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On FX intervention and the ECB/SMP
Yikes!! I posted this and a few minutes later the Fed/other CBs announces a round of coordinated measures to assist the ECB. My point in this article was that the ECB has no friends, and that was the weakest link in their defense of the EU bond market. It seems they now have friends. We shall see how good these "friends" are.
The ECB has been a big player on the buy side of EU bonds. Its intervention topped E200b recently. Of course that’s just a fraction of the supply that is out there. At this point, the ECBs efforts have been a miserable failure. Rather than put a ring fence around critical countries such as Italy, the ECBs tactics have added to the fire.
The ECB is in a bad position. The news flow and large supply have put them on the defensive. Defense is no way to run an intervention policy. At best, it’s slow grind to a loss.
I sat on FX interbank desks in the 70’s and 80’s when the NY Fed came into the FX markets on a regular basis in an effort to stabilize and steer the dollar. The “Stick” (what the Fed was called) was on both the sell and buy side at different times over those years. This was low-tech time. There was a direct telephone wire to the Fed desk. It would light up and they would ask for a price on $100mm USDDM (no Euros then). Dealers are obligated to make prices. You knew you were going to get slammed as soon as they said:
“Done for a 100 mil. We can carry on at that price”.
All hell would break out in the FX markets when the Fed intervened. I would get little sleep for a few days. After about a dozen of these sphincter event I formed my own opinions on how intervention should be conducted. There’s plenty of academic stuff on this too. The following are considerations when evaluating the efficacy of FX intervention. Some of the lessons apply to the dilemma the ECB finds itself in today.
When confronted with unstable markets where the instability is, by itself, undermining the broader economy, the first objective is to re-establish stability. There is only one way to do that in the short-term. The financial authorities must establish Two Way Risk back into the market. Ideally, the objective is to create as much risk in being long as the risk of being short.
The ECB has failed to establish two-way risk. Virtually every (Italian, etc) bond that has been sold over the last few months has been a “good” sale. There has been no risk to selling, the only risk has been in buying. If the ECB wants to be successful they must create a risk situation that is equally weighted. Call that shock and awe. It has to call the dealers and make them understand sphincter power. (As the Fed did to me.) In my day, the the term “Don’t fight the Fed” came into being because the Fed had learned (after early failures) that it had to be on the offense when it came to intervention.
Of course, it’s not all that easy. Over the years, currency intervention has repeatedly failed. For example, the currency “Peg” or “line in the sand” strategy has had mixed results. The Currency Board ($ peg) in Argentina worked well for a while and then had a spectacular blowup. The EU countries had numerous devaluations in the years running up to the Euro. (Fixed exchange rates didn’t work then any better than they do today). The best example of a Peg gone bad is when George Soros took out the Bank of England in 1992.
Some pegs have worked. The HK$ is a shining example. However, a peg is not without cost. Hong Kong’s reserves are now $281b. That comes $40,000 per person (just the opposite of the US). The Central Bank has been forced to absorb 9Xs the amount of money in circulation. Switzerland has recently adopted a peg. So far, so good. But they too have had an explosion in reserves. The Swiss are rapidly approaching the nutty levels in HK.
I don’t think pegs are relevant when it comes to options the ECB might consider. If they tried to peg (or even bracket) Spanish or Italian bonds they might get overwhelmed with sellers.
Speaking of being overwhelmed by the market, the experience by the Swiss National Bank (SNB) in 2009 is worth noting as a classic intervention mistake. The SNB tried to hold the EURCHF at 1.500. It was swamped with sellers at that price. In the end, the SNB was forced to fold. The error cost them dearly, both in money and prestige.
This is a real consideration for the ECB. At what price level(s) and under what terms should it use intervention? How do they respond if there is E500b of Italian/Spanish paper on offer and looking for a bid? Some say that 7% Italian bonds already indicate the end is nigh. I’m not so sure. But if this ratchets up another few levels and Italian yields push 9% the end will be very close indeed.
I’m quite certain the folks at the ECB are aware of this. So is the market. A test of each others will is in the offing. December is a time for things like that to happen.
A final example of flawed intervention is that of the Bank of Japan. Its policy is often referred to as, “Slow death by a thousand swords”. Everyone knows that the best time to sell USDYEN is a few hours after the BoJ makes a splashy intervention. They have been at this for years. It hasn’t worked once. It’s just a source of revenue for the exporters, banks and specs.
This is not a consideration for the ECB. Time is not on its side. Japan’s problem is that too much money is coming in. The ECB is looking at this from the other side of the mirror. The wrong side.
There is no example (other than Hong Kong) where a single central bank has fought the markets and won. Successful intervention has to be coordinated with other central banks and activities by supranational entities (IMF types). This is very important for the ECB. They are alone in this this fight. No one has offered a hand. The “Go it alone” plan won't work. The markets are much bigger than the ECB.
There is little evidence that currency intervention achieves more than buys time for an inevitable correction. The only evidence of success is that of the US Fed. They succeeded by intervening in a decisive magnitude, and in concert with other central banks.
