Thursday, 29 January 2015

Greece turns Singaporean after divorcing EU for a Russian.

Greece could end up better off divorced from the EU if they play it along the time honoured lines employed in manipulative relationships through the ages. So here is one suggested path they could take.

As with all negotiations there is a need for the other party to know that they are not the only one in the game and it looks as though the carrot/stick of Russian patronage is already being flagged by Greece. In a relationship this is the "Well don't worry darling, I don’t need you anyway, there are plenty of fish in the sea" stage.

This threat of competition is used to negotiate the best possible deal with the EU, in return Greece promises the world, new love and commitment - the ‘Of course I love you darling, wouldn’t do it if I didn’t love you‘ stage. We do have to worry that the EU has heard all this before, but let's press on assuming that they are kind and trusting.

Part of this negotiation would be for more cash up front in return for those strengthened future commitments, as per current suggestions of zero coupon bonds issued at 50% of face. This is the ‘Can I borrow £100, I want to get you something special but haven’t got quite enough to pay for it’ stage.

Next, spend the up front cash importing the best German/EU infrastructure and capital goods possible. This will please the Germans no end and encourage them to extend further credit from the private sector which you take full advantage of and leverage up on that capital goods importation. The ‘Of course you can trust me, isn't it going well, let’s open a joint bank account together’ stage.

Then build like crazy on ports, roads, tech infrastructure to the point that all the budgetary measures that the EU were inflicting on you blow out. The ‘Where has all the money gone from the joint account, darling?’ stage.

THEN Greece defaults on all EU debt and walks away. The ‘I’m leaving you. You never understood me and were far too controlling, surely you saw it coming’ stage.

Then Greece walks into a new relationship with the bit on the side they had been cosseting all the way through and she may have a Russian accent. The ‘I cant believe he’s left me for some Russian tart who’s only got her own interests at heart. And after everything I did for him!’ stage.

Once divorced from the EU, Greece can be reshaped along the lines of Singapore. Tsipras is standing under a socialist flag and can substantiate within that social control similar  of Singapore. Greece already has twin surpluses and free from the shackles of EU debt, EU regulation and EU politics it could quite possibly become a magnet for investment, free enterprise and trade that is finding European practices more and more restrictive. The same goes for financial services and institutions under the social cosh and restrictive regulations who may well find the proposition of moving to the new Greece attractive. Even providing old fashioned Swiss style (very) private banking to the world's grey money may be worth the compromise of being shut off from European funding through regulation and anti-money laundering requirements. But where there’s a margin there’s a way. At the very least they’ll be able to import Chinese solar panels without that ridiculous EU tariff being applied. Handy for a country with that much sun.

Other EU countries with similar EU constraints may watch on with envy and could themselves be drawn into doing the same and joining a Nouveau-Euro zone. The risk that the core EU have is that debtors default en-masse leaving them holding all that defaulted paper.  Once this is perceived to be happening there would be a stampede to the door, with the debt getting compressed onto the remaining members of old-EU. Much as with banks, a good eurozone and bad eurozone would evolve. Only in this case it wouldn’t be voluntary. All the debt would be end up compressing into a smaller space, much like a blackhole, only in this case the singularity may have to be a sacrificial holder. How about Luxembourg?

With previous debt load wiped out and proven backing (financial and military) from new sources, the credit function of Greece would suddenly look rather attractive. The risk of course is that they could play the same game again and walk away, but as is seen with company restructurings memories are pretty short when it comes to new opportunities.

In summary, there are many different courses that Greece can take but if we are thinking of them snubbing Europe and going it alone then there are opportunities to set up a hugely competitive free-trade state right on restrictive Europe’s doorstep.

Wednesday, 28 January 2015

10 Topical Questions

Time for a lighthearted quiz -

How many financial journalists does it take a network to cover a Greek election?

a) 1. To interview an expert.
b) 2. One to interview the other who is pretending to be an expert.
c) 4. One to do the story and three to rack up their airmiles.
d) 17 from Fox News. One to say that Greece is a no-go area for Germans and the other 16 to cover the resulting brouhaha.

What does it take to change a Greek government?

a) A majority
b) 36%
c) Eur 160bio
d) German stubbornness

If you have one Euro and use it to buy Swiss francs how many Euros worth of Swiss francs  would you have?

a) 1.0000. You worked it out on paper, not in the real world.
b) 1.2000. Remember to send a Christmas card to the Swiss National Bank.
c) 0.9999. You had done the exchange using FX banks via the WMR 4pm fix.
d) 0.8300. You had done the exchange at an airport FX counter.
e) -100.0000. You used it as margin at 500x leverage with a retail FX broker and have just found that losses can exceed deposits.

If you join the dots on a Fed forecast dot-to-dot puzzle you get

a) March 2016
b) A blurry line that keeps moving.
b) Astigmatism
c) What ever you want if you stare at it long enough.

