It seems every week there are new acronyms or catchy-phrases for Europe's Rescue and Fiscal Progress decisions. Goldman Sachs provides a quick primer on everything from ELA to EFSM and from Two-Pack (not Tupac) to the Four Presidents' Report.
The Fed is promising once again to pound nails with the only tools in its toolbox, a saw and a chisel. The "nails" the Fed is trying to pound down are unemployment and deflation. Needless to say, whacking these big nails with a handsaw and a chisel is completely useless: they can't get the job done. The Fed claims all sorts of supernatural powers to sink nails at will--"unconventional monetary policy," quantitative easing, money dropped from helicopters and so on. But all it really has are two tools which have no positive effect on unemployment or the real economy.
- The Fed can manipulate interest rates to near-zero
- The Fed can shove "free money" to the banks
That's it. That's all the tools the Fed has in its toolbox. Let's consider what these tools accomplish in the real world.
European equities are seen softer at the North American crossover as continued concerns regarding global demand remain stubborn ahead of tonight’s Chinese GDP release. Adding to the risk-aversion is continued caution surrounding the periphery, evident in the Spanish and Italian bourses underperforming today. A key catalyst for trade today has been the ECB’s daily liquidity update, wherein deposits, unsurprisingly, fell dramatically to EUR 324.9bln following the central bank’s cut to zero-deposit rates. The move by the ECB to boost credit flows and lending has slipped at the first hurdle, as the fall in deposits is matched almost exactly by an uptick in the ECB’s current account. As such, it is evident that the banks are still sitting on their cash reserves, reluctant to lend, as the real economy is yet to see a boost from the zero-deposit rate. As expected, the European banks’ share prices are showing the disappointment, with financials one of the worst performing sectors, and CDS’ on bank bonds seen markedly higher. A brief stint of risk appetite was observed following the release of positive money supply figures from China, particularly the new CNY loans number, however the effect was shortlived, as participants continue to eye the upcoming growth release as the next sign of health, or lack thereof, from the world’s second largest economy.
If anyone still actually cares, or trades, we just saw the third California muni bankruptcy in two weeks, German bonds priced at record low yields, and Spanish 2 year nominal yields just hit all time lows of -0.37%. Abroad Spain promised to crush its middle class even more by impairing retail held sub debt and hybrids, while forcing them to pay more taxes, a move which will lead to some spectacular Syntagma Square riotcam moments, yet which has sent Spanish bonds slightly higher. As for US equity futures, they continue the headless chicken dance higher even as company after company now rushes to preannounce horrifying Q2 earnings. And that's it in a nutshell.
Josh Barro of Bloomberg has an interesting theory. According to him, conservatives in modern day America have become so infatuated with the school of Austrian economics that they no longer listen to reason. It is because of this diehard obsession that they reject all empirical evidence and refuse to change their favorable views of laissez faire capitalism following the financial crisis. Basically, because the conservative movement is so smitten with the works of Ludwig von Mises and F.A. Hayek, they see no need to pose any intellectual challenge to the idea that the economy desperately needs to be guided along by an “always knows best” government; much like a parent to a child. CNN and Newsweek contributor David Frum has jumped on board with Barro and levels the same critique of conservatives while complaining that not enough of them follow Milton Friedman anymore.
To put this as nicely as possible, Barro and Frum aren’t just incorrect; they have put their embarrassingly ignorant understandings of Austrian economics on full display for all to see.
Last Tuesday we suggested that "Now The Fed Gets Dragged Into LiEborgate" when we observed that "Barclays also cited subsequent research by the New York Federal Reserve staff members that, according to the lender, concluded that banks’ Libor quotes were systematically below their borrowing rates by 39 basis points after the Lehman bankruptcy. “Barclays own submissions for tenors of 1 month to 1 year Libor were higher than actual Barclays trades on 97% of the occasions when Barclays had actual trades during the financial crisis,” the lender said." It seems that unlike the BOE, which had no idea of any Barclays problems and was merely calling up Diamond now and then to make sure the bank's money market risk mechanisms were operational and to chit chat about the weather (as per the BOE at least), the Fed has decided to take the high road and openly admit it was well aware of Barclays' LIBOR "problems." And like that the Senatorial circus just got exciting, while that popping noise is bottles of Bollinger going off at every class action lawsuit legal firm.
