Stress Test

The question stands: how much longer will the Fed allow the ECB to export its recession to the US on the back of the soaring dollar, and how much longer will the market be deluded that "decoupling" is still possible despite a dramatic bout of weakness in recent US data. Look for the answer in today's BLS report, which - if the Fed is getting secound thoughts about its rate hike strategy in just 3 months - has to print well below 200,000 to send a very important message to the market about just how much weaker the US economy is than generally perceived. For now, however, the ECB is getting its way, and the question of just how much European QE is priced in, remains open, with peripheral bond yields dropping to new all time lows for yet another day, while the EURUSD has plunged to fresh 11 year lows, sliding below 1.094, and making every US corporation with European operations scream in terror.  Looking at markets, US equities are just barely in the red, coiled to move either way when the seasonally-adjusted jobs data hits.

Four months ago, in another failed attempt to boost confidence in the Eurozone and stimulate lending (failed because three months later the ECB finally launched its own QE), the ECB conducted its latest stress test, which as we explicitly pointed out was an utter joke as even its "worst-case" scenario did not simulate a deflationary scenario. Two months later Europe was in outright deflation.  It was initially unclear just how comparably laughable the Fed's own stress test assumptions were, but refuting rumors that Deutsche and Santander would fail the Fed's stress test (perhaps because former FDIC head and current Santander head Sheila Bair wasn't too happy about her bank being one of the failed ones), moments ago the Fed released the results of the 2015 Fed stress test, and.... it seems there was no need to provide a sacrificial lamb as with stocks at record highs. In fact everything is awesome! FED STRESS TEST SHOWS ALL 31 BANKS EXCEED MINIMUM REQUIREMENTS

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"My hope is that as policy makers of the world continue to prescribe their remedies for the ailing economic patient, that they do not render it worse off... As with their predecessors, I suspect there is no doubt in the minds of our central bankers that they are the smartest they’ve ever been. Yet, I fear they are not the smartest they will ever be."

A bank which has €54.7 trillion, or a little over $62 trillion at today's exchange rate, in derivatives - a number that is 20 times greater than the GDP of Germany -  just failed a central bank stress test due to lacking governance and risk management controls and, just maybe, has insufficient capital? What can possibly go wrong.

As leaked by Reuters moments ago, here is the text of a document that describes Germany's position on Greece's letter requesting an extension of its bailout facility as nothing short of a Trojan Horse.

Due to the principal-agent problem in the asset management industry, most money managers rationally have a propensity to use a negatively skewed payoff distribution. This kind of behavior, in aggregate, is also evidenced in the historical data, which shows significant losses for professional investors during the largest market downturns. Most investors and asset allocators, in addition to these negatively skewed positions, further view the returns of hedging strategies in a vacuum, rather than as a holistic part of their broader portfolio. Thus, they are likely to consider portfolio hedging programs to be a drag on their performance numbers and further undervalue them. We believe these factors, among others, contribute to a market segmentation that creates an undervaluation in tail-risk hedges.

As we noted last week, the Swiss National Bank's decision to un-peg from the Euro (thus strengthening the CHF dramatically) will have very significant repercussions - not the least of which is for Hungarian and Polish Swiss-Franc-denominated mortgage-holders. The 20% surge in Swiss Franc translates directly into a comparable jump in the zloty value of loan principles and and monthly payments for about 575,000 Polish families owing a total $35 billion in mortgages denominated in the Swiss currency which has prompted calls for Poland's government to bail them out. Never mind the FX risk, the low-rates were all anyone cared about and now yet another 'risk-free' trade has exploded, Deputy PM Piechocinski says, if the franc "remains above the 4 zloty level, the government may provide support" to debtors but Poland's Central Bank is not supportive of the bailout.

Spoiler alert: nothing good, because what until yesterday was, indicatively, a 1 million mortgage (in HUF or PLN terms) is suddenly a 1.2 million mortgage. But what about the details? Here they are, courtesy of Goldman Sachs.

Things in risk land started off badly this morning, with the worst start to a year ever was set to worsen when European equities came under early selling pressure following news of German unemployment falling to record low, offset by a record high Italian jobless rate, with declining oil prices still the predominant theme as Brent crude briefly touched its lowest level since May 2009, this consequently saw the German 10yr yield print a fresh record low in a continuation of the move seen yesterday. However, after breaking USD 50.00 Brent prices have seen an aggressive bounce which has seen European equities move into positive territory with the energy names helping lift the sector which is now outperforming its peers. As a result fixed income futures have pared a large majority of the move higher at the EU open. But the punchline came several hours ago courtesy of Eurostat, when it was revealed that December was the first deflationary month for the Eurozone since the depths of the financial crisis more than five years ago, when prices dropped by -0.2% below the -0.1% expectation, and sharply lower than the 0.3% increase in November, driven by a collapse in Energy prices.

ECB's Vitor Constancio, October 26, 2014: "The scenario of deflation is not there because indeed we don't consider that deflation is going to happen."

ECB's Vitor Constancio, December 20, 2014:" "We now expect negative inflation in the coming months."

Despite the authorities' best efforts to keep everything orderly, we know how this global Game of Geopolitical Tetris ends: "Players lose a typical game of Tetris when they can no longer keep up with the increasing speed, and the Tetriminos stack up to the top of the playing field. This is commonly referred to as topping out."

"I’m tired of being outraged!"

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