The ECB launched a QE program last week. If you could pick one star for Draghi to be for the night would it be

a) Abba singing "Money Money Money"
b) Billy Idol singing "Mony Mony"
c) Pink Floyd singing "Money"
d) Sex Pistols singing "Pretty Thing (You've really gone and done it now)"
e) Jens Weidmann singing "Forging strategic plans without a crystal ball - the importance of target-based management within the German authorities, with the Bundesbank as a case study"

The SNB decided to manipulate the foreign exchange market 2 weeks ago.  If you could pick one star for Jordan to be for the night would it be.

a) Switchfoot with "Under the floor"
b) Paul Whiteman and his Orchestra with their 1925 classic "I Miss My Swiss (My Swiss Misses Me)"
c) Buddy Holly with "You're not square? I don't care".
d) Bestialized with "Destroying All F*cking Faith"

The film 'Indiana Jones - The Last Crusade' features which famous traders

a) Marc Faber as the grail knight in the cave of chalices waiting for someone to pick the real reason that China is a short.
b) Meredith Whitney as Dr Elsa Schneider driven by self promotion who ends up falling down a crevasse overeaching for the holy grail.
c) Peter Schiff as Sallah the larger than life amusing sidekick who is always warning Indy of the dangers of what he's doing.
d) Bill Gross as Walter Donovan the egotistic maniac after the holy grail to give himself eternal life.

If you were told that there was an impending snowy natural disaster coming your way and it was nowhere near as bad as they said would you

a) Thank your lucky stars
b) Be really annoyed that you can't have a week at home
c) Use it as a political weapon against local politicians
d) Put meteorologists alongside bankers on society's naughty step.
e) Be outraged and know you would feel the same way about any impeding asteroid strike.

If you were an Emerging Market economy would you switch all your funding into

a) USD as it's the base currency for most of your trade.
b) CHF because they pay you to borrow the stuff these days.
c) Euros because they will pay you to borrow it by the time you arrange the loan through the red tape
e) Greek Drachmas because though the interest rate is high you don't anticipate having to pay the principal back to anyone as that's how the Greeks treat debt apparently.

You have to get Weidmann, Draghi and Tsipras across a river. You are the only one who can row the small boat with room only for you and one other. How would you do it?

Monday, 26 January 2015

Greece's Political Bargaining Chips.

So we have had the EUQE and the Greek Election. There appears to be a huge sense of disappointment from the economic editors of the non-financial media that there hasn’t been a good story of market panic to play in exchange for the huge expenses involved in sending their person with a microphone to stand in front of the Parthenon. Here’s a tip to media cos. - Bluescreen backgrounds are so good nowadays you can keep your journalist in the basement of your cheapest to run building and they can still appear to be wherever they are reporting on.

Robert Peston, the BBC's economic editor, decided to explain the lack of movement by first listing all the things that could/may go wrong and finished by suggesting that believing things will be OK is ‘Naive’. Listen to him here min 37.30 onwards.  It sounds like he's hoping he will have a story in this one day.

And while we are talking about media Europe woes. Remember the Economist front page indicator alert calling for Euro-doom back in October? Let's have a Dax update,

What now? Tsipras is declaring allegiance to staying in Europe and considering debt renegotiation a no brainier. So what makes him think that those who have lent to him are willing to forgo their investments? The old banker saying ‘If you owe me $10,000 it's your problem, if you owe me $100bio it’s my problem’ springs to mind.

But whilst many feel that the main Greek threat is of killing (through default) the overseas debt hostages that it holds, this may not be the strongest card in Tsipras’s negotiating hand. If push really came to shove that debt could be buried in the ECB coffers and QE’d through an accounting fudge. Printing money to replace money that has otherwise vanished outside the EU with a Grexit, can hardly be considered inflationary. It’s more a loan guarantee backed by printed money.

Perhaps the biggest threat Greece can hold over Europe is over who they may 'have to' turn to for financial help in future and these new partners may not be the West’s best friends. I have been trying to dig up commentary on what would happen if Greece did go whole-hog and leave the EU, yet all I can ever find is references to economic outcome and deep delves into what happens to the debt. I am finding it very hard to find anything on potential political threats to Europe's most geographically important south-east border or opinion as to whom Greece may turn to for new allegiance.

It’s probably worth referring to a couple of old stories covering these issues as a reminder that stories of associations between Greece, China and Russia  are nothing new yet seem to have been forgotten in current commentary.

US Mediterranean Powers

China eyes Greek gateway to invest in Europe

However Greece is a member of NATO, so any such future link ups would be frowned upon yet could be used as leverage for compromise.

Greece and NATO: a long lasting relationship The Alternate Minister of National Defence of Greece, Yiannis Ragoussis, tells NATO Review how important NATO is for Greece, as well as about his country’s active membership in NATO

(bold highlights are mine)

'In concluding, I would like to underline that Greece’s current difficult financial situation actually contributes to the moral strengthening of its forces which are working harder than ever to maintain high standards and are making sure our people and our country is secure. Also, allow me to stress that Greece contributes positively in creating the appropriate structures and policies for regional security. Last but not least, enhancing security and stability collectively by forming Alliances has deep roots in Greek culture. Ιn ancient Greece, Athens took the initiative to form the first long lasting Alliance, the Delian League which has frequently been described as having many similarities with modern NATO. Greece, due to her geopolitical position and regional role, her active participation in all international organizations, her initiatives, her bilateral forms of cooperation and her explicit political will for peace, plays an important role in supporting the NATO of the 21st century'

This last paragraph highlights Greece's skills in alliance building but it shouldn't be assumed to always refer to building alliances with your friends.