European equities are seen firmly in the green at the North-American crossover, with outperformance noted in the peripheral bourses. Overnight news from the Eurogroup has confirmed that the EFSF/ESM rescue funds will be given the powers to intervene in the secondary bond markets, easing sentiment towards the European laggard economies. Gains are being led by a particularly strong technology sector, with the riskier financials and basic materials also making solid progress. Asset classes across the board in Europe are benefiting from risk appetite, with the Bund seen lower and both the Spanish and Italian 10-yr yields coming below their key levels of 7% and 6% respectively. The moves follow a spurt of activity in Europe with a number of factors assisting the way higher.
- EU talks up Spanish banks package, markets skeptical (Reuters)
- China’s Import Growth Misses Estimates For June (Bloomberg)
- The monkeyhammering continues: Paulson Disadvantage Minus Fund down 7.9% in June, down 16% in 2012 (Bloomberg)
- Draghi pledges further action if needed (FT)
- JPMorgan Silence on Risk Model Spurs Calls for Disclosure (Bloomberg)
- Norway's Statoil to restart production after govt stops strike (Reuters)
- Top Fed officials set table for more easing (Reuters)
- Euro-Split Case Drives Danish Krone Appeal in Binary Bet (Bloomberg)
- Obama Intensifies Tax Fight (WSJ)
- Europe Automakers Brace for No Recovery From Crisis (Bloomberg)
- Boeing’s Air-Show Revival Leaves Airbus Nursing Neo Hangover (Bloomberg)
- Libor Woes Threaten to Turn Companies Off Syndicated Loans (Bloomberg)
Despite the ongoing barrage of pronouncements out of Europe on a weekly if not daily basis, discussing the imminent launch and even more imminent success of the ESM, the reality is that many questions remain: such as will Germany just say nein again today, in the constitutional court's verdict, especially after the President asked Merkel over the weekend why it is that Germany has to keep bailing out Europe, a proposition which no longer impresses about 54% of the German public. More importantly, even though the debate over the explicit subordination of the ESM may be resolved (it never will be as the bailout funding will always be implicitly senior to general bondholders no matter how many pieces of paper are signed), a bigger debate now emerging is just who will guarantee the bank losses. Below, we answer that question, and virtually every other outstanding one, courtesy of this DB analysis, which removes most of the lack of clarity surrounding the European bailout mechanism. Yet the main axis of inquiry in our opinion is different: what is the timetable of funding rollout. Because as DB explains, "It follows that from July to October, the ESM can only lend about EUR 100bn. If that is committed to Spain, there is nothing left in the ESM until October. Any other intervention before October would have to be under the EFSF." In other words, assuming a smooth acceptance of the ESM today by the German court, and no further glitches, the best case scenario is one which provides for funding to Spain... and there is no other cash until virtually the end of the year under the ESM, whose implementation is staggered as the chart below shows.
European equities have been grinding lower throughout the European morning, with basic materials seen underperforming following the release of a multi-month low Chinese CPI figure, coming in at 2.2%, below the expected 2.3% reading. The focus in Europe remains on the Mediterranean periphery, as weekend reports from Spanish press suggest that the heavily weighted Valencia region may be pressed into default unless it receives assistance from the central government. The sentiment is reflected in the Spanish debt market today, with the long-end of the curve showing record high yields, and the 10-yr bond yield remaining elevated above the 7% mark. News from an EU council draft, showing that Spain is to be given extra time to meet its deficit targets did bring the borrowing costs off their session highs, but they do remain stubbornly high at the North American crossover. The gap between the core European nations and their flagging partners continues to widen, as Germany sell 6-month bills at a record low of -0.0344%. As such, the 10-yr government bond yield spread between the Mediterranean and Germany is seen markedly wider on the day.
