Uncertainty and European Bank Risks

The stress of the global financial crisis continue to haunt European banks as the economy continues to slow and bond vigilantes target sovereign debt of countries (such as the countries of the eurozone) who do not have their own fiat money.  The emergency lending facilities of the ECB have become more important for many European banks. On last Monday, banks deposited 128.7 billion euro with the ECB and borrowed 555 million euro overnight from the ECB Marginal Lending Facility, which was up from 90 million the prior day.  As Greek default becomes more inevitable and other eurozone countries struggle with sovereign debt financing, the interbank lending market has shown increasing stress as the skepticism about bank liquidity throughout Europe grows.  On Tuesday, European banks borrowed 2.82 billion euro overnight from the ECB, despite the stigma attached to the Marginal Lending Facility.

As the result of increasingly perceived risk by investors, European banks will pay more for the $100 billion of cash they need to raise by the end of the year.  Banks are hoarding cash, depositing it with the ECB, rather than lend it to other banks as political leaders squabble and preach deficit reduction which will only slow the economy faster.  Credit Agricol, with significant Greek exposure, posted profits which beat forecasts and felt compelled to complain about unjustified market irrationality and volatility.  A Bundesbank board member stressed in public comments that recent dollar money market tensions were far from the 2008 crisis levels and European banks are not facing a funding crisis as the result of U.S. money market funds becoming more selective to whom they lend.  The Bundesbank board member emphasized the liquidity available through repos and the ECB's readiness to mitigate problems with the swap agreement with the Fed. On Thursday, the Greek central bank (Bank of Greece) announced it had activated an Emergency Liquidity Assistance program to insure liquidity funding and all small, medium, and large Greek banks, except the National Bank of Greece, have indicated they will participate.  A Fitch survey of U.S. money funds showed a 9% decreased exposure to Europe last month and significant caution with respect to Italy and Spain.  Bankers have estimated that Italy lost $40 billion worth of money market funding in July.  While these figures are miniscule compared to the 8000 billion euro funding of the 91 eurozone banks, it does show the true state and reliance of eurozone banks on short term funding with some 58% of that funding needing to rolled over in two years and 47% in less than one year, but the official line is that there is nothing really wrong with the eurozone banks.

Today, Christine Lagarde of the International Monetary Fund, in a speech at Jackson Hole, said that European banks may need urgent forced capital injections to stem the eurozone's sovereign and financial crisis as they must be strong enough, in her words, to withstand the risks of sovereigns and weak growth.  She indicated that while private funding should be the priority, public funding, perhaps through the EFSF, should be ready.  She emphasized the IMF's change from immediate fiscal tightening to fiscal programs which allow spending to continue now while economies stay weak and reduce deficits over the long term.  This speech occurred at the same time as the second and third largest Greek banks announced an all share merger to be followed with a 500 million euro capital injection.

This IMF changed emphasis which acknowledges the need for public spending to feed growth during periods of declining aggregate demand is a refreshing change from the 1997 austerity mistake the IMF imposed on Japan which stifled growth.  Eurozone banks will remain key indicators in a global economy which is slowing down and economic contraction which eurozone austerity has accelerated.

Print Page

Radio Appearance Discussing Global Economy

On Saturday, August 20th, I was a guest on Saturday Session with Bishop on WMAY and streaming live to discuss the global economy.  The conversation focused more on China and the United States and briefly touched on Europe, which is a larger and more looming problem, due to time constraints.  I am providing a MP3 link to the interview appearance.  It is all about growth globally and jobs in the United States and several eurozone countries.

Print Page

Does High Frequency Trading Stoke Volatility?