But this FT article from 2012 is worth revisiting
Greece: Moscow’s new naval partner?

With this paragraph being of particular interest,

"But as western investors retreat, state-owned Russian and Chinese companies have gone bargain-hunting. Cosco, China’s state-owned shipping company, has already won a 35-year concession to operate the Greek port of Piraeus. Russia’s Gazprom is reportedly eyeing the privatisation of Greek gas company Depa and grid operator Desfa.
A 30- or 50-year deal that provides Russia’s navy with basing rights at Piraeus might one day make sense for both sides. Over time, the deal could bring Greece’s cash-starved government as much as $200bn.
It is impossible for Lucas Papademos and his technocratic government to cut such a deal, in part because Greece’s Nato allies would strongly object. But a future Greek coalition led by the New Democracy party, under enormous populist pressure to raise money and to resist demands from Berlin and Brussels, is another matter."

That last line sounds as though it could now be invoked. If for nothing else but a very strong negotiating weapon.

Finally, let's imagine one more threat that Greece could hold over the EU. They could set up as a financial centre happy to handle the grey money of the world to a point that would make previous ventures in Cyprus look positively schoolboy. Sitting outside the EU they could also sell themselves to financial institutions as environments to operate from free from the growing strains of EU regulation (including bonus caps).   Just a thought....

Thursday, 22 January 2015

Three Bells in a Row and Euphoric Highs.

At last we have a full set, the global slot machine has finally hit the three bells in a row jackpot payout. The BoJ, Fed and now ECB have all paid out.

You will have to excuse this doctoring of an old Tenpole Tudor album cover that has been sitting in my collection since the glory days,  but the aghast faces add a little soupçon of market QE commentary.

So what now? To be honest I was surprised at how long Eur/Usd took to make up is mind as to what to do with a dithering around the 1.1550 area until the details started to emerge of the who how and where's of the actions. But now that Eur/usd is on the move it won't be long until the extent of such moves are being quoted in standard deviations. Have you noticed how standard deviations of moves are only ever used to explain losses? Never profits of course as those are down to genius.

In the press conference Draghi was asked about Euro FX rates and his response was that FX rates were not targeted nor part of policy. This should be of absolutely no surprise to anyone as if he were to suggest that FX was an essential policy tool for rebalancing economic imbalances he would immediately be contradicting the logic of the original implementation of a single currency across Europe and effectively the existence of the ECB.

I haven't been through the whole structure of the ECB QE mechanism and there will be much smarter folks than me digging through the complexities.  I am half waiting for one of them to get to the bottom of it all and declare that actually it's all another accounting game dreamt up by the Obfiscators General, once again leading the market on a Euro Keystone Cops chase after the real stimulus.

As it is, we have a cart load of European debt being bought up and the yield curves being played with. Short term rates are unchanged in Europe but Denmark has gone even more negative (-0.35%) and bond yields across Europe are all doing their bit to make cash (as in piles of notes) the most attractive hold by yielding 0.

I have suggested before that with bond yields at zero any equity paying a dividend can be priced up to near infinity and still give better yield, but now with bond and cash in bank yields going negative we can say that an equity doesn't even have to pay a dividend to give a better yield. How strange it would be if we end up with negative dividend equities where holders are charged each year for the pleasure of owning the stock, but I guess that's only what a company doing countless rights issues is actually doing.

So whilst various quarters remark on the equity valuations being at historic stupid highs, with respect to earnings expectations rolling and dividend payouts, on a yield basis they are very good value. Add to that the fact that the market has been fighting every up move and is not monstrously allocated to equities I can still see those babies moving higher. It ain't over 'til the euphoria is at its highest but the market, like a clubber afraid of missing the fun, is only just fumbling in its pocket for the pill.

This of course applies to European equities more than the US, which is just coming down from its own MDMA (Monstrous Debt Monitising Action) induced high. Considering the mood toward Europe expressed by every US commentator from Novemeber to mid-January I would be very surprised if any of them are not longer than 'very short' which suggests there is plenty more Edward the Seconding to be administered to those positions.

Europe looks grim, but I am tending to look at this dip in the European economy as being near a natural low anyway, into which the ECB have now thrown a QE stimulus bomb. Like a homeopathist's argument with a near death patient, if the economy now grows they will claim success, if it dies they will say they were only cleared by the Germans to act too late claiming if they'd been allowed to do it earlier it would have lived.

I know that everything Europe is in focus, but if the emerging markets were bleating like hell that the Fed was cutting off their liquidity a year ago should we be looking at the ECB having provided the replacement? If so then the biggest flows could be coming from EM doing Euro issues instead of Usds which will really crack Eur/usd.

