What TMM have learnt this week

Having spumed out all their funding ire yesterday, Team Macro Man are resting back exhausted. It is time for reflection. So what have we learnt this week?

- Funding disasteristas have had their guns spiked by CB actions, or rather - offer of actions (you know TMM's thoughts on the funding story from yesterday's post).

- TMM are surprised that so many people who should know better don't (on many issues).

- SNB have survived the first week of eur/chf 1.2000 defence despite a crucifiction of everything Euro earlier in the week and a market adamant that it will fail. Looks solid.

- UBS didn't and doesn't. There is a really good reason why you don't promote people from back or middle office to front office: they know the systems well enough to cover their tracks. Better the norm where very few front office people have a clue what happens to a trade once they press "done". Leeson, Kerviel and Adoboli all had this in common. Note to management - if you want to hire a back or middle office guy to do a front office job, hire them from a different bank.

- When traders are in the office past 10pm, something is a foot. Risk managers should have an alert for when traders fail to "beep" out of the office.

- Judging by TMM's inbox Nigerian scammer jokes are easily transposed to Ghanaian scammer jokes.

- TMM are still scratching their heads as to how he managed $2bio, or is this the biggest kitchen sinking ever?

- All European politicians should be fired.

- Timmy G is running european policy.

- Lagarde has bigger balls than the tow hitch on a redneck's pick up.

- Be sceptical when punters declare Asia/NOK/SEK the "new safe haven".

- MXN may be cheap, but some folks seem determined, to TMM chagrin, to make it cheaper.

- Materials inventories are piling up in China and Chinese cement co's are trading really poorly (which makes TMM happy).

- In non-political land Global IP was actually not too bad in August.

- Ringfencing bad european debt would have to involve seas and oceans.

- Banks are to become village post offices.

- Village post offices are to be closed.

- Old fashioned Merchant Banking will respawn with TMM looking forward to names and addresses such as "Wimble, Womble and Phlewwin, Old Dribble Lane, The City" returning to fashion.

- leverage is for pivots.

TMM are now settling back to watch the second half of Greece vs Germany...

What Euro Dollar funding crisis?

But first, what a difference a phone call makes.

1. Germany and France put in a "catch up" to their pal Papa in Greece and tell the world that they told him that they are right behind him.
   
2. The Letch makes a "tell it like it is" call that mentions Mangler and is overheard.
3. A UBS trader makes a couple of calls which result in a final one to his imminently ex-boss involving the words "HOW MUCH?????" being screamed a lot.

To which the market is replying:

1. "Oh good, that's all sorted then. Can I now buy Greek debt yielding over 100%?".
2. "Ooohh... he's a one isn't he!".
3. "Jeez, that's not good. I'd better shut down my risk just in case I haven't dotted an 'i'."

But TMM is thinking:

1. Is that Timmy G's voice in the background? This should be enough to divert the attention of the attack dogs long enough to focus on other market things. Isn't Aussie looking sick!
2. Its always been hard to prove that Berlusconi has lied.
3. We wish we were forensic auditors, demand is about to go through the roof again. Oh gawd, we are going to have Vince Cable on every media outlet crowing his 'told-you-so-evil-bankers-turn-them-all-into-village-post-offices-staffed-by-sweet-old-ladies' mantra. Also, rogue trader announcements have uncannily marked market turns (Leeson and Kerviel).
   

There has, however, been one phone call made that makes no difference at all:

"Hello Mr Osborne. This is Dr King. Mervynflation and our expectations thereof are running like Usain Bolt on speed, but as policy bias appears to be moving from monetary to fiscal, it's not my problem and I suggest you raise taxes".

Now then, on to something that has been sticking in the craw of TMM for some time and has them jumping up and down in frustration every time a headline on European funding is waved in front of them as example of "the massive US$ funding crisis that European banks are suffering". The sheer frenzy that journos and punters whip themselves into reminds them of this scene.