There is a lot of speculation in the financial media and among individual citizen traders about whether high frequency trading is responsible for market volatility because it ignores fundamental analysis for data trends.  Obviously, high frequency trading could increase trading volume and accelerate market trend through volume.  While the sheer volume and speed can effect prices and there has been speculation that a high frequency trader could, and maybe has from time to time, driven an equity or futures price up on sells and buys to itself, the real question is the fairness of access.  All high frequency traders have direct access to the market through broker-dealers making trades in nanoseconds, causing the question to be raised whether they have the proper structure to insure proper margins and other technical regulatory safeguards.  Since a single high frequency trader could send a million or more messages a day to a market with few trades, the cost to the stock exchanges for adequate data networks is very expensive.  Individual traders do not have direct access to the market and must meet all regulatory conditions as do broker-dealers who have direct access to the market.  The bottom line question is, consequently, one of fairness.  Do individual traders get speedy market execution and a fair market price? 

The Review of Futures Market has a special issue (Volume 19)of which the first article reviews the research literature and methodologies on high frequency trading and the last article is on the effect of high frequency trading in the futures market.  The first study finds high frequency trading is a natural evolution of the trading process, add "quality" to the market through added liquidity, lower trading prices, and reducing bid-ask spreads at the cost of shifting profits, however small on individual trades, through trading volume, only pose a modest manipulative threat because they typically do not hold positions overnight, and only present a problem when they withdraw liquidity from the market causing system breakdown or cascading.  The study suggests the need to design electronic trading systems and to slow or interrupt trading and/or change the trading mechanism.  The last study finds that high frequency trading increases liquidity in the futures market.

Individual investors would be wise to not spending time researching and fretting about the effect of high frequency trading on equity prices and concentrate on the technical and fundamental information of the equity and the market.  You never fight the market and individual investors need a very profound analytical and economic reason to be in individual stocks during a market correction.  Consequently, individual investors would be wise to pay attention to not just price movement of the equity and the market, but the volumes.  This market is not only in correction but it has been testing March lows for the last two weeks with temporary reflexive rallies of short duration.  A week ago last Monday, Monday the 15th, was the fourth market day in successively lower trading volume (down 16.6% that day) even though it went up 213.88 on the DOW.  The next day was down in price but up only 6.1% in volume.  The next day was up marginally on 14.6% down volume.  Thursday of that week it went down 419.63 on up volume of 63.5%.  Monday of this week (22nd) the DOW was up only 37.00 on down volume of 20.4%.  On Tuesday it was up 322.11 on only 1.7% up volume.  On Wednesday, the DOW was up 143.95 but on down volume of 8.5%.  All of these days of trading have been volatile.  The likelihood that today would be a down price day with up volume would have been a reasonable bet and, in fact, that is what is occurring at this time.  By watching price, volume, and economic news, which means knowing what economic reports are coming out on what days not just event news, the individual investor should have some reasonable trend indication which will serve them well as they stay out of individual stocks during any correction and research stocks to buy when the market trends up for more than a short reflexive rally. 

Pay attention to technical and fundamental information on both the equities you are researching and the market itself.  You can control your buy and sell decisions and learn from them.  You cannot make yourself a better trader by researching the effects of high frequency trading.

Print Page

Gold is Correcting

When Gold hit a record $1917 an ounce this week, which was up 16% from earlier this month, trend profit taking set in creating a market correction and gold has been dropping.  The Shanghai Gold Exchange on Tuesday raised gold margins by 26% and the CME in the United States on Thursday raised gold margins 22%, both of which undoubtedly created margin calls and more selling.  Professional traders have learned and practice profit harvesting in which they reduce positions to capture and lock in gains over 20%, depending on the market and position, and definitely when they have substantial gains, such as 100%.  Even private investors who have gold at $400 or $800 basis should have been reducing their positions to no less than their original investment to lock in profits.  Gold is a crisis hedge and has been going up accordingly.  With the continuing crisis in the eurozone and the determination of eurozone leaders to pursue austerity which will only increase and magnify the problems slowing growth in Europe and globally, gold will stop its downward moves on economic news perceived negatively and start back up.  What one wants to avoid is the historically documented reversals of gold from highs to prior lows such as $400 and $800.