Now oil - I am going to own up to being a bit illogical and ill disciplined here. I own rather a lot of 'oil going up' related stuff now and am looking at this last 2 weeks of stability as a base formation. CTAs have been monstrous short, yet their greatest friend, momentum, is fading. Stimulus in Europe should be better for it than no stimulus and shale co's are shutting down faster than I thought. One other function I am wondering about is the cross hedging by owners of High Yield oily things. A logical hedge would be to sell oil forward against your HY risk. If this has been the case then any rally will see not only the High Yield pick up but also the oil hedges against it get lifted, creating a greater up move (and repeat).  I am hoping, in a not clever trader way, that the damn black stuff goes up again.

Interestingly oil co's are now saying there will be a supply problem further down the road if prices stay low. Which shows up an interesting feature of commodity markets caused by the harmonics of supply and demand along the forward price curve. If they are right then this fall in oil may not be the start of a steady low phase but more the start of oscillations, which if not damped, will cause a Tacoma Narrows bridge price event. 

A Chocolate Based Solution to National Debt

I have just received the most baffling email, which has left me unsure as to how to respond. Is this the latest attempt by some bot (though the address looked genuine) or Nigerian scammer to raise a reply and syphon all my personal data and bank account contents from me, or even a genuine one trying to get their money out as the Nigerian FX market has frozen up. You have to feel a bit sorry for the poor Miss who's uncle really is trying to get $40m out of the country. She must be wondering why the heck no one is accepting her genuine $8m for helping.

I thought hard about publishing the email as it was directed to me but as it is actively asking me to press you, dear readers, to act I feel I am but assisting towards that request.

Dear Polemic,

Perhaps you can urge your readers to write to their elected representatives along the following lines:

People who have made correct predictions in the past, and/or have good BBB ratings, predict that another Great Depression could arise from the popping of our national debt and money printing bubbles. The latter could eventually cause hyper-inflation such as was seen in the early 1920’s Weimar Republic. We must stop printing more money—or we risk starvation, social unrest, and threats to our democratic freedoms.

As for the national debt, I read that due to the drought there is expected to be a shortage of chocolate in the next few years. One of the more sustainable uses of the tropical rainforests is the harvesting of chocolate. If we purchase rainforest land for $75 an acre (we can pass a Constitutional Amendment if need be) and then sell it to chocolate makers for $2,500 an acre (with there being two or three billion acres,) then we can eliminate the current deficits for the next ten years. Perhaps by then the economy’s growth will be enough to cover it.

Best regards, xxxxx xxxxx

Is this just

a) A nice person trying to do their best.
b) Someone trying to jam up the wheels of political administration
c) A nice person who consumes a lot of chocolate.
d) Someone who knows me very, very well and knows that this level of wind up will leave me scratching my head as to its authenticity - if so well done.

If you have any comments, you would like me to relay to the author I will happily pass them on. We may just have time to warn the ECB that QE is not the answer and that a chocolate based solution to the world's financial woes are only a rainforest away.

Monday, 19 January 2015

Swiss i-flation and the absurdities of negative rates.

The Swiss National Bank has managed in one fell swoop to conjure up deflationary pressures beyond the worst fears of the ECB. A 20% currency move in a day has resulted in record withdrawals of Euros from ATMs and mass migrations across the borders to fill up on fuel and empty the shelves of supermarkets during this "20% Off Everything Sale” for Swiss shoppers. There is a teeny positive for Europe in that anywhere 30km from the Swiss border can raise prices and create a bit of Euro inflation due to the massive new demand, but it won’t take long before Swiss retailers drop prices at the next restocking as the goods on their shelves are cheaper to import and basic competition means they have to. At which point all inflation measures in Switzerland go deeply negative.

To balance this the SNB has cut interest rates on sight deposits to -0.75%. Interest rates have been negative at -0.25% for some time, but we have coped with the logic of Swiss negative rates by confining all things Swiss to a little box that works in a parallel universe of finance on different laws of financial physics, where cuckoo clocks, expensive watches, hard cheese and mountain shaped chocolate bars operate in their own airport duty-free shop of unreality.

But a move to -0.75% is hoped to counter the huge deflationary pressures via the effect on FX with regards to negative carry for overseas investors which will weaken CHF and the via the effect on Swiss locals encouraging them to spend money rather than holding it in banks where they are charged for the pleasure.

With regard to FX moves, carry costs are only a detractor if those costs exceed any gains perceived to be coming through underlying price moves. If we assume USD/CHF has a 1% negative carry (note that is 1% over a full year) then they are hardly a consideration when spot prices are flying around by that amount a day, an hour or, as with last week, a fraction of a second. It only becomes a consideration when all other considerations are neutered, hence quiet markets tend towards carry creep.

As for the domestic saver what do negative rates mean to them? At the moment negative yields sit firmly in electronic-money land with paper money immune from holding fees other than the cost of storage and security. In the case of Switzerland we have seen demand for highest denomination notes go up through the roof. The most up to date on the SNB website are for 2013 and one can only assume that since then demand has only increased.

