Latest on central banks, liquidity, rates and much more, by PIMCO’s T ony Crescenzi.
- If the eurozone is to endure, it will require reduced economic differences among countries and larger common fiscal capacity.
- Emerging market central banks are likely to remain in wait-and-see mode while looking to the U.S. for clarity on the fiscal negotiations and domestic macro prints for signs of moderation in both inflation and activity.
- While central banks in advanced economies have not traditionally used explicit policies to target exchange rates, the European debt crisis may change all that.
Full read here.
A few points on risk and size by Golem XIV.
People always say Follow the Money. You might do better to Follow the Risk.
Risk is the pollution created by the process of making money. So where you find people making one you will surely find them hiding the other. You’ll find both at the banks.
Banks have managed to convince the regulatory authorities – their regulatory authorities, and I use the word ‘their’ advisedly – to convinced them to count the creation and storing of risk as part of the banks contribution to the nation’s GDP. I wrote about how our governments count risk creation and storage of as part of the bank’s GVA (Gross Value Added) in What the Banks Contribute to GDP. Our government’s reasoning is that risk is an unavoidable by-product of the financial industry so the industry should get credit for dealing with the stuff. But imagine counting the creation and storage of radioactive waste as part of the value added of the nuclear industry? Would it not seem perverse to celebrate increases in the amount of waste being stored and see it as evidence of what a wonderful industry it was, rather than ask why they produced so much in the first place? Would it not seem odd to talk glowingly (sorry) of the increases in radiation levels being stored, and reward the industry accordingly, rather than ask if there might not be a safer, less radioactive way of generating power? It seems to me this is the situation we are in with banking.
A few comment by Biderman.
The biggest problem the developed world is facing is that the governments and banking institutions that got us into the present mess are not capable of solving the problems they themselves created. Not even with new leadership.
Why? Not enough income growth and too much government spending. That is obvious looking at the combined income statements and balance sheets for the United States, Euroland and Japan. The bottom line is that the combined take home pay, whether taxed or not, of everyone in the United States, Europe and Japan is not sufficient to generate enough taxes to pay all current government expenditures. Let me repeat that, the developed worlds take home pay is not sufficient to generate enough taxes to pay for current government spending.
Market comments by Hussman of Hussman Funds.
In recent weeks, market conditions have fallen into a cluster of historical instances that have been associated with average market losses approaching -50% at an annualized rate. Of course, such conditions don’t generally persist for more than several weeks – the general outcome is a hard initial decline and then a transition to a less severe average rate of market weakness (the word “average” is important as the individual outcomes certainly aren’t uniformly negative on a week-to-week basis). Last week, our estimates of prospective market return/risk improved slightly, to a level that has historically been associated with market losses at an annualized rate of about -30%. Though that improvement falls into the category of a distinction without a difference, at least we can say that conditions are not the most negative on record.
Over the course of the coming cycle, I expect that we will easily observe conditions among the many favorable clusters in the historical record, where we will not face the syndromes of hostile conditions we’ve seen recently (e.g. overvalued, overbought, overbullish, yields rising). Valuations, though rich, are nowhere near where they were in 2000, and even the tepid valuations of early 2003 provided ample opportunity to accept market risk without the need for significant hedging. Unlike 2009, the next cycle will not unexpectedly present us with the need to capture Depression-era data in our approach (which we’ve addressed). Even without significant undervaluation, there are many combinations of market conditions that have historically been associated with strong subsequent market returns, on average.
So there’s little doubt that market conditions will provide investors with a strong basis to accept risk at various points over the coming market cycle. The difficulty today is not only that valuations are rich, but that on our metrics, present market conditions cluster among those that have produced strikingly negative market outcomes on a blended horizon from 2-weeks to 18-months. Wall Street’s beloved forward-earnings multiples only seem reasonable here because profit margins are the highest in history (largely as a result of steep government deficits and depressed savings rates). Once we normalize for profit margins – which is necessary because stocks are very long-lived assets – valuations are elevated, and are coupled with a variety of historically hostile, overvalued, overbought indicator syndromes. Moreover, while our economic concerns do not significantly feed into our concerns about the equity market, we continue to view the U.S. economy as being in an unrecognized recession that started about mid-year.
