From Maurice Pomery of Strategic Alpha
Keep The Faith….
We need to look at why the funding rates were cut. It is not because everything is better:
Firstly this action, coming in a timely fashion, was certainly warranted and shows a new resolve to act in a banking crisis. However it is the fact it was warranted is the problem and whilst it makes Dollar funding cheaper, it remains to be seen if banks trust each other enough to lend. I am not sure about this and the situation must have been really bad for such action as it was clearly not as pro-active as they may like to suggest. A crisis was very close indeed and whilst this action eases the situation it may not be a cure. The banks still face massive headwinds from here. The RRR cut from China helped risk appetite earlier but again is a clear sign that lower growth and thus easing is on the way in China. Hard or soft landing we don’t yet know but a landing for sure as evidenced in last night’s fall in the PMI data. (China PMI came in at 49 vs 49.8 exp) The steep fall in exports was what caught my eye!
Banks still look set to hoard cash so lending probably will not increase and the appetite for credit is poor. The action is prudent but suggests that the central banks think that the worst of market conditions might be yet to be seen! There is now so much expectation at the December 9th meeting and even EU leaders have ramped up its importance by suggesting it is now or never! Whilst these moves do not fix the underlying problems that are leading to market stress, it does at least mean that European banks can fund their dollar assets cheaper than would otherwise have been the case. This move has seen the 3-month cross-currency basis swap come into to -131bps from -157bps yesterday and -162bps immediately before the action was taken. What worries me is the track record of EU leaders coming up with anything near the expectations of the markets is appalling. Haven’t we been here before? I think Fed’s Fisher put it well when he said "We are not bailing out Europe, we are trying to meet a shortage of dollars." In other words Europe still has all the problems it had two days ago.
This meeting now takes on a more important meaning with many feeling it is time to look at the fiscal unity and ceding of sovereignty. Are the outer Nations really that close to allowing this central government? I am not sure a weekend meeting can produce that! The coordinated action is clearly a short term plaster and possibly an insurance of some sort if failure at this meeting happens. If we come out with little real action, banks will certainly be stressed. Now here is the point in the more macro outlook; European asset disposal (forced or unforced) risks creating a tightening of financial conditions in other economies, and to the extent that this influences global growth expectations, it would affect currencies through changes in risk appetite and capital flows. The US banks are still not going to be keen to increase exposure to European banks and nor will anyone else and the deleveraging that has to take place will matter. (Data from ratings agency Fitch shows that US money markets have slashed funding for French banks by 69pc and German banks by 50pc). European banks will shed assets and they have billions in EM’s and Eastern Europe and will be forced to withdraw and dump these assets and exposures! This WILL matter. Global growth could take a nasty knock and I note with interest another cut in rates from Brazil as the economy weakens.
There may be growing support for the ECB to become the lender of last resort but you can forget this unless the Germans take a massive leap of faith and do a U turn. Surely the fact that there was a coordinated move from central banks suggests the ECB will not budge. We may well get an extension of loan tenures but lender of last resort seems unlikely now. Do people really expect the Germans to give in after suggesting to their voters at home that they won’t? Remember how political these people are as it is all about power. However it is now plainly clear that all this action will be for nothing if the sovereign issue is not sorted out and December the 9th is just next week. The bomb is ticking for Europe.
There was some chatter that it makes sense for the Fed to now cut the discount rate which looks plausible as effectively the OIS+50bp funding rate is offering cash to offshore names at a rate that is below the current 0.75% Discount Rate at which the Fed will provide emergency funding to US domiciled banks. We may then see a reduction to placate domestic banks but it will likely only come after a FOMC meeting to discuss it and is NOT seen as an emergency as they don't expect to see much use of the Discount Window. It will be more of a book keeping issue. The cut in the lending rate is only relevant to those banks that have the collateral required for discounting with the ECB. If the issue is a shortage of collateral then the change in lending rate won’t assist many of the banks that are short USD funding. Yet again it looks as if the EU leadership have been given some time to actually make something happen. I just wonder if they can!