Attempts to manipulate free markets invariably end badly - after all, they are, supposedly, by their very nature, free. Over the past few weeks, the exposure of the Libor-rigging scandal has monopolized the headlines of the financial press. The rather obvious implication being that given almost half the reported inputs that help establish the Libor rate are discarded immediately, Barclays simply CANNOT have manipulated the Libor rate alone. Period. At best this is a cartel, at worst it’s outright fraud on a scale that is completely unprecedented. In Grant Williams' humble opinion, the Libor scandal will mark a fundamental change in the treatment of financial conspiracy theories in the media. The sheer amount of coverage it will undoubtedly receive will signal a shift in attitude towards the exposing of such scandals rather than the blind-eyes that have been regularly turned in recent years. Prime amongst conspiracy theories that may soon be finally proven to be either valid or the figments of overactive imaginations, are those alleged in the gold and silver markets. If the long-stated claims about government-sanctioned, bank-led manipulation of precious metals markets are eventually proven to have any validity whatsoever, the fallout from the Libor scandal will prove to be (to use the words of Jamie Dimon) just another “tempest in a tea pot” as the precious metals are the very underpinnings of the entire global financial system.
It should come as no surprise to anyone that major commercial banks manipulate Libor submissions for their own benefit. As Jefferies David Zervos writes this weekend, money-center commercial banks did not want the “truth” of market prices to determine their loan rates. Rather, they wanted an oligopolistically controlled subjective survey rate to be the basis for their lending businesses. When there are only 16 players – a “gentlemen’s agreement” is relatively easy to formulate. That is the way business has been transacted in the broader OTC lending markets for nearly 30 years. The most bizarre thing to come out of the Barclays scandal, Zervos goes on to say, is the attack on the Bank of England and Paul Tucker. Is it really a scandal that central bank officials tried to affect interest rates? Absolutely NOT! That’s what they do for a living. Central bankers try to influence rates directly and indirectly EVERY day. That is their job. Congresses and Parliaments have given central banks monopoly power in the printing of money and the management of interest rate policy. These same law makers did not endow 16 commercial banks with oligopoly power to collude on the rate setting process in their privately created, over the counter, publicly backstopped marketplaces.
A generation of market participants has grown up knowing only the era of central bankers and the 'Great Moderation' of (most of) the last two decades elevated their status significantly. While central bankers are generally very well aware of the limits of their own power, financial markets seem inclined to overstress the direct scope of monetary policy in the real world.
If markets fall, investors need only to run to central bankers, and Ben Bernanke and his ilk will put on a sticking plaster and offer a liquidity lollipop to the investment community for being such brave little soldiers in the face of adversity
Monetary policy impacts the real economy because it is transmitted to the real economy through the money transmission mechanism. This has become particularly important in the current environment, where, as UBS' Paul Donovan notes, some aspects of that transmission mechanism have become damaged in some economies. Simplifying the monetary transmission mechanism into four very broad categories: the cost of capital; the willingness to lend; the willingness to save; and the foreign exchange rate; UBS finds strains in each that negate some or all of a central bank's stimulus efforts. In the current climate, it may well be that the state of the monetary transmission mechanism is even more important than monetary policy decisions themselves. Some monetary policy makers may be at the limits of their influence.
With global PMI rolling over again, dimming unemployment growth, and slowing EM Asia impacting global production, it is no wonder than BofAML's economics team sees a dearth of 'feelgood' factors in the market. In fact, as they note, further rate cuts in the euro area and China along with around $500bn of NEW QE in this quarter are priced into the market with any hope for risk assets to rally more consistently, investors will need to see not just willing-and-able central bankers but an abatement of the sovereign crisis in Europe and improvement in global data - neither of which they expect anytime soon. Easier monetary policy can only cushion the blow from higher uncertainty in the US and Europe. Effective policy breakthroughs would thus have to come from compromises in the European Council or in US cross-party politics. Investors have yet to zero in on the real impacts of rising economic uncertainty in the US. As Ethan Harris and Michael Hanson have argued, it is unlikely that the cliff is fully priced into the markets and US political dysfunction will share the spotlight with the European crisis over the next few months. And as last time, the joint act will likely undercut investor confidence.
And in the meantime, not a peep about any bank in the US, which is ironic considering JPM, Citi and BofA are BBA member banks, and had among the lowest fixing rates during the period in question, and as Bob Diamond himself said, "everyone did it." One may almost get the impression that US regulators and politicians, gasp, have a motive to not investigate banks for not only criminal but civil malfeasance. And why should they: after all there is unlimited taxpayer money. And if that ends, the US can just print some more.