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Euro Basis Swap Perspectives
We noted early the lackluster improvement in the EUR-USD cross-currency basis swap, especialy compared to its trend and previous crisis scenarios. Peter Tchir, of TF Market Advisors, puts today's central bank actions into context relative to the underlying problems being faced in Europe and covers the implications of some of the headlines that may have slipped past in the middle of the rally-fest. We were down over 1% on futures overnight specifically because
the EFSF was a failure and banks were downgraded (belatedly) by S&P. No one is talking about EFSF right now. The IMF denial and now the Italian 'deal' is also off the table. Back on the table is "treaty changes".The swap line announcement seems largely symbolic in that changing the rate to 50 bps instead of 100 bps is not a game changer.
So the Euro Basis Swap is once again a topic of conversation.
It was certainly on the radar screen of the bears as one of the rates that was not responding to the “Grand Plan” or other policy actions.
On September 15th (green oval above), the first attempt at global co-ordination to bring the rate down was done. They put in place swap lines at OIS + 100 bps back then. The basis swap reversed that gain and got worse with the market into the end of September and early October. It participated in the October rally, but never got back to levels of September 15th, and started fading with the Grand Plan.
Many investors view this swap as an indicator of how difficult it is for European banks to fund in dollars. The basis swap can move around for many reasons, but there is good reason to believe it is an indicator of how difficult it is for European banks to fund their US businesses.
In normal times, European banks borrow in dollars to fund their US positions. That makes sense. As the banks face pressure on their USD funding rates, they have two choices, they can either pay up to get $’s directly, or they can borrow at home in euro’s and “swap” it into dollars. The basic premise is that foreign banks have more ability to raise money in their home countries or through their own central banks at times of stress. As they get shut out of borrowing directly in dollars they rely more and more on funding in their domestic market. US Banks may be scared to lend to French banks, but French institutions and individuals are far less likely to be as concerned. The borrow at home and swap it into dollars. That drives the basis swap more negative. Although that is only one of the explanations of the moves in the eur basis swap, it is a reasonable way to look at the market.
To the extent that is why the rates were moving, it is clear why the central banks wanted to intervene. It doesn’t cost them anything to do and it provides the banks with a chance to earn more positive carry. By making such big globally co-ordinated announcements, it probably makes it easier for banks to shed the stigma of using the facility and can bring their cost of funds lower.
In the end, does it change the need to shed assets? No. Does it print money? No. Does it virtually ensure an ECB rate cut? Yes.
All this is being done to support the banks and their ability to function and in theory to lend. I think it will be successful in supporting bank credit spreads (this and other statements and actions point to senior unsecured debt as being protected). I doubt it encourages the banks to lend or to retain assets rather than continuing to deleverage. In which case it will be a policy disappointment.
Will any of this come at a cost? Will there be renewed pressure for banks to forgive sovereign debt? With public opinion so heavily against banks, does all of this help for banks really still come without a cost to them? Politically there is a lot of support to make banks take some pain. The focus of that pain is becoming more narrow – stocks and sub debt at risk, short term unsecured debt and depositors safe. From the banking side, I think JPM is the best prepared to take advantage of any situation that puts renewed pressure on European banks to negotiate sovereign debt forgiveness, with DB best positioned in Europe (Ackerman has seemed the least scared of the problems for the past few months and stepped out of the IIF led negotiations). GS could do well, but they have become so demonized by the public that I doubt they will be able to take full advantage of any situation.
Like some other recent policy announcements (new IMF fast lending to otherwise good countries that are affected by contagion) this policy is okay in normal times, but is even more important and useful if the ECB decides not to print and the IMF doesn’t step up to provide massive money without demanding some restructuring in addition to austerity.
Lost In The Shuffle
Great US data. Much better than expected. Clearly a good sign.
Monti say IMF loan not being considered for Italy.
Juncker says EFSF Capacity may reach 750 billion. Guess he had to come up with some number.
Greek debt not being renogotiated?
The globally co-ordinated central bank policy moves have started, and more likely to come (ECB rate cut for example), and that is all the market is discussing. We were down over 1% on futures overnight specifically because the EFSF was a failure and banks were downgraded (belatedly) by S&P. No one is talking about EFSF right now. The IMF denial and now the Italian denial is also off the table. Back on the table is "treaty changes".
We moved 5% basically on the PBOC reserve change and the swap line announcement. The swap line announcement is largely symbolic in that changing the rate to 50 bps instead of 100 bps is not a game changer. The hope of more to come and that they are working together is positive, but it isn't really new, and hasn't done much when it only addresses liquidity and cost of funds. Asset purchases have worked, lowering funding costs hasn't done much.
For what its worth, this policy also dovetails nicely into a non printing solution. This policy is probably even more important if the ECB is going to dealy printing money and buying sovereign debt. It helps even if the ECB prints, but is critical if the ECB holds off awhile longer.
With German bunds well bid, stocks back up to October 27th levels, the pressure to print may be off. Maybe they have already agree to print, but time and again the market has underestimated the willingness of Germany to try and find a solution without creating new money.
It's been quite a day already.
Chart: Bloomberg
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This doesn't fix it all?
Am I the only one who thinks this is an unbelievably stupid idea?
These EU banks are broke, they cannot pay their current bills... so the answer is for them to take out more loans (from US) and incur more bills, they won;t be able to repay?
WTF---OVER!?!?!?!
Why do I feel like I'm in a game of Monopoly with cheaters?
They aren't cheating, you just didn't know the rules.
'In the end, does it change the need to shed assets? No. Does it print money? No. Does it virtually ensure an ECB rate cut? Yes'
Does it ramp the 'market'? Does it bullshit momo chasers into a false sense of security? Does it have yet unknown unintended consequence?
But of course.
The Fed is SCARED!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!
Global Central Banks "Last Tango in Paris" - "Fire up the printing presses, gang!" Or at Least Overnight Swaps Rates Were Cut 1/2%
http://confoundedinterest.wordpress.com
Pffft- why will Germany lift a finger, now that it knows that the Fed will bend over for them?
Anyone looked at nflx over the past half hour? Someone big just dumped it.
We need to restart the BAC countdown. Some fun must be had today.
If you decided to buy a bankrupt airline yesterday you are up 41% in one day!!!!!
Go Wallstreet con job!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!
Ere long, the Fed will be paying the failing banks to take the dollars off our hands. I mean, why charge anything? What is the point of getting a nominal sum?
HYG beginning to tell the truth.
SPY coming down off the gas and air.
EUR/USD falling too. French downgrade is imminent and right when reality starts to set the in the ECB will show up with a nice rate cut.
What will they ever use as collateral for those dollars out in Europe? I wonder.
Anyone else notice, there is hardly any intra-day volatility anymore? All of the volatility is off-loaded onto the overnight futures sessions. This is exactly the pattern of 2009.
The Mafia should be taking notes. This is how loan - sharking is done.
http://georgesblogforum.wordpress.com/2011/11/02/the-daily-climb-2/