Some have characterized this correction in gold prices to panic selling, because it was overbought, and to fears the FED will not satisfy the market with comments on Friday from the Jackson Hole economic discussion meeting, which is reaching for causation since the FED has little it could announce from such an academic exercise.  With the margins being raised, we are seeing the same market correction silver saw in May.  It was time then to sell silver and it is time now to sell gold and harvest profits.
Dennis Gartman of the Gartman Letter was one of the professional trading advisors who began cutting their gold holdings on Tuesday when gold got "frothy" at $1910. On the same day, Nouriel Roubini was sending messages that gold was in a hyperbolic bubble, which implies a possible correction, although he also acknowledged, as I stated above, that uncertainty is rising and gold should consequently continue upward after a correction.  It does not appear that any gold correction will burst the bubble given the uncertainty in Europe and slowing global growth which will make the economies of Europe worse faster, but it will briefly reduce the size of the bubble as the professional and smart traders lock up their profits.



Print Page

European Bank Liquidity

Starting last week we started seeing questions surfacing regarding the liquidity needs of European banks as a result of the volatile swings in the stock markets (if bank stock equity goes down they face the need to raise more capital) and potential opening market attacks on French banks (which I find hard to believe resulted from misinterpretation of a fictional series in a French newspaper). On August 10th, ECB overnight lending facility use jumped $5.75 billion dollars (4.058 billion euro), although it could have been from timing issues as banks awaited the arrival of ECB six month funds.  It was noted last week that the LIBOR-OIS (bank credit risk) spread with EURUSD basis swaps was widening but differently than it did in 2008.  The LIBOR-OIS was due to a rise in the LIBOR which would indicate the gap is being driven by liquidity measures, but the EURUSD basis swap was increasing on the short end implying near term caution rather than systemic risk.  Short term wholesale funding problems are magnified when access to long term funding in senior unsecured debt markets become more independently difficult for banks.  Nomura  noted the net stable funding ratio shows CASA, SocGen, Bankia, UniCredit, Commerzbank, and Intesa with the lowest ratios, but no European banks have reserve problems and, as of last week, no European bank had gone to the ECB for USD liquidity.  In relation to the short term liquidity functions last week, it also appeared that the peripheral eurozone countries were having a collateral crunch as well as a credit crunch.

Yves Smith at naked capitalism noted this week that mid-tier banks are finding it harder to get funding in interbank markets, that five year CDS of eurobanks are trading wider than they did in 2008m U.S> money market funds have cut back on exposure to European banks, eurobanks are have a harder time borrowing euro from the ECB to swap for US dollars, and the eurozone is not prepared for any large scale recapitalization of banks program.

On Wednesday of this week, one European bank borrowed $500 million, which was an unusually large amount for one bank, from the ECB in US dollar liquidity for the first time since February.  This would indicate it was probably a larger European bank under temporary stress.

Today, the Wall Street Journal wrote that the New York FED is meeting with the U.S. offices of large European banks to gauge their vulnerability to to escalating financial conditions and potential funding difficulties as U.S. branches of foreign banks became net borrowers of dollars from their overseas affiliates for the first time in a decade.  The New York FED President, Dudley, was quick to publicly state this was just a standard FED review.

On this Wednesday, excess liquidity in money markets actually rose 167 billion euro as Euribor lending rates went down.

This has led to a renewed discussion, involving nerves, noise and funding fears, of what level of funding stress European banks may or may not be facing.  While there are indications of stress in the wider markets, the spread on the three month Euribor rate and the overnight  index swap OIS rates has widen but nowhere near the post-Lehman 2008 peak.  What is interesting is the spike is from a drop in the OIS rate not the Euribor, which implies banks think the swap rates will drop and liquidity improve.  This would indicate the situation is not one of extreme stress, but an evolving situation which requires watching.

Print Page

Inflationistas Beware

When the PPI (wholesale prices index) report came out yesterday for the United States, it caught everyone off guard, because core PPI went up 4 tenths to 2.5% when it was expected to go up two tenths and headline PPI went up 2 tenths  to 7.2% when it was expected to be unchanged.  The increase in the core PPI was a jolt and prompted many of us to dig into the report and wait to see the CPI report today with every expectation it would exceed expectations of up 2 tenths for both CPI and core CPI.  Today, the CPI report showed headline CPI went up 5 tenths to 3.6% and core CPI went up the expected 2 tenths to 1.8%.