As the SNB themselves have noted  "The high proportion of large denominations indicates that banknotes are used not only as a means of payment but also – to a considerable degree – as a store of value.” .

How could the powers that be detract from this parking of money in cash rather than forcing it to recycle into the economy? Other than introducing unenforceable laws about maximum cash holdings, an alternative is to reduce the supply of bank notes in issue. This could lead, through the arbitrage of holding costs, to bank notes trading at a premium to face. 1010 electronic CHF for a 1000 CHF note sir? If we are to move into extreme absurdum thoughts, other fanciful ideas could include biodegradable notes that decay under your pillow or perhaps a reverse bank note auction on Saturday evenings on prime time TV where random bank note numbers are drawn and those notes cancelled!

But what do we call this new scenario? It's related to the cost of cash itself in money terms rather than other asset terms. It isn't inflation and it isn't deflation. It's off on an axis all of its own where cash is subject to its own inflation, creating all sorts of confusion. So far the only kind of 'flation' it has produced in the real world is imaginary and theoretical rather than observed. Just like the imaginary numbers we learned about at school, perhaps we should call it i-flation.

The whole idea of making money a costly and toxic asset does lead us into a parallel universe of negativity with negative money spawning from negative rates, where money avoidance is the game. Negative pay, you are paid to take food from shops, paid to fill up with fuel, muggers would hold you up at gun point and stuff your pockets full of money and most ironically bankers are made to take the biggest bonuses possible. Basically the name of the game is to keep your bank balance as negative as possible. Which socially would be quite acceptable as the 1% and the 99% immediately find their positions in life reversed. Cheaper than revolution.

* This post has drawn massively from a post I originally wrote on the Macro Man  blog back in 2012 when Euro rates went negative. But it is so topical now it was too apt not to.

Thursday, 15 January 2015

Trust Me, I’m a Swiss Central Banker.

One trade structure I have always liked is the peg break trade. I first deployed it in 1997 with the Thai Baht. It is fairly simple and involves the option market pricing smooth curves of probability, thanks to nice models, over realities that are far from such. If I had had the confidence to put it on in EURCHF, or rather a lack in confidence in the Swiss national bank, then It would have looked a bit like this. Sell 1.2000 Eur puts Chf calls and buy twice as many 1.1750 or there about Euro puts choosing the period to make this 1x2 put spread at zero premium. The payoff being zero if no break but if there is to be a break I lose between 1.15 and 1.20 but make on everything below. The theory being that when pegs break they don’t mess around with 500pt moves instead jumping right over the loss zone into profit. This isn’t a bleat about missed trades, but an idea for future application and, more importantly, a lesson in faith.

Hands up. I had complete faith in what I was told by the SNB with respect to their attitude towards the everlasting floor. Wasn't it only a couple of weeks ago that the peg was held up as a cornerstone of policy? Why did I have faith in what the SNB said? Because removing the prop of central bank credence in the midst of a market that is completely controlled by central banks and the expectations of what they will do to save the world leaves a financial world orphaned. It's is a bit like hearing that your parents aren’t yours. If this faith is destroyed we have to question the worth of analysing Fed dots or every word from Draghi. Central bank policy has been working as much through words than actions, as has been clearly seen with the ECB and EU manipulating the Euro's bounce from the edge of doom in 2012 through threats of future actions rather than their implementation. However the SNB have effectively done for central banking what the Ferguson Police Department have done for community policing.

I feel betrayed and I feel confused. How could they do this to me? Am I fool for trusting them? Like that orphan I am searching for reasons as to why they made the decisions they did and questioning my own naive belief. There are times when you have to package up risk assessment into a bundle and put it in the drawer. You can’t live life unless you have trust in some of the building blocks. Time would be wasted in a dither and decisions never reached in time to act.

What was so important for them to deceive us and to threaten the very integrity of the cornerstone of Central Bank policy?

Let’s look at why the floor was put in place in the first place.

6th Sept 2011

The current massive overvaluation of the Swiss franc poses an acute threat to the Swiss economy and carries the risk of a deflationary development.
The Swiss National Bank (SNB) is therefore aiming for a substantial and sustained weakening of the Swiss franc. With immediate effect, it will no longer tolerate a EUR/CHF exchange rate below the minimum rate of CHF 1.20. The SNB will enforce this minimum rate with the utmost determination and is prepared to buy foreign currency in unlimited quantities. Even at a rate of CHF 1.20 per euro, the Swiss franc is still high and should continue to weaken over time. If the economic outlook and deflationary risks so require, the SNB will take further measures.

At that time the Euro was imploding and the CHF was seen as a Euro type currency but without the risk of Euro implosion and so CHF was seeing vast inflows as money sought a safe haven. The moves were indeed causing short term dislocations for Switzerland against its natural trading partners within the  Eurozone. The action was justified on this basis and combined with super low interest rates did indeed stem the flows and take the steam out of the run.

