Not Again

By: Michael Ashton | Fri, Feb 10, 2012
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Once again, dawn broke on Thursday with great excitement. A Greek deal was at hand! Stocks were higher, although not very much higher, and commodities were bid as well as disaster was at last averted.

Now, this next part probably won't surprise you as much this time as it did the first two dozen times: the deal was something less-than-advertised.

Yes, there was a Greek deal. But the deal in question was a deal among the leaders of the various parties in Greece about how to promise austerity. That deal must then be discussed with and approved by the Troika (ECB, EU, IMF). Oh, and this has nothing to do with the private sector initiative (PSI) discussions, which are still not done. So this great deal that we waited breathlessly for was pretty much the first stages of an agreement that would be meaningful even if doomed to failure.

You probably also won't be so surprised when I tell you that the deal the Greeks agreed to among themselves did not pass muster with the rest of Europe, who are the ones who are supposed to put up the money for Greece. "In short: no disbursement without implementation," said Jean-Claude Juncker, in summary of the EU policymakers' meetings. According to the Bloomberg story, "he set another extraordinary meeting for Feb 15." I wonder how many extraordinary meetings you can have, before they become ordinary? Apparently the Greeks left a little wiggle room, in that their parliament needs to vote on this new deal in a vote that the finance minister says is tantamount to a vote on membership in the EZ. This is all supposed to be done by February 15th. Don't these guys have any respect for Valentine's Day?

Love is definitely not what is in the air at the ECB. The central bank held policy steady today, but ECB President Mario Draghi said as his press conference that he no longer sees substantial downside economic risks. (And yet, like the Fed, inflation should stay above 2% for "several months" and then decline, I guess because that would be convenient to him.) Whatever is in the air at the ECB, they should pass it around.

Let's try and work through the logic here:

  1. There is no substantial downside economic risk.
  2. For Greece to default or to leave the Euro would mean the end of life as we know it.

therefore There is no substantial risk that Greece is going to either default or leave the Euro.

I think I have the syllogism (oh, that word comes from Greek) right, although it's probably not important that I do so since neither 1 nor 2 is correct.

From logic to mathematics we travel: Draghi did say generously that the ECB is willing to give up its "profits" on Greek bonds in order to help the solution, as long as they don't sell at a loss since that would involve monetary financing of governments. In what la-la land are these guys living that buying bonds at $50 and selling them at $25 produces a profit? It would make my job a lot easier if I could use Draghian math. Unless the ECB bought bonds at $50 and then marked them at par, or carried them at cost rather than marketing them at all and is counting as "profit" the coupon income, this is nonsensical. So I conclude that the ECB is in fact doing one of those two things, either of which would get them jailed as a private investor.

Maybe I am too cynical (also a word that comes from Greek and means literally "doglike, currish"), but if this is how they steer ships in Italy then...oh, too soon?

Meanwhile in other central bank follies, the Bank of England tossed another £50bln log on the fire, bringing the QE total to £325bln. You know, core inflation in England is only at 3%ish, so it's important to guard against incipient deflation!

In the U.S., Initial Claims was again a little lower-than-expected at 358k. We can probably at this point reject the null hypothesis that the underlying rate of claims is still around 400k, where it was until the second week of December; until now, the error bars around the estimate prevented such a conclusion at least in a statistical sense. Is the level now 375k or are Claims still improving? It's too early to say. I expect that it is still improving, but I also expect it's not going to continue that way.

Bigger news was that the Justice Department reached a settlement with Wells Fargo, Citigroup, Bank of America, Ally, and JP Morgan over the 'robo signing' flap. Those firms are on the hook for $26bln between them. JPM fell -1.2%, Citigroup dropped -1.7%, Wells was -0.2%, and Bank of America, which took the biggest hit, of course rose 0.6%. I do not understand the fascination of buying financial dinosaurs now that there are big dinosaur hunters around, but investors are delighted to jump into BofA at an 0.5% dividend yield. I've been saying it since 2008, and it hasn't changed yet: the business of large trading banks has fundamentally changed, I think forever. Return on Equity is going to be much lower in the future in the past because (a) volumes of all products are lower, (b) balance sheet leverage is lower, and (c) margins have not widened, and if anything are under further pressure as most products move to exchanges. Banks sell the product with the most elastic demand curve in the world: money. If your bid for the five year note is 100-04+ and the market is 100-05/5+, you will print essentially zero business. (This is why banks love highly-structured product for which a price is not readily available many times.) You cannot count on margins going up, ever. And those three parts, (a), (b), and (c), are the three parts of RoE. Bank stocks may be great trading vehicles, and some banks may gain at the expense of other banks, but as a whole the industry is dead money, in my opinion.

The Treasury today announced that they will auction 30-year TIPS next week. The auction size was only $9bln, compared to expectations generally of $10bln, but the roll still opened quite wide (implying that you get more yield to roll forward to the new issue than you 'should.' The Street is either quite concerned about trying to auction 30-year inflation-linked bonds at a real yield of 0.75%, and they probably should be, or dealer risk budgets have been so desiccated that the limited number of bona fide TIPS dealers aren't sure they can underwrite the issue at something close to the current price. In any event, after the announcement the long end of the TIPS curve was crushed, before bouncing and ending only 4bps higher in yield on the day. The nominal 10-year note sold off 5bps to 2.04%, and 10-year breakevens were down 2bps.

Commodity indices gained 0.5% despite a very soft performance from grains and softs. The energy group rose 1.2%, industrial metals put on 1.5% (now up 10% over the last month), and precious metals rose 0.6% (+8.2% over month ago).

The only data of note on Friday is the University of Michigan confidence number for February (Consensus: 74.8 vs 75.0). I predict that we will head into the weekend expecting a deal to come out of Europe over the weekend, as we will be told it is "imminent." Why not try that old chestnut again?

 


 

Michael Ashton

Author: Michael Ashton

Michael Ashton, CFA
E-Piphany

Michael Ashton

Michael Ashton is Managing Principal at Enduring Investments LLC, a specialty consulting and investment management boutique that offers focused inflation-market expertise. He may be contacted through that site. He is on Twitter at @inflation_guy

Prior to founding Enduring Investments, Mr. Ashton worked as a trader, strategist, and salesman during a 20-year Wall Street career that included tours of duty at Deutsche Bank, Bankers Trust, Barclays Capital, and J.P. Morgan.

Since 2003 he has played an integral role in developing the U.S. inflation derivatives markets and is widely viewed as a premier subject matter expert on inflation products and inflation trading. While at Barclays, he traded the first interbank U.S. CPI swaps. He was primarily responsible for the creation of the CPI Futures contract that the Chicago Mercantile Exchange listed in February 2004 and was the lead market maker for that contract. Mr. Ashton has written extensively about the use of inflation-indexed products for hedging real exposures, including papers and book chapters on "Inflation and Commodities," "The Real-Feel Inflation Rate," "Hedging Post-Retirement Medical Liabilities," and "Liability-Driven Investment For Individuals." He frequently speaks in front of professional and retail audiences, both large and small. He runs the Inflation-Indexed Investing Association.

For many years, Mr. Ashton has written frequent market commentary, sometimes for client distribution and more recently for wider public dissemination. Mr. Ashton received a Bachelor of Arts degree in Economics from Trinity University in 1990 and was awarded his CFA charter in 2001.

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