TMM reply "there isn't a funding crisis - there are more dollars floating around than you can imagine" and here we put our case as to why and try to debunk some of the recent hysteria over "funding" headlines, messages, emails and cut n pastes from the "Hero Zedgers" that appear to confuse simple issues. We want to clear a few things up.

Forgive us for starting with old material, but for completeness, in the early days of the crisis, as USD funding markets shut down, leveraged institutions in Europe and elsewhere were forced to use the FX Forward market to borrow Dollars in significant size, driving the Cross-Currency Basis sharply negative. In the case of EURUSD, this basis is the difference between exchanging a stream of US 3m Libor coupons and a stream of EUR 3m Euribor coupons, and is quoted as the number of basis points deducted from the 3m Euribor stream. If 3m Libor and 3m Euribor were both riskless and there were no relative liquidity preference for USD over EUR, then this difference would be ZERO and the FX Forward would be priced as the difference between the two deposit rates. However, that is the world of textbooks, academics and arbitrage, something TMM have rarely found to be useful in their careers. But we digress, the point here is that the more negative the basis moves, the more people are willing to pay for USD through the FX Forward market.

Since 2008/9, cross-currency based funding has reduced significantly as banks and hedge funds de-levered their balance sheets, and the advent of QE led to the explosion of the Fed's balance sheet and a sharp increase in the excess reserves of foreign banks' US subsidiaries accounts with the Fed. This means that cheap and abundant USD funding has been available to those large international banks lucky enough to have an account with the Fed, but smaller ( and usually peripheral European banks) in need, have usually had to utilise the FX Forward market to borrow dollars.

With the European situation deteriorating, the 3m Cross-Currency Basis (see chart below) has once again moved sharply negative, but in contrast to 2007-8, TMM's mates in the forward market report more USDs than pieces of Lego in the overnight and tom/next markets, while term prices are moving largely on the back of broad-based risk aversion. This is an important point - early on in the crisis, FX Forward and basis markets were a leading indicator of trouble precisely for the reason that such large funding exposures had been built up in the 5years prior. This just isn't the case anymore. By early-2009, the large part of bank cross-border funding exposures had been unwound as European banks sold EUR/USD in order to pay down the losses on those US assets. And, as above, central banks have provided significant amounts of liquidity and liquidity back stops in the form of FX Swap lines - simply put, the amounts traded in this market just aren't that large anymore, because generally, banks do not need to tap it for USDs.

Yesterday, TMM's IBs lit up in excitement at the ECB's USD Auction Allotment showing that two banks had borrowed the princely sum of $575m from the ECB. The below chart of the facility's usage should put this into perspective. Today's ECB marginal lending facility showed a jump to EUR 3.4bn borrowed, from the usual few hundred million a day. More excitement. I don't think anyone would be particularly surprised that a few peripheral banks might be having a tiny(!) bit of problem funding, and were forced to go to the ECB facility to pay 2.25%. But let's be realistic- versus assets earning yields of 5% or more, this is hardly going to force them to go bust. But that is a different point entirely. TMM's main point here, is that this number often bobs up and down because of technical factors such as:

1. A missed payment from a counterparty for a number of reasons ranging from human error to IT systems issues.
2. Someone not accessing the ECB's MRO in enough size and thus being forced to pay up for funds.
3. Someone getting their funding calculations wrong (TMM have seen it happen first hand) and it being too late to rectify by the time they realised this.
4. An unexpected late day payment.

This stuff just happens, it is not unusual. Of course, were the amount to move rapidly higher then it would certainly signal something more serious, but as of now, TMM are unconvinced.

Next, while historical data for European CP issuance in the US is sketchy, due to the primary nature of the market, as a proxy, the below chart shows 30day Natixis Commercial Paper, which should be a reasonable approximation to the rates that European banks are paying directly on CP in the US. It has certainly moved higher over the past two months, but as a reality check, 0.45% for one month unsecured money is hardly a sign of severe funding stress.