Its unknown whether historical observations of what has and has not worked to bring stability to the FX markets is relevant to the intervention fight that the ECB finds itself in today. There is no history describing what is unfolding in the EU bond markets. This makes it all the more difficult to forecast what will happen next.
To the extent that the history of FX intervention provides some clues to what is coming, it does not paint a pretty picture. The ECB can’t shock and awe. It has no friends. It's unable to establish two-way risk. The clock is ticking. It has limited resources. We are already at crisis levels. Further deterioration will accelerate across other markets and broaden the sense of panic.
Did I mention that the ECB knows all this? And that it has no friends?
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why is there no liquidity if theres so much money being printed?????????????
The Germans have been intransigent about control of fiscal stability, hence the "Fiscal Stability Union" which would sidestep the EU treaty on a bilateral basis with Germany and France.
Once Germany and France are in, so are Belgium, Austria and Holland. The Italians will not be far behind, given that the IMF is already auditing them as we speak. Spain, ditto. Strip out the UK and that's over 90% of Eurozone GDP.
The little guys can decide if they want their own currency back.
The ECB has never, in my opinion, been outside of the FED's circle of trust. The adjustments to OIS across the board is a temporary solution. The fiscal stability idea would be permanent and would create a stronger deleveraging effect due to guaranteed austerity. That opens the door to ECB printing, either by lending to the IMF (Christine Lagarde, FRENCH FINANCE MINISTER, supported by the US) or some other chicanery, but printing it will be. The die is cast as it were, there is no turning back by the big boys. Just as the US provides the firepower and defense blanket for Europe, aka NATO, the FED does the same as lender of last resort. Now it is the ECB's turn. This entire move has been well orchestrated and it seems, well leaked.
Are the swaps recorded in the SOMA or as part of some other ledger that the Fed keeps?
Question does the swap trade look like this:
Foreign bank needs cash to shore up it's balance sheet because its bond portfolio is underwater--------> It goes to the ECB and posts these bonds as collateral to borrow Euros (as the ECB won't print Euros w/o collateral) ------------> The bank takes these euros and exchanges them for dollars at a 50 pip cost ----------------> The Fed electronically creates dollars (a liability on its balance sheet and takes the euros back as an asset ------------> The Fed assumes that they have no liability as the foreign banks will have to true up their account when they close the swap. So if the euro declines in value they will have to make up the difference to the Fed. ---------> the only way out then is that the foreign banks start to see orgainc economic growtrh that allows for the bonds in their portfolio to gain in value to reduce the need for the infusion they got in the first place, so when they go to unwind the swap they can do so in a way that does not harm their balance sheeet.
A couple questions;
1. Does the ECB do the swap for its member banks or is the swap done directly with the foreign bank?
2. In reality is not the dollar that is created by the swap really collaterialized by soveign debt that has been posted by the foreign bank?
3. Is not the ECB's balance sheet impaired by this?
4. Does not the creation of these electronic dollars devalue the dollar?
Nah they just swap IOU's. You and I could do this and we would both be millionaires.
Last massive once-in-a-hundred years solar EMP was in 1921........we're about due, wonder how that would work out........
Read "Dies the fire" and you'll find out. Medieval to say the least. But no Fed so it's an even trade.
Again, and again, THANKS Bruce
Today's intevention will not create one job, won't fix housing, save involvent banks, or get rid of CDS's. It makes things worse by enabling more credit. It's the last thing we need. This is a defensive move by these central bankers. The "know" something very bad is about to happen. Why else do this at all?
It keeps them in power yet another day, while their buddies continue to grab the loot.
Exactly right. Kind of like Wiemar.
Not often a blogger gets instant validation from TPTB -- congratulations, Bruce.
Re: Bank Guy's comment below. Name for the new Northern European currency: the Neuro.
and the Bank of Euro will be called the Burro.
Nice one, i agree with the sentiments, you have to scare the living daylights out of people with interventions, really fuck with they're heads like the SNB did. Being on both sides massively, at frequent random intervals, would shake out an awful lot of people...
They are thinking in weeks and months. The years are still going to lead the same place, though. For now, "Everybody to the other side of the boat again!"
Bruce,
This morning's Kumbaya moment from the central banks ... I know I am getting older and my hearing is not as sharp as it used to be; because what I heard was:
"This time it's different!"
Did I miss the part where they have enough money for the ECB to buy everyone's debt at interest rates north of 7% on a two year?
barliman
Nope. You just forgot to take your crazy pills this morning. Take an extra dose and lie down until your doubts about the power of fiat go away. /sarc
These people always think "doing something" is better than doing nothing.
It is better for a few minutes then it gets worse again.
What we really need is more of doing nothing and letting nature return the dead to dust.
Be looking for more plastic surgery and taxidermy of sovereigns and banks. It is all they know.
As soon as you think all the cards are on the table and that you have won a hand, they pull another ace.
They have played more aces than there are cards in a deck.
As I always tell the "But, We Have to Do Something!" crowd, how about you cease adding to the problems? That's something, and it's actually beneficial.
First Rule of Holes.
A question for you, BK, given that Bruce Krasting is a Swiss citizen and knows the Swiss frame of mind ... and re another framework the SNB could use.