Guest post by Peter Tchir.
The Bull Case
I had turned bearish on the situation in Europe last week, which had worked well until yesterday. I remain bearish, but there is an obvious and possibly realistic path for the bulls.
1) Spain, followed by Italy ask for and receive OMT and ESM support. The terms of which are generous.
2) Spanish bank recap goes ahead.
3) Budgets work, economies show signs of rebounding and markets reach new highs.
That is the bull case in a nutshell, and I had believed in it for awhile, but don’t see anything working out quite smoothly.
Guest post by Peter Tchir.
I have clearly had another change in sentiment on the outlook for assets in Europe. At the height of the crisis I was an unabashed bull. The timing of this Bloomberg TV interview couldn’t have been better, but in general the bull case was based on 3 things
· Not doing anything was risking catastrophe and a Eurozone wide banking run, followed by a freeze in economic activity
· That the Spanish bank bailout deal would progress and had been designed to get banks up and running in a timely manner
· Prices already reflected much of the risk and little of the upside
From the moment of the “whatever it takes” speech, where Draghi clearly answered my How Dumb is Draghi question, European markets rallied.
The Spanish bank bailout seemed to be running slower than I would have liked, nothing was getting done in Greece, but at least Draghi seemed determined to follow up on his promise (or threat if you were short). His first ECB after the big pronouncement was a bit of a dud, but he said enough to keep the markets happy.
Stiglitz reminds us again.
“If you don’t do that, you have this adverse dynamic: the weak countries get weaker and the whole system falls apart,” Stiglitz said today in an interview in Geneva. “And this has to be done fairly quickly” because in a couple of years, “there won’t be any money in Spanish banks.”
Full video below.
Must read on the doomsday cycle. Via Voxeu.
Industrialised countries today face serious risks – for their financial sectors, for their public finances, and for their growth prospects. This column explains how, through our financial systems, we have created enormous, complex financial structures that can inflict tragic consequences with failure and yet are inherently difficult to regulate and control. It explains how this has happened and why there are more and worse crises to come.There is a common problem underlying the economic troubles of Europe, Japan, and the US: the symbiotic relationship between politicians who heed narrow interests and the growth of a financial sector that has become increasingly opaque (Igan and Mishra 2011). Bailouts have encouraged reckless behaviour in the financial sector, which builds up further risks – and will lead to another round of shocks, collapses, and bailouts.
This is what we have called the ‘doomsday cycle’ (Boone and Johnson 2010). The cycle turned in 2007-8 and was most dramatically manifest in the weeks and months that followed the fall of Lehman Brothers, the collapse of Iceland’s banks and the botched ‘rescue’ of the big three Irish financial institutions.
The consequences have included sovereign debt restructuring by Greece, as well as continuing problems – and lending programmes by the IMF and the EU – for Greece, Ireland, and Portugal. Italy, Spain and other parts of the Eurozone remain under intense pressure.
Yet in some circles, there is a sense that the countries of the Eurozone have put the worst of their problems behind them. Following a string of summits, it is argued, Europe is now more decisively on the path to a unified financial system backed by what will become the substance of a fiscal union.
As we warned about Spain to revive the market nervousness a few days ago, we are suddenly back to watching those Spanish yields climbing again. Markets do not like uncertainty. The contradictory messages from Spain, is once again making investors “confused”. With markets at critical levels, vol at relatively low levels, and an extreme reading in the put call ratio, you should be prepared for a sharp pullback.
Spain is still in pain. From El Pais.
“Uncertainty is a risk,” said the Spaniard, who is also the EU commissioner for competition. “Sometimes it is difficult to take a decision and this is a very complicated situation. Any alternative has its pros and cons, but to maintain uncertainty implies a risk that the debt market or another factor increases tensions again. We have learned in the past two-and-a-half years where these tensions could lead to.”
According to government sources, Rajoy wants to delay asking for a second bailout on top of the rescue package for the country’s banks and may even eschew the option if the economy improves sufficiently to avoid the political stigma involved.
However, Economy Minister Luis de Guindos is in favor of requesting a second intervention as soon as possible to ease market pressures. He would like to see one of the European rescue funds buying Spanish debt in the primary market to trigger purchases in the secondary market by the European Central Bank (ECB).