As a comparison, the below table shows the current implied US $ funding rates from the FX Forward Market vs the ECB $ Auction and the above direct US $ CP issue assuming different rates of Euro funding - unsecured (Euribor), EUR Repo market, EONIA, the ECB's 7 day MRO, the LCB's LTROs and the ECB's main refinancing rate. The ECB $ Auction works out to be about 1.1% (1week US OIS +100bps), but in reality is a bit more expensive than that due to the need to post collateral for the 12% haircut. The point below is that generally, market Dollar funding costs are just not high enough for banks to need to tap the Fed/ECB swap lines, with only the 3m Euribor-based rate being really higher than the ECB auction rate.

Graphically, looking at the 1M implied funding rates, it's not really obvious that these are particularly extraordinary, and only at the kind of levels seen last December. The Orange line shows the rate implied from Euribor, the yellow line implied from the ECB's LTRO, the whte line implied from Eonia, the green line implied from Euro repo and the pink line the Natixis US CP rate. The chart makes clear the distinction between unsecured borrowing in Europe and swapping it (orange), and accessing the ECB's LTRO and swapping it (yellow) and the secured repo-based borrowing (green) and the better-quality banks that are still able to access the Eonia market (white line) and US market direct (white line). As we have hit the level at which it is becoming attractive to access the ECB's US $ Auction facility, TMM would not be surprised to see the allotment here move higher should current market rates prevail, but would not read anything into it other than the fact that it may well be cheaper to tap than the market itself...

A slightly longer term chart:

Unless the allotment spiked dramatically into tens of billions of Dollars TMM does not think there really is a Dollar funding crisis in Europe.

How Europe Sees Itself

Happy Birthday To Us

Today is the fifth birthday of this Blog. Macro Man couldn’t have picked a more torrid 5 years and perhaps one day a lump of magnetic material will be dug up from a bog, analysed and found to contain the financial equivalent of the iridium that pointed to an explanation for the death of the dinosaurs. The Macro Man diaries could be pawed over by academics of the future to then be held up in business schools, philosophy, psychology and history classes as proof of how NOT to run an economy, financial institution, monetary system, political system, society or world.

Or, more likely, held up as an example of how in the past people had nothing better to do with their lives than invest man-years developing complex technologies so that they could waste more man-years filling them with complete rubbish, (if they don’t find Facebook and Twitter first).

In the past five years we have spectacularly seen the western hegemony go from boom to bust. The complexities of economic theory proved, E=MC2 like, to be nothing more complex than a meld of "live within your means" and "if someone else is willing to do your job for less, you are screwed", leaving us at this very moment unemployed with the debt collector at the door.

Today's story is once again that the debt will be paid off by a massive infusion of money from China, the type O universal money donor to all the type AB universal money recipients of Europe.

"Nothing changed there over the last 5 years."

Meanwhile the second wave banking crisis appears to have come to fruition. The mighty French banks that appeared unscathed by the 2007/8 sub-prime mortgage disaster are currently suffering from their own sub-prime sovereign disaster. To the point that the vigilantes are marking BNP's market cap at EUR29bio... This, for a company that has 50bil of tier one capital, made E7.8bio profit last year, had assets last year of 3.1 trillion and most importantly, is the pride of a government proved to be interventionist in the protection of its national treasures and whose demise would make Lehman Brothers look like a Buckingham Palace tea party, TMM think that it has all gone too far and refer you to Andy Haldane’s superb speech. Especially the part:

“Asset prices are guesses about the future. Faced with uncertainty about the future, market participants form these guesses using their own heuristics. One such heuristic is the “popular narrative” – a simple story that aims to make sense of reality. Risk on/risk off is precisely such a popular narrative. The effect of popular narratives is to increase psychological contagion in financial markets. Simple stories generate market mood swings. The greater the uncertainty, the more compelling the simple story and the greater the amplitude of these mood swings...

...All of these behavioural elements have come together in today’s financial markets – disaster myopia, intrinsic uncertainty and deep trauma. This may help explain why risk-takers have their foot poised on both brake and accelerator, why risk capital is in stop-start mode. That implies a risk of heavy and persistent financial congestion in the period ahead. With hindsight, Roosevelt’s fear (of fear) in 1933 was well-founded,
economically and psychologically. It may also be being repeated."

