They Really Do Care

By: Michael Ashton | Thu, Mar 21, 2013
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It really is a marvel of a market these days. It doesn't strike me as completely odd that stocks have recovered almost all of the losses they experienced on the first Cyprus news, but what is amazing to me is that the VIX index has retraced about half of its jump and that "fear index" sits just about a point and a half above six-year lows.

Yes, Cyprus is a small country, which is a point that seems endlessly repeated as a sort of incantation, a warding against bad stuff happening. As my friend Andy F pointed out, subprime-mortgage-backed paper was also pretty small (roughly 1.3T in size compared with a worldwide bond market around 80T), and somehow still managed to leave a mark. Cyprus is very small, relative to the Eurozone. But if it was as small in significance as it is in relative GDP, do you think the EU finance ministers would be wasting this much time on them? It's a bit like saying "I don't care about my grade in Calculus," and then staying up all night studying. There's a clue that perhaps someone cares more than they're letting on.

If Cyprus was insignificant, as opposed to small, then the other Eurozone countries would simply pony up the dough, or wave goodbye and let Cyprus exit the Eurozone.

But they can't just pony up the dough, as that would continue a bad precedent.

And they can't just wave goodbye. Why? Because Cyprus's significance far outweighs its size. If Greece had left the Euro, there would be no precedent value to Cyprus's doing so and this crisis would have been but a blip. But it doesn't matter how big the first domino here is: the EU has sworn that the Euro is inviolate, that it's impossible to undo, that there's no provision from anyone leaving the union, etc. If any country leaves the Euro, the statement of absolutes is exposed to be false. And worse, from the standpoint of the elites...what if a country leaves the Euro and survives?

So, while everyone tries to persuade investors (and they're largely succeeding, it seems) not to be concerned about Cyprus because it's so small, the country declared that its banks will remain closed through next Tuesday. Russians are lecturing Europeans on how the seizure of private property reminds them of Soviets. And, after declaring that the Cypriot government had to enforce the levy or lose the bailout funds - and then watching the legislature vote 36-0 to reject the levy - European officials are trying to find some way to look like they are sticking to their principles while compromising them. The ECB has delayed a decision on whether to keep supporting Cypriot banks as the discussions between Cyprus and Eurozone finance ministers continue. Looks like someone really does want to pass that unimportant Calculus exam! Perhaps we should not take the protestations of insignificance at face value.

All of which is to say that within a week or two, unless the Eurozone capitulates, Cyprus is still going to go through bank failures and sovereign default and possibly exit or be ejected from the Eurozone. The market is pricing a near-100% chance that these finance ministers capitulate, scuttling their own political futures for the sake of the Euro and returning the Euro crisis to a slow simmer from a rolling boil - not solving anything, but delaying the inevitable. So far, this has been a good bet. But 100-1 odds are probably worth taking, especially when it involves a politician sacrificing his/her future for an idea.

The FOMC also met today, and as expected the pedal remains pressed to the metal. If there had been any question about that one week ago (and I don't think there really was), the Cypriot events eliminated any chance that the FOMC would even hint at an eventual walking-back of liquidity. It's not going to happen any time soon.

On Thursday, we'll get a look at Existing Home Sales for February. While most focus will be applied to the headline number, which is expected to touch 5.0mm sales for the first time (absent government programs) since 2007, I am much more attentive to the year-on-year rise in the median home sales price. That figure was last at an astounding 12.61%, and surely can't go much higher than that?

 


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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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