Blain's Morning Porridge - 7th Sept 2017. What is Draghi not going to say and why..
Originally Sent Sept 7th.
Blain’s Morning Porridge – September 7th 2017
“I’m very well acquainted too with matters mathematical, I understand equations, both the simple and quadratical. About binomial theorem I’m teeming with a lot of news, with many cheerful facts about the square of the hypotenuse…”
For the avoidance of doubt – the Morning Porridge is market commentary, it is not investment advice…
So much to wonder about this morning… Will we still be smiling after the ECB press conference?
I suspect so… relax.
In the news this morning we have the remarkable solution to the looming US debt ceiling problem: Trump supported the Democrats’ solution thru to Christmas while snubbing his own party. Smart – a clear signal to Trump’s supporters (remember, if he stood again tomorrow he’d probably win) its politics and not him that’s the problem. It’s a less subtle signal to bickering Republicans about who’s going to keep them on Capitol Hill come elections next year! Get past the noise, and pushing the debt ceiling down the road allows him to focus on immediate issues (policy initiatives) and threats (the hurricane season being just one).
Then there is Stanley Fischer’s resignation from the Fed – being seen by many as a loaded message about the dangers of deregulation and Government interference, but it also opens the door for Trump to simply rubber stamp the appointment of The Squid (its shadowy operatives) to run the US central bank. (Loud Dr Evil “Mwhahah” heard in background..)
Meanwhile, Theresa May will be debating Brexit.. ah. Bless..
Before scribbling about the ECB, let’s delve into history…
Next week, 14th September, marks 10-years since the shocking TV footage of customers queuing outside Northern Rock desperate to get their money out – the first run on a UK bank in 140 years.
It was the wake-up-and-smell-the-fear moment.
In fact the Global Financial Crisis was already well underway. I’d already seen my attempt to escape investment banking and set up a credit hedge fund collapse as banks “hibernated” the investment funds earmarked for us. It had started in the US sub-prime market early in the year, triggering a redemption stop on Bear Stearns’ bond funds, followed by BNP admitting it didn’t know the value of its CDOs. But the queues outside Northern Rock woke the world to how “Crisis” was going to affect us all!
It was the day I started writing the daily Morning Porridge. I seem to remember the first one was a rant about the unforgivable and unfathomable failure of the Bank of England to extend support, control and avoid the run on Rock.
For the next 10 years the financial markets have been repeatedly harangued by Politicians and the Authorities – told that too big to fail will never ever happen again. Politicians are still banker bashing and assuring us taxpayers will never pay for the mistakes of bankers again. The entire capital stack has been flipped on its head. I will happily argue markets have been made less efficient, less liquid and less transparent by years of over-regulation and political fiat.
Sure.. mistakes were made.. but is what we have today any better?
Today, we’re going to see the consequences of Modern Finance in action when Draghi Talks!
He is the very model of a modern central banker. He is a highly talented, clever and committed man, but he’ll be juggling words to avoid upsetting whatever balance between the messy convoluted politics of member states and what the ECB thinks it has achieved.
A few years ago, despite all the protestations about tax-payers never again paying for banker mistakes, he committed Europe to unlimited financial largesse when he bailed out the banks with free money to go buy government bonds. He said: “WE WILL DO WHATEVER IT TAKES”.
The markets absolutely believe he will and will hold him to it. “Whatever it takes” (WIT) has become an article of faith keeping Europe together by papering over its many financial cracks. (I just know that is going to infuriate some of my European readers.. but..)
The market buys WIT. Repeatedly – and they know Draghi really has no choice but to deliver. Repeatedly. Without the WIT promise keeping investors in the Euro market, we could be doomed to a repeat of the European Sovereign Debt Crisis – which boils down to a lack of confidence in some European countries (who no longer have access to their own money), and therefore their financial and industrial sectors, can repay their debts. A crisis or default in one EU member will have immediate and terrible contagion consequences across the rest.
During the depths of Euro Sovereign Crisis in 2010-2012, the ECB eased these doubts with LTROs and later QE effectively backstopping their debts! (Don’t tell the Germans its defacto debt mutualisation).
This is the real reason why Draghi won’t upset us today with details on how the ECB is going to pull the morphine of extraordinary monetary policy from a market addicted to it. He can’t afford the market to cold-turkey and panic. The risks to Italian bond spreads in particular, the entire European corporate bond market, and the exposure of Europe’s multitude of SSA guaranteed borrowers wearing the Emperor’s New Clothes, is just too frightening to contemplate.
If, say, European financial policy over the last 10-years had been successful and caused all Euro members to improve productivity, hit debt targets and create sustainable debt loads for the future, then we’d be getting Normalisation. But in Europe, and especially in Italy, very little is fixed… which means pretend and extend is more likely.
So what we will get today is soothing talk about how the ECB is thinking about normalisation.. but nothing firm on how or when they are going to do it. There might be some justification about low inflation and the dangers of no-flation pushing back timing – and the ECB’s bond buying will continue.
If you don’t believe me, read the following article from the new issue debt team at Bloomberg: https://www.bloomberg.com/news/articles/2017-09-06/draghi-distortion-how-1-000-corporate-bond-buys-upended-market
It’s a pretty good explanation of why European bond yields are pants.
Meanwhile, Pimco were on the tapes saying ECB won’t raise rates till 2019 and will defer balance sheet run off till 2020. I suspect they might be early..
To ice the cake this morning I note that Tajikistan – that well know paragon of central Asian fiscal rectitude - is planning a bond issue to finance a hydro-scheme that will take at least another 15 years to complete. It’s going to upset all their neighbours. As the next crisis in Asia will be water wars, I confidently predict the bond will go swimmingly well. Er.. maybe.
Even better, Ukraine is also planning a new bond issue. Regular readers of the Porridge will be familiar with the “Ukrainian Chicken Farm Moment” theory of new issue stupidity.. If you need a refresher course in how this immutable law of bond market physics works, drop me a line.
Out of time, and time to do the day job…
Bill Blain