Roughly paraphrased as "MAN UP!".

This is particularly apt today where simple story 1, the “we are saved” FT story, has been replaced within a couple of hours by the “we are doomed” story written by a proven euro shock jock trying to whip up panic over BNP using the well known and innocuous ECB/FED swap lines.

TMM urge the market in true scouser style to please “CAAAAALM DOWN”. Which is really not their job as it should have been enforced by a stern hand and clip around the ear from the Eurocrats. But, like a ginger haired teacher in a Peckham Comprehensive school, they appear to have lost complete control of the class.

The rest of the world is steadily losing patience with the lack of European control too. The US’s Timmy G is being airlifted in to sit in on the EU finance ministers gathering in Poland on Friday which to TMM smacks of early 2010 when he taught the Eurostriches the one trick of STFU which worked so well throughout the summer of 2010. Unfortunately it is now completely inappropriate and is having the wrong effect. Now they urgently need to be taught how to speak again, but with one voice. So TMM are hoping that a new era of SWOV will be forthcoming.

That’s enough of the heavy stuff. Normally at school on your birthday you get a cake and are allowed to play games so to celebrate we would offer up the chance to expand TMM’s glossary of TMMisms and invite suggestions. The top 5 will be added. More if thought apt. We know this is pretty pathetic but as we don't have any TMM T-shirts, mugs or financial bailouts to hand out its the best we could come up with.

View of Hell

With the G7 having once again pulled off another spectacular impression of a wet sponge, the market is now feeling like Neville Chamberlain declaring "I have in my hand a piece of paper..."

But they are not as naive. So thanks G7, your commitment to solving a problem that unfortunately has time dependency attached to it has left today's markets looking like a work by Hieronymus Bosch.

Observe the French banks in the background of the work providing the back lighting for the rest of the scene as periphery debt holders jump from the cliff (top left) as the battle at the gates of Fortress Europe are fought. The rest of the symbolism is pretty obvious though TMM invite your own observations.

But through TMM's less medieval eyes we see the picture slightly differently and can sum it up as:

1. Greece obviously wants to get away with doing as little as it can. Hence, fiscal slippage.
2. Germans have foot on Greek neck, and whenever they loosen it, Greeks backslide.
3. Germans push their foot down harder on Greece's neck, so Greeks come up with the goods.
4. It doesn't make sense for Greece to default when it's running such a large primary deficit, so the Greeks acquiesce when pressure is applied.
5. IMF/Germans send the cash.

But with the G7 sailing on by, it looks like the markets are going to be left alone to sort their own problems out rather than counting on any lifebelts being thrown in by the CBs or policy makers in the short term. TMM hope that the need for self help rather than spoon feeding will result in a little more introspection rather than the mad dash from bad headline to bad headline. This morning's news flow really hasn't been that bad as the Europeans do seem to be trying to show a little more unity than usual, and official expectations of the Troika outcome are being flagged as positive. TMM hope that it's worthy of Prokofiev's cheery "Troika" that they can't get out of their minds every time they hear the word. But for today we are back to "price" once again being the news...

Halfway through hope

 We mentioned yesterday that the hopes of the world were resting upon the actions this week of the central banks and policy makers. A day later we have had the results in from the BOE, the ECB and Obama's job package with only the G7 to come.

ECB - TMM's take was that JCT spent the first 15 mins trawling through the usual numbers associated to CPI and other price stability measures to justify their "no move" stance. Meanwhile the market was starting to mumble  "errr.. and? Does the guy really not get it?" The growing "does he not get it" then manifested itself in the more and more pointed questioning along the lines of "do you not get it?" to which he more and more violently expressed the view that it wasn't his job to "get it" as the only stupid piddling target he had been given to play with was  "price stability" - Which TMM think he felt is like being told you are in charge of the cup holder in the Millennium Falcon as you take on the Empire's Deathstar.  Mind you, he did put a very convincing case for what a wonderful job he had done with the cup holder and how he was amazed that no one had called him into the Federation's Galactic headquarters to give him a medal. Unfortunately TMM didn't quite see it that way and think his reading from the start of his forthcoming memoires has instead just highlighted the rift between the ECB and the politicians at a time when unity of response is needed. Lagarde, even this morning, is saying that monetary policy needs to be more accommodative but until they change the ECB's mandate TMM think it will probably take until December before the rear-view mirror of the ECB 12 yr old quants  picks up enough historic data to trigger an inevitable rate cut.  -1 Point.