When looking at the PPI numbers, it should be remembered that PPI has been more volatile than CPI, although it has been trending  with CPI more closely recently.  The headline whole sale prices were up on tobacco, trucks, and pharmaceuticals.  Looking at crude prices were down for the third straight month declining 1.2 with commodities down, but core crude prices were up on copper and corn.  We have previously written about copper in relation to China as loan collateral and the slowing global growth should bring it down as well as corn being up temporarily on weather conditions and Japan.  Crude foods were down 8 tenths.  Finished goods were up 6 tenths on fresh fruit (which are in season), melons (in season), eggs, dairy, coffee, and beef and veal with crude down 9 tenths but processed up 7 tenths.  Intermediate prices for foods were up only one tenth on processed eggs and natural, imitation, and processed cheese.  The FED is more likely to look at intermediate prices for future trend.

Headline CPI was up on food at home, dairy, fruit, energy, gas, and apparel.  Core CPI was up on shelter and medical care.

It is apparent in the CPI prices that there is impact from past higher commodity and transportation prices which have since started to decline and this decline in commodity and transportation prices is not yet reflected in the current CPI.  When looking at CPI, it should be remembered that headline CPI is more subject to transitory volatility which does not stick.  Consequently, core CPI is a more effective tracking of inflation/deflation trends.  While this does not help the pain of a pocket book in a grocery store today, it is significant in having a more accurate macroeconomic perspective.  Core CPI went up the expected amount and, at 1.8% annualized, it is still below the FED 2% target for growth.

Growth remains the problem not inflation long term.

Still, it is historically relevant to realize that if the CPI figures were as calculated in the 1980s, it would be approximately 11%; if they were as calculated in the 1990s, it would be approximately 7%.

Print Page

Links 8/16/2011: Eyes on Growth

These are links from last week through 8/13/2011.  A little hindsight never hurt objective analysis.

Hussman's market commentary beginning of last week.

Grantham last week on global economy, seven lean years, and investing in a corrupt world.

Kudlow Comedy Capers.

Facing reality

Investor flows and 2008 Oil prices.

Index funds and commodity prices.

Equity prices and growth scares.

Down stock market not S&P downgrade but lack of growth.

S&P decision irrelevant.  Bill Mitchell

David Levey on S&P downgrade as unwarranted.  Rajiv Sethi

Defining economic interests.

Limitations of ECB are its failures.

Market reaction and default. Paul Krugman

Eurobonds or bust.

Slithering to the wrong kind of union.

Stagnant and paralyzed.

Tax Expenditures are big government and should be cut (what the rich do not want to hear).

Target2 & ECB liquidity management.

An experiment in austerity. Bruce Bartlett

An alternative to austerity.  L. Randall Wray

Bank of England's substantial risks.

Deficits and defense spending.

The many ways to count Chinese debt.

Eurocrisis reaches the core.

We don't have a long term debt problem.  James Galbraith

It is a weak economy not a AAA credit rating downgrade.

Illinois budget does not address pension payment backlog.  Moody's

Still waiting for expansionary contraction in UK.

The crisis is unemployment not debt.

Income inequality is bad for rich people.  Yves Smith

The FED dissenters.

Failed monetary policy created this crisis.  Joseph Stiglitz video interview

The return of the Bear.  Steve Keen

Debunking demand and supply analysis.  Steve Keen

Fractious national leaders cannot lend stability to Europe.

Irish NAMA bad debt assets.

Freedom is not built on free market corruption.

Europe's rational idiocy.  Yanis Varoufakis

Why ECB must issue eurobonds for its own survival.  Yanis Varoufakis (I have long advocated need for eurobonds but I do not believe the ECB would be the proper issuer)

Chaos is dawning on dysfunctional governments.  Andy Xie

German taxpayers willingly subsidize bankers.  Michael Hudson

Germany must defend the euro.

Tea Party not factually correct; a conservative criticism. Simon Johnson

Shorting ban on euro banks and macroeconomic threats.


Will the Swiss franc be pegged to the euro?

