Tuesday, 6 January 2015

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.


Anonymous said...

Very right on the funding currency point-to copy macro-man comment posts reflexivity seems to be driving the USD/EUR switch...look at short term basis- Fra/ois and its ilk, negative or low rates have stomped on it and in extreme cases- CHF have inverted, regulation also has played a part- less appetite to punt that product suite ...re EM agree just a risk management exercise and the "yield tarts" (should trademark that-or start a fund) will be out in force when the exercise is over.

LB said...

"Yield sluts" is even better.... of course we are one innit :-)