BoE -  Think they must have had McKinsey Consultants in to advise on their policy announcement having obviously been told just to photocopy the last one and send it out again. Nil Points

Obama - Better advised (probably by Simon Cowell) having already teed up the market for a $300bil plus from an earlier $250bil, he went for $447bn (why not $450bn?!). TMM didn't actually hear the announcement but would not have been surprised if it had been accompanied by the "sentimental rising success of underdog to winner" music, so overused in X-Factor style shows, after brief background interviews with his friends and family all saying how much he REALLY REALLY wants this to work, it's his dream, how it will change his life should he win and how he really hopes the Republicans will give him their votes. TMM think that him holding out the olive branch of $245bn of tax cuts mean the bulk of the stimulus should be enacted. Not the viewers' favourite, but having Simon Cowell behind him means through to the next round. +2 points.

The net effect of the above has been to make Eur/usd the litmus paper of Austerity vs Stimulus policies and it's now trading on a 1.38 handle.

As a quick aside on another function that TMM is being told to sell Eur/usd on -  There has been plenty of muttering out there about a possible announcement of HIA2, a sort of super HIA where repatriated funds are conditional upon "good" investment. TMM however think the likelihood of such an announcement in the short term is neither likely nor advisable because all it does is encourage corporates to keep cash abroad for the future, on the expectation that there will be another future tax holiday with result being that corporation tax receipts fall structurally. Bad idea.

We now await G7 - Whereas the results of the other announcements appear to be parochial, the response to this one should be global. Interesting that we had the first glimmer of agenda with Geithner's piece yesterday in the FT. Not exactly earth shattering in its novelty but if they actually get any of this done then it will be seen as a seismic shift relieving some of the stresses in the plate tectonics of imbalances. TMM's reading of punters is that little is expected ."What can they do?", which means they start a point up. TMM would like to see something a little more punchy and wonder what the chances of the following happening are:

1) G7 propose global bank stress test administered by the IMF, and commit to forcibly recapitalise banks either directly (for those governments that can afford it) or via EFSF (for those that can't).

2) G7 and China state they are ready to support the Eurozone by explicit purchases of government debt from Exchange Stabilisation Funds.

3) G7 agree to extend the scope and attractiveness of central bank swap facilities and explicitly encourage their use by banks.

4) G7 reiterate commitment to "No More Lehmans".

5) G7 reintroduce bank liability guarantee schemes (e.g. TLGP).

6) G7 announce a new round of gold sales in order to recapitalise banks.

7) G7 central banks agree to purchase bank bonds

And finally, this has been out for a bit but considering the Lagarde comments and those she made at Jackson Hole and pre-G7, TMM wonder if this paper first pubished in March could form the basis for a new Marseille Accord creating a new system for Global Capital Markets and FX?


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Stop Press

TMM have over the past year experienced first hand the absurdities of Greek economics and now hold up as exhibit A this latest piece of data.

"Data released by the Hellenic Statistical Authority (ELSTAT) suggested that Greece imported 1.5 million euros worth of olive oil -- once a staple of its agricultural production -- from Germany in 2010"

Dax Rebate

Who would have thought that the ballooning of fear would be deflated by the sedentary Swiss. But that is certainly what appears to have happened with the hysteria levels much lower as our IB chatometers have returned from doom+ levels to a more balanced outlook with stories of hope tentatively being offered. So for now the equation is:

Global Terror + SNB + Hope(G7+HIA+ECB+UKQE) = Relief

Which suits TMM just fine.