But the Swiss economy was and has been since, running a trade surplus against which, without the allowance of FX moves or recycling of those surpluses to adjust, has meant that even after the short term flood of safe haven seeking money abated the underlying pressure has been for CHF to strengthen. This constant has eroded any slack produced after defusing the Euro panic speculators and this in itself is a fairly good reason to question the floor policy.

But it has been the recent collapse in European growth and falling yields that has provided the latest wave of pressure. The SNB has been buying Euros at an increasing rate but unlike the 2011/12 panic there is little to see the pressure slackening without a rise in European yields. The opposite is most likely to occur with the ECB lining up to cut rates further. With EU QE a distinct possibility were the SNB really ready to stand in the way of a potential 1 trillion Euro of QE flooding against their dam? Faced with that it would make sense to step back, open the gate and wave the truck through rather than being mown down by it.

Another function is what the SNB have been doing with all the Euros they have been purchasing through intervention. Most of it is parked in bonds. Most in Euros, but the SNB has been diversifying reserves from the start. I can well remember the impact these diversification flows had on the likes of Aus$ and Swedish Krona as their first purchases were moved from Euro into diversified higher yielding currencies. Since then I have always had in the back of my mind the level of FX losses they must have been racking up as SEK and AUD fell and that these diversification would one day come home to haunt them.

Yet the SNB' latest figures show a profit of CHF38bio so something else has countered the FX losses (if they are taken into consideration at all). One only has to look at the performance of bonds, particularly the least risky Euro ones that they are most likely to hold (Bunds), to see where the plus side of the equation has come from. The SNB is in a fortunate position, being a central bank, of not having to mark its FX reserves to market so this has meant that intervening and parking the proceeds in bonds has provided a healthy profit. But the yield compression that has served them well now sees Bund rates negative out to 5 years, meaning that there is now a cost to parking the proceeds of intervention.

So the SNB have stepped back from an impending wall of Euro about to hit the market through QE and they are avoiding future costs in continuing the policy. Two further reasons to desist.

What of the SNB’s huge existing holdings of European bonds? Well, if they were to sell them all in a rush they would suffer moving the market against themselves. But the QE that threatens their floor through FX pressures is going to provide a massive bid for European bonds into which, should they chose, the SNB can hand their holdings painlessly, effectively passing the bond risk at very favourable levels from their balance sheet to the ECB's. Thank you.

How ironic if market positioning looking for the ECB QE to support their long Bund positions is usurped by the SNB filling the bid. Going forward the removal of the SNB floor has also removed a very strong bid in the European bond market and, to that matter, the likes of AUS and its other preferred diversification holdings. The end of SNB intervention will have a small part in increasing global yields as they desist from exporting negative rate pressures via their actions. Swiss negative rates will remain more Swiss.

To summarise the potential reasoning for the SNB removing the floor and in the process undermining all faith in their future commitments -

- The pressures on the CHF through real economic functions has mounted to a level to make the CHF no longer expensive at 1.2000
- To get out of the way of up to EUR 1trillion of EU QE.
- Yields are so low on their reserve holdings there is no cost benefit.
- EU QE will provide a bid into which to exit their existing holdings.
And let's add - Popular opinion in Switzerland towards the size of the SNB's balance sheet has made the whole policy a political hot potato.

There has been talk that they are preempting the risks to the Euro from a Greek Exit from the Euro. I would suggest that this is NOT a factor.

Nearly all of this reasoning premises ECB QE and with that in mind it is the strongest possible evidence that ECB QE is about to occur and central bank liaison has occurred. The cut in CHF repo rates could also been seen as an indicator as to where the SNB ( with maybe ECB help) have determined the effect of QE will drive effective rates in Europe to.

The lowering of rates to -0.75% on sight deposits to counter the tightening pressures of a stronger CHF is not universal though. It only applies to financial institutions and to amounts over a threshold. Whilst deposit rates are two tier in this manner negative interest rates can not be considered to be the actual interest rate consumers will experience.

If the general public were to receive negative rates on all their bank held funds one could assume that CHF1000 notes (yielding 0%) will demand a premium and the sales of hollow mattresses will boom.

The lesson is that if you peg yourself to someone else's monetary policy without the ability to recycle within a joint central bank then stresses to your own balance sheet will become intolerable in either extreme. If Switzerland had joined the Euro this would not have happened. This should be a lesson to all those considering currency pegs (including the Scottish National Party).

So where from here?  The first rush of CHF buying may well abate as the negative rates kick in and though we have seen EUR/CHF crater to 90 I would not be surprised to see a bounce, whether it is great enough for the SNB to start to reduce their balance sheet into is a harder call.

The effect on the street has been catastrophic. There would have been plenty of correlated trades crucified too and losses in CHF catalysing the closing of other positions as risk rules kick in as VaR models go into apoplectic spasms.

I imagine that senior managers have queues of 12yr old quants at their doors explaining how this wasn't meant to happen as their models didn't predict it.

Wednesday, 14 January 2015

Chainsaws at the trunk.