Swiss franc exposes foreign currency denominated debt exposure of Hungarian banks.

Unofficial U.S. problem bank list at 988.


Print Page

German GDP less than Spain GDP Q2 2011

German GDP for Q2 2011 came in at one tenth of a percent growth; five tenths was expected.   Spain had a growth of two tenths of a percent.

Eurozone GDP Q2 grew two tenths of a percent; three tenths was expected.  The eurozone and German economy are slowing.  The French Q2 GDP was unchanged (zero growth).  Manufacturing and exports declined and the eurozone trade deficit widen even though imports declined 4.1%.

Yesterday (Monday), a VOXEU paper asked if Germany can be Europe's engine of economic growth and concluded that Germany needs, as many economists have been urging for some time in discussing the current account imbalances within the eurozone, to rebalance sustained growth toward domestic demand with increased domestic investment and higher incomes which implies less unemployment if done right.

Meanwhile the credit crunch in the eurozone periphery continues as European banks struggle to obtain short term funding at a time when lower stock equity from the recent market downturn will require many banks to raise capital.

The European markets are down and you can expect the U.S. markets to open lower.

Print Page

UK Riots and Unemployment Map

Here is a map which provides UK riot incidents information on an unemployment map.  You can move it around as if it is a Google map and you can click on individual locations for specific incident information and you can see the color coded unemployment rates on the map.  It is not coincidence that these riots took place in high unemployment areas as we have written previously.

Print Page

Michael Pettis on Hidden Debt in China

In Michael Pettis' private newsletter received July 31st, I covered the first half on why china needs to buy U.S. bonds here and the second half of his July 31 private newsletter began with "Thinking about balance sheets".  Since July 31st, Pettis has also published in the Wall Street Journal an article on why China's export economy cannot continue and will slow down.

Since all four scenarios under which China can sell U.S. government bonds is unlikely (see link above for the first half of the newsletter), the purchase of U.S. government bonds is going to continue until there is a dramatic change in global imbalances.  Despite rumors every six months that they will stop buying U.S. Treasuries, they cannot until they have rebalanced their economy  and eliminated their large trade surplus.  this will take a long time and PBoC domestic debt is going to rise dramatically.  The rise in PBoC domestic debt is going to become an increasing problem for China, which most economists writing about China do not understand, according to Pettis, "...the root causes of Chinese imbalances and the vulnerabilities in the growth model. They do not see the relationship between rising debt, financial repression, and low consumption. What is worse, too many analysts see the problem of local government debt as specific to local governments and caused by misguided polices on their part, whereas in reality it is a systemic problem."

Pettis believes his approach to understanding the Chinese balance sheet is quite different as he tries to understand the development of the system as a whole and then tries to figure out how it will "...logically evolve within balance-of-payments, balance sheet, and monetary constraints."  He admits to being addicted to reading about finance and economic history, with understanding historical precedents key to his approach.  "Furthermore the work of economists like Hyman Minsky, Charles Kindleberger and Irving Fischer drives my sense of balance sheets and how changes in the structure of balance sheets affect economic outcomes. Among other things it leaves me very skeptical about prospects for financial systems, like China’s, that are engineered to maintain stability at all costs.

"Not only do these kinds of financial systems typically sacrifice efficiency for stability but, as any good Minskyite could tell you, regulatory regimes that force stability onto the financial system always result in increasingly destabilizing behavior by the agents within the system. Instability, in other words, is simply repressed and pushed forward, and the financial system must become increasingly inefficient in order to suppress the increasingly irrational behavior of agents within the system. In any financial system, as Minsky famously said, stability is itself destabilizing."

In Pettis' view, it was apparent in 2004-5 that using the balance sheet approach, the rise in Chinese debt argued that within a few years there would be real questions about debt sustainability, because "...there was no logical way for the growth model to continue functioning without an unsustainable rise in debt, and it was already pretty clear that without reform and liberalization in the Chinese financial system we were eventually going to run into another banking crisis. And ignore what you may have heard from other analysts – there has been absolutely no meaningful financial sector reform in the past decade."  He then credits Charlene Chu and her team at Fitch with best analysis of the Chinese banking system and creativity in discovering and counting debt as well as Victor Shih at Northwestern  and Logan Wright at Medley Advisors. 

