Blain's Morning Porridge - July 6th 2017 - Global Tightening, European Sovereigns and Why is DB
Blain’s Morning Porridge – July 6th 2017
“Well first you have to imagine a very big box fitting inside a very small box. Then you have to make one. It’s the second part people normally get stuck on.”
Interesting day’s play in prospect here in the Euromarkets as investors digest the US FOMC saying they’re going to start selling the balance sheet later this year. The global normalisation is underway… Ouch.
I am grateful to my BGC colleague Are Levonian for spotting this in the Fed minutes that stock prices: “suggested that increased risk tolerance among investors might be contributing to elevated asset prices more broadly; a few participants expressed concern that subdued market volatility, coupled with a low equity premium, could risk a build-up of risks to financial stability.” I suppose they are Americans and like to use many words when one – COMPLACENCY – would do.
And what’s happening in Europe?
Many analysts are waking up to the worry the ECB taper is already de-facto underway – effectively tightening and normalising European monetary policy. (Europe may finally be experiencing growth, but its hardly blowout, job-creation is low-paid and still not addressing youth underemployment.) Europe’s Central bank needs to balance its purchases according to the weight of each member state and is restricted to 33% of a nation’s debt. They are underweight in some countries and overweight in others (worryingly France and Italy), and are running out of Bunds to buy - meaning the continued “official” appetite of the whole programme is open to question.
I am sure there is a whole department of ECB lawyers reading the regulations to see how the programme can be extended. I read this morning the weighted average maturity of the ECB book is only 4 years – meaning the taper could be surprising fast. And I also read the ECB might just be considering buying Semi-Sov debt into the mix – yeah, that would work…. Interesting..
I noted some concerns about France and Italy debt – not surprisingly the ECB is overweight both. Earlier this year both countries spreads to Germany ballooned on the back of political fears. While the politics now look more stable, I detect increasing niggles on debt sustainability.
Not for one moment suggesting am I suggesting Italy or France is headed for imminent default… perish the thought.. but neither of these countries has the key attribute of a proper sovereign state.. Neither hold the keys to their own printing presses, meaning they can’t just print money to keep the state cash spigots open. Both are hostage to the EU and the Euro – and Brussels/Frankfurt is likely to complain loudly if they breach debt rules while Germany remains vehemently opposed to approve anything that sniffs of mutualisation.
Italy’s debt remains way too high, (No sh*t Sherlock), and working it down in a nation of populist politics, low growth, high unemployment, and low quality jobs, isn’t a priority. It’s just been landed with a bill to taxpayers of over €10 bln for the recent bank bailouts (and remember the banking system is still short a further €15 bln) – thus the Italian debt load looks set to increase.
France is a different matter. Macron intends to reform and rebuilt, and part of the strategy is to convince Germany it’s going to work. But France is highly dependent on the state sector – so it’s not just the Government debt, but the enormous French state agency sector, creating long-term taxpayer liabilities. How much of the French Semi-Sov sector is properly accounted on the government balance sheet, and how much hides behind the polite fiction that implicit state support makes off-balance sheet state debt a national obligation?
And can the Germans really complain? Their own semi-sov sector is large…
Meanwhile, I got a call last night from a Journalist asking about Deutsche Bank moving investment banking assets back to Frankfurt. My immediate reaction is “good luck to them” – more people make coffees in the City of London than actually work in Frankfurt. But what’s happening is more interesting; Deutsche looks like its moving its massive derivatives book from London to Frankfurt. Why? Surely there isn’t an arbitrage between where to book swap trades? Or is more to ensure London based trading books don’t become hostage to a BREXIT spat if EU Banking Pass-porting becomes a bone of contention. I’m told other banks are looking at similar options..
(I’m wondering if I should open a Dublin office of the Blain pension fund…?)
European Banks remain front and centre on my Threat Board.
I discussed my latest banking disaster thesis with a number of clients y’day. I’m wondering if the current rash of bank clear-ups across Southern Europe means that Central Bankers and Regulators know something is coming. Maybe they are clearing the decks to make sure weak banks aren’t caught up the big October Reset Moment so many folk now expect, and trigger a series of wobbles that make it worse?
Best response was “Bill, methinks you credit central banks with too much if you believe they have clue…”, to the inevitable “if even the Central Banks think a crash is coming, then fill your books as they are probably wrong..”
Finally, years ago I was fortunate to work for a God of Finance – Matt Winkler, who had the job of launching Bloomberg Business News across the globe. He was tough, but he changed the face of the financial press – moving it from palsy scratch-my-back tittle-tattle to proper source and fact led analytical journalism. The attitude was “not to be their friend”, but to demand answers to complex financial questions. He succeeded: Bloomberg Business News has become one of a limited “go-to sources of financial news”.
It’s good to see Matt is still contributing articles. I was reading one yesterday on the investment strategy of PIMCO CIO Mark Richard Kiesel. I loved this line in particular: “He sees no reason to invest in the U.K., where a year after British citizens voted to exit the European Union, the pound is weak, the economy is anaemic and inflation is rising.”
Yep, that sums it up nicely..
The article was a fascinating examination of Pimco’s Fixed Income strategy: refusing to be swept up in the Trump rally, focusing instead on slow growth and low inflation as the Fed raises interest rates. He anticipates US growth around 2% rather than the optimists who see 3% plus.
A key quote in the piece: “The demand for high-quality income-producing assets exceeds the supply of these assets… it you can find the situations, the unique situations, whether it’s a country or a company where the fundamentals are actually set to improve, you’ve got to buy that!
Ah ha, that’s a clear signal to be looking outside the conventional box and buy “alternative” real assets creating real returns. I’ve got a few stashed in my pipeline.. 7% and safe…
No porridge tomorrow… have a great weekend.
Bill Blain