The greatest risk to the most blindingly obvious of trades is when the base of the trunk from which all those implied and correlated trades expand in a spreading tree is threatened by either rot or the axe with those far up in the foliage knitting their esoteric finesse missing the obvious. So to those putting on fiddly-widdly cross emerging correlation trades, or those happily selling EUR/USD on European QE expectations, or those selling EM USD debt on funding costs in domestic currency, "HELLLLOOO UP THERE ! Hi, Yes you! There is a bloke down here with a chainsaw chopping through your trunk of ‘Usd rates are going up’

"What was that? No I’m not talking tosh, look at the retail sales figures and look at the response US Treasuries have shown to it. Can’t you hear the shrill screams in the wind up there of ‘New low yield in 30yr?"

I am so concerned that nearly every trade out there is premised upon Usd and US rates going up and Euro growth and Euro rates going down that when the time comes, just as it did last year, for expectations of US rates to be pushed out yet another year (as they are in the UK) then the response across all asset classes will be stunning. All the usual trade suspects will be welcomed back into society and interviewed as persecuted heroes on national TV. “They did WHAT to you Mr High Yield Emerging Market? How could they!” Into that rebounding shock you can throw oil too.

The time is getting closer and my 19th Jan date still stands as the day to roll out the wheelbarrow from the shed and start shipping in the harvest of this year’s yield crop.

Before I go lets look at one thing to cheer us up - Bitcoin sub $200. A large glass of your finest Shadenfreude please landlord. The whole point with bitcoin that nearly everyone seems to miss is that it doesn’t have to have a value. It is a payment system and as such the bitcoin itself is only rented for the nanosecond needed to transfer my Gbp to bitcoin to the Usd that Mr Techno geek selling a bong in colorado needs to use to buy his lump of marsh willow, leaving bitcoin as valued as the electron in a credit card payment or even the plastic the credit card is made of. It really doesn’t have to have a value at all. With only the Winklevoss Bros and the tinfoil hat brigade and the pump and dump industry built up around it holding tomorrows relic perhaps its time to guess the next iron pyrites of financial fashion.

Thursday, 8 January 2015

Europe - Stormy Weather Clearing

Today's Uk weather forecast could be applied to how I feel about Europe. "Today's stormy weather will clear to the east bringing in scattered showers but with sunny periods'

Current storm 

Growth data is terrible
Inflation data negative
Interest rate expectations are through the floor (QE et al)
Structural problems

Gaps in the clouds

Collapsing energy prices is good deflation (stimulation)

Falling currency (stimulation) - I haven't seen or heard any data on how many fewer petrodollars EU now has to buy, probably because it doesn't support the sell EUR/USD meme.

Potential to patch things up with Russia - Yes, I do see this as being a big part of the confidence problem in Europe but I am holding probably more hope for positives out of the 15th Jan Astana conference than most

Greece is not sinking EU - No, it won't and German hints at debt restructuring defuses extremist Greek policy.

Structural problems - The one thing we have learnt is that the EU is built not out of rigid girders but out of copper piping. If it doesn't fit there will be some plumbing lawyers capable of bending it to do so.

Merkel being a diplomatic genius - The lady is impressing me more and more and I wish she was standing in the May UK elections. I'd vote for her over any of the current UK leadership offerings.


This leads me to think that the growth data we are seeing is lagging some immediate positives. The immediate negatives are all definitely negative but could quiet easily improve.

If I therefore look at this dip in the European economy being near a low but the ECB sees this as a dip deep enough to warrant  throwing in a QE stimulus bomb. Which, in my eyes, could be like throwing a firework into the petrol store because it feels a bit cold in there.

None of this means that the EUR will bounce as a currency because that's all wrapped up in interest rate expectations but considering how extreme the views on US/EU interest rate paths are it shouldn't take much to tip it.

The only positive effect of the horrendous Charlie event is that I don't think I have seen Europe so unified in response to anything. Awful events such as this scratch off the hard skin of nationalism and show that underneath Europe is more unified than perhaps many had realised.

So, come on folks, Europe isn't THAT bad.

Tuesday, 6 January 2015

2015 - The year of the whip for markets but also index funds.

One of the most notable things about 2014 was the demise of the macro funds at the expense of the index tracker. But 2015 feels as though it is going to be a game of many halves. As we saw towards the end of 2014 sector rotation was massive and though the performance of your long only general index may have not given you cause to think there was anything wrong with your investment decision paying minimal fees as all equities rallied, there was monstrous opportunity lost. Discretionary performance picked up into the year end just as long only indices started to put in shabby performance vs spectacular volatility. Plenty of this performance will have been currency related but when the index fund holder looks at their risk return vs discretionary they probably won't care as when the trends abate and the performance dwindles they will start looking for something a bit more creative.

So here are some calls for the fund market in 2015 -

 - Trends in equities and bonds will end. This is the year of the whip.

 - Though general equity indices will see a path of general sidewayness with high volatility there will be large sectoral oscillations.

 - Because of the above, funds will start to move from index trackers towards discretionary as the point above means that GOOD discretionary starts to perform.

