setting up an emergency USD100B facility in a fresh attempt to protect the modest export-led recovery from the threat of a continued rise in the yen’s value. 

[The other overnight news, Moody’s downgrade of Japan to Aa3, has been a non-event for markets. Moody’s rating is now on a par with its rival Standard & Poor’s (AA-)]

On the face of it, Japan’s monetary authorities’ choice of this indirect option already looks ineffectual.

But even seasoned strategists in Tokyo have said this morning that the moves partly leave them scratching their heads.

The oddity of the choice of measures centres on the use of the somewhat obscure Foreign Exchange Fund Special Account (FFFSA).

The plan is that FFSA will lend funds of up to Y100bn to Japan Bank for International Cooperation (JBIC) at 6 months JPY Libor rate.

The strategists ask: 1) why the MoF decided to utilise the FFFSA in such an indirect way? 2) why theMoF aims to facilitate M&A at this stage?

They note that in the FFSA account, within Y115trn of total assets, Y3.4trn are foreign currency deposits and Y82.0trn are securities. It’s said a large part of the assets is held in USD-denominated assets, with over 90% invested in government bonds.

Therefore, rather than what we saw today, currency intervention would seem to be the most direct utilisation of the FFSA.

The strategists suggest the possibility of diplomatic considerations in order to “co-operate with other countries’ monetary policy.”

Question two is even more difficult to answer.

Obviously, following the disasters which hit the people of Japan and their economy earlier in the year, the government has instituted many measures designed to buttress the industrial sector. The overnight action seems to be within the same vein - but also looks constrained by the upcoming circumstances of the government’s inchoate status - governing party elections on Monday.

Which brings us back to our original point.

Hence for the short term, given current circumstances, there’s scope for USD/JPY to plumb/set historiclows with the most recent being 76.37.

Overnight the pair reversed from a peak around 76.88 and is now at a weakly looking 76.53.

If we take the textbook to the triangle showing in our hourly chart below, we are faced with a target of 73.50. Common sense alone suggests we need a more cautious one!

Using retracement extensions brings up medium-term targets around the new low, plus a potential newer one, 75.46.

As for the longer term, well, the scope of this post is too small to deal with the fundamental schism - cited by Moody’s in its rating cut this morning - which is stymieing Japanese politics.

Suffice to say that Naoto Kan, the seventh PM in Japan in five years, will have spent just 14 months in office before his exit and the linked article suggests that the ‘revolving door’ in Japanese government doesn’t look to be slowing down just yet. 

Therefore monetary policy and the political stability to both do intervention and to make it count, are at risk of remaining weak.

ThSM

USD/JPY compressed, hourly chart with 100-day moving averages, Bollinger bands and Fibonacci-based retracements