Putting together leads from various sources, including from here in ZeroHedge, and from my EU contacts in Brussels.
The possibility there may be a new strongly paired Swiss - German currency shortly. Germany may be putting out failing, un-workable, un-sustainable ideas on purpose, because Germany is secretly planning to exit the euro before Greece does, and Germany is stalling participating in a euro plan when Germany knows it won't be there.
A super-strong Swiss - German currency which would soon be among the world's favourites.
The Swiss franc is already pegged to the euro, and if Germany, and perhaps some other northern countries leave the euro, the Swiss would obviously shift their peg to the new German money.
It is cheaper for Germany to re-capitalise its own banks (which would collapse from the debt they hold in euros on the other countries), than it is for Germany to promise to pay for all of Europe to infinity.
Switzerland could help solve its own drastic problem of the upward pressure on the value of the Swiss franc, by buying some German bonds to help re-capitalise German banks, maybe some other AAA bonds too. The Swiss and new German currencies could stabilise together as a linked pair.
Germany getting ready to leave the euro, explains the German 'No' to most solution measures, why Germany is suggesting ridiculous solutions ... why Germany is exacerbating the crisis ... which Germany will shortly solve.
And this way the southern countries could keep the euro, the European central bank could inflate for them, they could print like Ben Bernanke, they could have cheaper currency to attract tourists and export, et cetera.
This is a fit-the-dots explanation for why Chancellor Angela Merkel and the German leadership are acting so strangely ... so obstructionist to possible solutions to the euro-zone ordeal ... saying things that rather makes things worse ... pretending to support ridiculous pipe dream plans for 'supervising' Europe ... offering up a laughable EFSF programme.
In the UK Telegraph, Ambrose Evans-Pritchard has been suggesting this for quite a while, Germany leaving the euro as the best solution for everybody, leaving the southern countries with a currency deflation option to rescue themselves.
In a few days Germany will lead a meeting which will establish procedures by which countries could exit using the euro ... theoretically they have Greece in mind, but maybe indeed, Germany is secretly preparing its own exit, as already suggested here on ZeroHedge by Alexander Gloy of Lighthouse Investment Management.
It is of course unusual for Germany to be so bold in this way ... but maybe it is time for Germany to be bold again.
Could it be what the doctor ordered for Switzerland as well? Of course your thoughts here re the Swiss would be significant.
The Swiss are screwed. It is only a matter of time before their peg causes trouble. Is it possible that the Euro breaks up along north south lines. If this were to happen it would be tempting for the Swiss to join in a more formal currency alignment with the the New Euro. It would be relatively easy for the SNB to manage a float where there Euro was just France, Netherlands, Belgium and Germany.
So it is possible. But I don't see it happening any time soon.
"The Swiss are screwed"
I'd be grateful if you would be more precise - for example "the SNB is screwed" - which is still a slight exaggeration from "the floor the SNB has set won't work forever".
Bruce, the SNB has a floor working, as you pointed out yourself. Just to make sure, they are trading favors left and right.The floor (not peg) will hold as long as the SNB is useful to the FED and the ECB. Since it's useful to have several trilateral swaps...
The Germans? UK's blogs simply don't get it. Germany won't do anything alone, this is a British Media Fixation (and I would not count Switzerland as substantial company anyway) and leaving the whole South in the rain is simply "not an option". The British Media "don't get" this part of the German Psyche since WWII. You can explain nearly everything in all things called "Euro-" by pointing at their unwillingness "to go where nobody follows". This in contrast to the UK, which is "leading" us (all alone for the moment) towards Iran...
Saying the UK is 'leading us' into Iran makes about as much sense as saying a robber's poodle is leading his master into burglary.
Bulldog, at least Bulldog
Bad boy!
Belgium?
Benelux...
Bruce, since you're too modest to toot your own horn, I'll do it for you. Back in late August, you wrote:
"I maintain the next move by the Fed is to massively open up the dollar swap lines with European central banks."
You nailed it--with Japan and Canada coming along for the ride. U da man.
How does this "new friends" intervention change things? Are you still pessimistic?
more funny money not real profit.
http://covert.mypressonline.com
I'm always pessimistic. Look at the markets post the news. They're soaring across the board.
Me, I see the steps today as the clearest evidence out there that we are in a mess. CB support is a band aide. It will work for a bit. Probably through year end. By January the realities will have set in.
Bruce, when it comes to FX your concept of the ECB "not having friends" is a useful simplification.
When it comes to saving a TBTF, the EuroDollar market or the First World Sovereign Bonds market, the FED and the ECB are best described (again, a simplification) as Mother and Daughter.
By January? By then Italy's bonds won't be the issue for at least half a year and the British Pound might take it's moment in the limelight. Then we will see how many friends Mr. King has...
As long as the UK keeps abstaining from UN SC sanctions against Israel, and keeps killing brown people alongside Uncle Sam, it'll have all the friends it needs (read: The Fed)
You're still the bestestest, Bruce.
:D
hi there Orly, welcome back to pomegranate juice and sauce. Good recipes for all.
All I can do is ask what happens to any “market” when the majority of the participants go away because they are either scared to death, broke or pissed off?