 - Discretionary macro will find they are short of portfolio managers as they have mostly been replaced by quants who are absolutely brilliant at working out value in their space but unfortunately don’t have a clue as to how someone else’s space effects their space, especially if it hasn’t happened before.

 - Macro hedge funds that have sold their souls to pension funds and real money investors will feel like straight jacketed loons peering out at freedom from the confines of their asylum as the risk rules imposed upon them by their new masters of dull money mean that they can’t participate in the way they would really like to. Or stay in when under pressure.

 - Fast swings will seek out and eat at the edges of risk boundaries. Much as lions will take down the wilderbeast on the edge of the heard, funds that can’t move fast enough or are too restricted by process will under-perform as their positions are taken away from them in a steady stream of stop losses on both sides of the market.

All in all it's lining up to be a very whippy year.

Let the slaughter begin.

I was thinking that the start of the year butchery was going to be along the lines of sacred ritual with the sacrificial victim soberly paraded in white gowns through the crowd before being laid on a slab to be sacrificed to the Gods of Trading. But yesterday’s action looks more like the market lynch mob has rounded up the usual suspects and is stringing them up from the lamp-posts having heard down at the pub that 'they did it’.

The usual suspects are oil and US/EU divergence but unfortunately also being rounded up are the usual suspects' wives, kids, cousins and anyone in the same gene pool. Anything that can be argued to be associated with oil or US/EU differentials is being culled too in a BSE like bovine massacre. Cows to the slaughter, sacred or not.

The funding is dead long live the funding.  Differential CB policy, or at least expected differential CB policy, is saying that the king of funding, the USD, is dead and a new king is being crowned - the weak prince Euro. If bankers are the public’s scapegoat for all wrong, then Europe’s two Gs (Greece and Growth) are the trader’s banker.

The extrapolationistas see it like this.  Europe is a basket case that doesn’t need any further debate so just sell everything Euro. Even the steady hands of reserve managers have voted with record disinterest in the Euro as a reserve currency.  It is amazing how shallow the central bank world is when it comes to reserve management. Whilst the dollar yields zip then it’s all 'reserve diversification blah blah' for risk reasons (remember the days China bought EUR/USD on every USD/RMB intervention?), but now that the USD might be getting a bit of yield back and Mr Bund is asking you to pay HIM to hold his issuance (call the police), it’s suddenly “Diversification? Nah, we are just yield tarts”.

Meanwhile the call goes that a strong dollar and higher US rates double whammies Emerging Market USD based debt, on the refunding side by higher funding costs and the repayment side due to FX making it more expensive. This will lead to the tide of funding receding as risks increase, leaving the waters shallower (less liquid) in EM but, more dramatically, the EM of EM, the frontier countries, will be left beached high and dry. Worst case you are a commodity producing country that hasn’t actually run a surplus because you’d rather spend it and what is more you have used the commodity USD income to back USD debt but now you haven’t got a USD income as commodities have fallen so far. So the likes of Venezuela, Russia and Nigeria are considered ebola cases.

I would suspect that there is/will be a hot money panic in everything EM, especially Frontier, as risk rules override long term fundamentals. There will be some bargains being thrown out with the bathwater and I'm going to be waiting with my baby catching net. In the longer term a yield is a yield and you can't keep a yield addict off the gear for long.

Stepping back one could say that if a change in rate policy is destabilising the world then is rate policy the right tool to use? A whole generation of analysts, economists, traders and investors have been brought up to believe that monetary policy is the only tool in the box, but your author remembers his time at the LSE having socialist ideals of fiscal policy drummed into him by sandal wearing beardies (back in those days beards weren’t hipster cool, they were usually soaked in real ale or patchouli oil). But there would be some merit to applying fiscal policy instead of raising US interest rates. I have suggested it before with respect to the falls in oil prices and am still waiting (we must be close) for the first country to hike energy taxes on a green ticket. But a more generalised move to tax raising, if targeted correctly could have benefits

- It would counter deficits run up in the great economic bailout when debt was transferred from private to state hands. It’s repayment time.

- It would be local to the US and so not cause global imbalances via funding knock on effects that we are seeing in EM.

- It would counter wealth disparities that QE has produced.

Of course the problem with invoking tighter fiscal policy is that it is decided on by politicians and with that comes a lot of baggage. How inspirational it would be if the politicians could, as they have with Monetary policy, hand responsibility to an independent agency.  Or maybe 51% of the  responsibility. But until that happens? in the US? FAT CHANCE.

Let’s get back to the markets. It all feels very deja vu. If we were to turn back our watches by a year we would be hearing exactly the same thing, at similarly deafening volume. Turkey and South Africa were toast ane EM in general was going to blow up by March. Which they didn’t. Why not? Well as far a i can remember it suddenly looked as though the US wasn’t going to raise rates as fast as everyone thought. We could well be in the same play now. We have extremes of belief that the Fed is going to hike asap, that Europe is going down the Swannee and oil is lubricating the ride down the every increasingly slippery slope.

I’ll stick to my plan in my last post as so far everything is going to that plan - buy risk immediately before the ECB and Greek elections.