TMM have, as you may have detected, been erring between tentative equity buyers in the style of "on the one hand" hedge me calls analysts, to outright "so excited we cant pee straight" buyers. Of course, the SEWCPS signal is usually a sure indicator of unreasoned stupidity, so we thought we d better have a closer look and see if it is justified.

And that brings TMM onto the DAX, which has taken a very large pummeling in recent weeks. Obviously, the imposition of short-sell bans in Europe, preventing the EuroStoxx future from being used as a hedging mechanism has played a large part in its under-performance as "hedgers" moved to short the DAX instead. TMM use the term "hedgers" loosely, as it seems to them that given the wild cheering on their IBs and email messages the past couple of weeks to the move lower in the DAX, that there are a great deal more players short the index than merely hedgers alone. Indeed, TMM's sales coverage has highlighted a lot of interest from macro hedge funds in being short, meaning that there are a significant number of "Tourist Traders" in that market. The trouble with this is that the DAX is a lot less liquid than the EuroStoxx. Now, TMM have learned very painfully in the past that when trying to get out of positions that are illiquid when everyone else is positioned the same way that the door isn't big enough and you get Pink Flamingo-ed.

Now, TMM admit, positioning is not a sufficient trigger for reversals, and neither are valuation-based arguments - which as many point out - are vulnerable to becoming value traps. But for completeness, TMM reckon it is worth considering what the downside in DAX could be. As with all models, the below (very) naive model for the YoY change in EPS for the DAX (based upon lagged ISM, IFO, CPI, PPI and Wage growth) is meant only to be illustrative from the macro level, rather than fully explain earnings growth or margins or any particular specifics. [Stats Geeks: the large tech-related write-downs in 2001-3 make it not particularly meaningful to look at YoY % EPS growth when modelling, but looking at the straight change in EPS growth should eliminate the root unit problem in the regression.]

The last model print in the chart assumes that IFO falls 4pts this month to 102 (which seems reasonable given the falls in the PMI etc), and the final three lines are rough forecasts of the underlying variables for a Mild Recession (e.g. 2001-3), a Mid-Cycle Slowdown (e.g. 2005) and a Global Financial Crisis-style Hard Landing (e.g. 2008/9).

Translating these into more meaningful %age changes and the implied Earnings yields under those scenarios, and making the exceptionally conservative assumption that the current DAX price discount ZERO fall in earnings (while it clearly does)then in a GFC-style crisis, this would imply earnings falling nearly 87%, leaving an earnings yield of around 1.4% (vs. Bund Yields at 1.89%). Now, TMM tend to think this model is perhaps too pessimistic, given that in 2008/9, earnings actually only actually fell about 60%, and that would leave the earnings yield sitting around 5.8%.

Either way, the point of this exercise is to demonstrate that the DAX already pricing in a pretty dire macroeconomic outcome. In fact, TMM reckon that it is hard to argue that the DAX does not already price in EPS falls of some degree, and thus the above numbers understate the actual Earnings Yields in such scenarios. And thus, it is pretty hard to argue that the DAX is anything but exceptionally cheap in this framework, with a forward P/E of just 7.3x.

Now lets look at the background. Interestingly news-flow has begun to improve, with the German Constitutional Court ruling and Italian fiscal packages voted through, the US economic data stabilising, a US Jobs Plan in the offing and the potential for a G7 policy response that is likely to target the recapitalisation of Europe's banking system (judging by recent leaks), all falling onto a market that has been up until recently been wrist slittingly suicidal. The technical picture is also supprtive of a run higher with dojis/island reversals in various equity markets and even a soothsayer signal in the DAx itself, we reckon that the conditions are in place for a more dramatic rally.

SO, are we still at SEWCPS levels? Yeah... why not...? Where's the fun in life if you can't jump around like a 9 year old at the sound of the ice cream van coming down the road*?

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* TMM have a friend whose dad told them at a very early age about the tune the ice cream van plays: "Well they play it when they have run out of ice cream and have to go back to the yard". Masterful parenting.