Here Is What Just Happaned

From Peter Tchir of TF Market Advisors

Much Ado About Nothing

What just happened?  The Central Banks have agreed to either create programs to lend in $'s or in the case of the ECB, expand their existing 7 day program.  It is definitely globally co-ordinated, but for any central bank to offer a USD program, they need to work with the Fed, so assuming the ECB decided to work with the Fed, it seems like a no brainer to involve the other central banks.  Bank of England is an obvious candidate - look at the share price declines of Barclay's and RBS.  The Swiss Central Bank was likely to join already, but a day with UBS announcing a $2 billion loss, they had extra reason to go along.  Japan always seems to be up for a good intervention.  So it is globally co-ordinated, that is important, but it was also and easy and obvious co-ordination.

How do banks borrow in USD?  In good times they call the short term lending desks of other banks and borrow dollars.  Simple.  They can also post $ assets in repo agreements to fund them.  Lately some banks weren't lending or were willing to lend at rates that the borrowers felt was too high.  They could then finance themselves in their home currency, Euro's for example.  They could get that money relatively cheaply - possibly from depositors or even going to the ECB and entering repo agreements on their Euro assets to get Euros.  Then they could do basis swaps to convert the Euro borrowings into dollars.  EUBSC <crncy> <go> is the basis swap level.  That had increased as banks chose to borrow in Euros and swap into dollars.  As that got expensive, they weren't getting any savings.  Along comes the Fed/ECB and decide to intervene and ensure that European banks don't have to pay too much for their dollar borrowings.  Notice the instant reaction in the basis swap. 

Chart: Bloomberg


It will ensure that banks can borrow in $'s.  Their own central banks take the credit risk (as they already do) and provide the $ funding at attractive levels.  Yes, it should be clear to all that the people who do interbank lending for a living are charging the wrong price.  This is helpful in that it keeps costs of $ funds more in line with cost of funding in their home currency, but isn't a game changer.  That reduction in cost is minimal, and in the case of the ECB this is an extension of the 7 day program they already have in place.

If the central bankers are going to throw spaghetti against the wall and see what sticks, it is good to have a lot of spaghetti. 

What is the next action?  I suspect we will see some effort to push sovereign CDS spreads tighter.  Would it be something as intelligent as immediately forcing all sovereign and bank cds to be cleared?  Heck no, that might annoy someone.  It is more likely to be announcement of banning naked shorts, increased margins, and the ability for the EFSF if not central banks themselves to sell protection.  CDS would gap tighter and bonds are unlikely to react much.  When the ECB intervened in the Spanish and Italian bond markets, the initial reaction in the bond market was big.  Over 1% in yield terms across the board in a very short time frame.  The CDS never reacted as positively.  In any case, the market remained dubious of the effectiveness and we have seen yields rise in spite of continued buying.  CDS shorts will be painful if this occurs, but it won't fix anything long term.  There is nothing about the budget problems in various countries that are affected by CDS.  It also means that auctions are likely to do less well as the short covering bid dries up and that moves down will be exaggerated, just like the moves up. 

To the extent there is still anything left that can be construed as a "market" it seems that the fundamentals all point at market being too high.  Data is weak and sovereign defaults and bank write-downs are not fully priced in, but with governments and central banks willing to do and say anything to try and prop up the market, it is very hard to go down.  Yesterday's head scratching move higher waiting for the conference call, and then the even more curious march higher after the benign headlines, followed by an equally inexplicable 1.5% drop into the close, is a sign of how broken the market is.

My best guess right now is that so many shorts were set yesterday at 1200, that if we break above that again and hold it, 1230 is an easy target.  On other hand, one good default headline could be enough to take us to 1150 in a heartbeat (we were at 1160 yesterday briefly).  The economic data was weak, and this action by the central banks is not a game changer.

If you think that Greece is going to default, as I do, and that the individual governments and central bankers are going to do all they can to prevent the problems getting out of control, this is a consistent step.  They may as well put in place as many things as possible in advance of a default.  Rather than scrambling and reacting to an announcement, they will put a lot in place in advance, and then, when the default occurs all they have to do is implement a few new and exceptional programs.

On a side note, any chance the jobs bill is causing layoffs to increase?  If cash for clunkers can change the timing of car purchases, why can't layoffs be tied to this bill?  Lay someone off and if the jobs bill gets passed, you can hire them back and get some government kickers to subisidize the "new hire".