Pettis specifically cites the Fitch report, "Growth of leverage still outpacing GDP growth" as an example.

Earlier this year, the PBoC unveiled the concept of "Total Social Financing" in an attempt to measure real growth in bank related credit by including various type of important loan growth which had not been included in older measurements.  For many years the key measure of credit growth was the new Renminbi denominated loans made by Chinese banks.  "By setting annual, quarterly or monthly quotas for the maximum amount of new RMB-denominated loans, the PBoC hoped to maintain some control of credit expansion in China."  But it does not work that way, because as the PBoC limited the growth of that kind of credit, the banks found innovative ways around the constraints and pushed new lending into other forms of lending.

When the PBoC produced Total Social Financing numbers earlier this year, the data showed that RMB loans were 92% of total TSF, but by 2010, new RMB loans had dropped to 56% of TSF.  "Clearly loan growth, correctly measured, far exceeded the already-very-high numbers that we had all been looking at. Among other things this meant that M2 was even less useful as a measure of monetary growth than in most other economies because much of the growth in deposits had been disintermediated. The real growth in the form of money for which M2 is a proxy was much higher than actual M2 growth."

Pettis hypothesizes that the intention of the PBoC in releasing the TSF data was 1) it needed a way to demonstrate how amazing the expansion of credit has been to the pro-growth faction in the State Council and 2) "...they wanted to reassert control over credit expansion by widening the scope of credit instruments they were monitoring."  Pettis immediately made what he believes was an obvious prediction, given his belief "...that growth is determined mainly by increases in investment, which are themselves determined mainly by increases in credit", the the TSF would quickly lose its usefulness by September of this year.  However, Fitch has already found additional credit instruments other than those included in TSF which have been expanding quickly and he quotes Fitch:  "The main portions of this uncaptured financing include letters of credit (LoCs), credit from domestic trust companies, lending by other non-bank financial institutions (NBFIs) and loans from Hong Kong banks."

 

The adjusted Fitch TSF numbers are interesting, because they show "RMB loans are down for the first half of the year, with new renminbi bank lending declining by 9.7%, from RMB 4.6 trillion in the first half of 2010 to RMB 4.2 trillion in the first half of 2011.  

"TSF is also down for the first half of the year, but of course by a lot less than new RMB loans. It declined by 4.7%, from RMB 8.1 trillion in the first half of 2010 to RMB 7.8 trillion in the first half of 2011.

"So overall credit growth is down, right? Perhaps not. It looks like Fitch’s adjusted TSF is actually up, and this doesn’t even include private lending pools and non-bank sources of lending, which anecdotal evidence suggests is way up."  Pettis then relates a communication from a PhD student who had been doing research in Ordos Municipality in Inner Mongolia relating finding a tremendous amount of informal financing schemes with some have monthly interest rates as high as 4%.  Pettis is not surprised by this as "The relationship between credit expansion, investment growth and GDP growth means that as long as GDP growth rates are high, credit growth is going to be accelerating."  He challenges if you do not see this you are not looking at the right numbers.

One last point he wanted to make was the the LGVF bonds issued by local government financing vehicles are getting hammered in the market, declining in the last month from 2-10% depending on maturities.  Pettis believes that less than 10% of LGVF debt is in bonds and roughly 80% in the form of bank loans.  He believes this will have implications for debt going forward, because, if one is a newly appointed mayor and how you perform over the next five years will determine future promotions within the political machine and you realize you have inherited a crushing debt burden and few revenues with which to cover the debt, what do you do. Soldier on and hope something turns up within 5 years and you do not get blamed for the revenue shortfalls?  Or do you make a big stink about debt immediately to establish it was not on your watch?  Could a noise be expected by mid 2012 to have arisen?  

Pettis also says it is not clear how many of the LGVFs can meet debt servicing costs and some of their land collateral may have already been pledged more than once.

Print Page