Here’s your epic face ripper continuing right on cue. The news driving markets this morning is threefold:
That’s a lot of news. The payroll tax extension is obviously great news. We still aren’t quite sinking into the austerity trap and with 10% deficits the negative impact of the balance sheet recession is being greatly reduced. The ADP figure is not entirely reliable, but it is consistent with my general idea that the US economy is hanging in against some incredible global headwinds. And the swaps are negative in that they expose the USA to foreign denominated debts, but positive in that they show the central banks of the world are cognizant of the crisis and attempting to be proactive. This doesn’t hit at the crux of the European crisis, but it does show that Lehman 2.0 is at least attempting to be avoided. There’s much work left to be done in Europe before this crisis is resolved though…But still, this is a good start.
TPC, would you care to expand in another post on the negativity of the foreign-denominated debt the US will certainly take on as part of this coordinated action? Would like a more in-depth view of how that could impact the Fed.
The swaps expose the Fed to some relatively small amount of risk. Nothing to get too worked up over. Besides, the risk of total Euro collapse is practically nil and I think the Fed and ECB have hashed this out in advance. Still, providing dollar liquidity to Europe can be seen as a somewhat helpful maneuver. It’s certainly not going to fix Italy’s debt crisis and budget woes, but it does mitigate the risk of Lehman 2.0 spreading to the USA. Clearly, they’re watching this whole thing very closely so, unlike 2008, they appear proactive to some extent. That’s a good sign.
Does this make it harder for Europe to work together for a real fix of fiscal and complete monetary union?
If they didn’t work together when the Bond Vigilante Bernstein Bears were hunting them through the woods, why would they do it now the bears are sleeping in the bushes?
Good news, but I hope it’s not businesses as usual.
The important swap line (Fed/ECB) was already in place. Only the price has changed (lowered by 50bps) and margins are reduced. So it makes $ funding cheaper and less collateral has to be pledged. A positive for banks, and a positive sign maybe, but for the rest it does very little IMO.
Right. Very little overall impact. Not much downside though unless the EMU implodes which is very unlikely in my opinion.
In terms of foreign debt we’re talking 50 bps excess the original swap, right? Because its excess of OIS? Hope I’m understanding this correctly.
Anyway, is there a good measure anywhere of how many net liabilities in Candian dollars, pounds & Euros there are on domestic balance sheets?
Cullen,
You forgot to mention that China is cutting it’s reserve requirements by 50bps. Not sure if this is a good thing or bad though.
China cut is really minor overall but not a great sign for them because it indicates slowing growth. I expect we’re going to see riots in China again b/c of inflation if they continue to see the need to ease credit.
Cullen,
Dollar funding liquidity may, as you point out, help stop the bank runs, but it will not make anyone solvent. So the problems persist, in addition to more UK austerity coming. Merkel still seems against every potential solution… ECB purchases and Euro Bonds. Of course, that is the only option on the table unless a break up occurs.
The gop is now backing an extension but this is not an improvement nut instead a contunuation of the status quo…at least it is now creating friction. Who pays the inteteat on this debt?
The adp report has consistently overestimated employment. Perhaps it is an early indictor that reflects the true condition of the labor market. However I have 2 well educated frienda who were recently employed in the healthcare field, one sells software the other is a nurse, neither one can find employment and they are concerned as the nurse has been looking for over 4 months.
Again the system operators are pushing on a string. The issue is demand and fear not putting additional money and security to bankers and wall street. Fools to the man.
Debt forgiveness in a time when future payouts are the underpinnings of current valuations seems to be a voluntariy measure that is to burdensome gor the market to bare.
I believe natural economic forces ie deflation will force the marketa to write off the debt and recalculate present valuations based on future cashflow streams.
“It's certainly not going to fix Italy's debt crisis and budget woes, but it does mitigate the risk of Lehman 2.0 spreading to the USA.”
Please elaborate. How does it mitigate the risk of Lehman 2.0?
Lehman was a wholesale liquidity crunch that shut down commercial paper markets. In Europe, government spending is down due to austerity strategy. However, there are huge amounts of soverign debt that needs to be rolled over. With the ECB not acting as a lender of last resort, the markets could fear a liquidity crunch in Europe. You settle with Euros, not freshly purchased Greek or Italian bonds.
The Fed action is to keep open the swap lines they established a few months ago. The lowered cost of funds increases liquidity. If they had let those lines expire, it would have decreased European liquidity, hence a greater risk of a wholesale banking crash in Europe.
Anyone have a good primer/explanation/educational pamphlet on these swaps? Just not familiar with them and how they actually are performed. Even if someone just wants to lay out the basics in a comment that would be great.
http://www.federalreserve.gov/monetarypolicy/bst_swapfaqs.htm#5631
Zero Hedge does a nice job explaining swaps:
http://www.zerohedge.com/news/foreign-currency-liquidity-swaps-aka-global-bail-out-plan-b-faqs
Thanks guys.
The swaps are simple to understand. They’re unsecured loans to the ECB so their member banks can obtain dollar access if needed. It helps to cap LIBOR and provide liquidity to the banking system. It’s a high risk maneuver for the Fed because of the unsecured nature of it, but being in Euros is relatively low risk as is so I don’t want to overstate this. There’s an inflation risk if member banks use the funds to buy goods and services, but that’s remote. More likely this just shores up the EU banking system and boosts confidence a bit. Other than that, there’s not a lot of meat here even though market participants overreact every time something like this is announced. They think there is some mythical power being unleashed and various websites will imply that this is going to crash the USD and cause the world to end. You can’t even begin to comprehend the nonsense being discussed on trading desks until you know some of these guys. It’s amazing how little Wall Street actually knows about all of this. Ignore all that garbage about the end of the world inflation coming. Bottom line is, this is a sign that CB’s are being proactive, but it’s not a sign that the Euro crisis is being directly dealt with. Remember, this is a solvency crisis. The banking crisis is an extension of the solvency crisis. The risk of course, being short here, is that the EMU comes up with a deal on December 9th and the shorts get jammed for ANOTHER quick 4%….
Thanks Cullen,
My reply to your above comment was written before I saw this. The whole thing seemed mostly ceremonial to me, a public statment committing to working together to further prevent collapse by continuing agreements already inplace, but at a better rate.
I assume since the repo agreement is made at the time of the swap its all on the books upfront and there can’t be much worry about, and that’s before even considering that there can’t be a massive need for a lender of last resort USD in Europe, although I’d be more than gald to see a number tacked on to USD liabilites held on Euro balance sheets.
Very confusing. Because the word “”swaps”" suggests that the ECB has lent Euros to the FED as a part of the deal. They should use the word “”loans”" instead.
Yes but there really is no good word for it. Its a swap of currency a the (market) exchange rate and a swap back at the same exchange rate later.
But there’s interest accruing in the meantime, so it has characteristics of a loan as well.
Lesson to perma-bears–never underestimate the actions of desperate central bankers, including, at some point in time, even the actions of the ECB.
Or, you can count on the Fed to create a “trading event” that gives markets the impression of a solution. I think ECRI has it right, there’s nothing the Fed can do to impact the inevitable, just short term efforts that fail. The only solution… southern tier EU countries submit to German fiscal control. If that happens, I’m a bull.
Gold and oil will soar as the printing press starts again. Middle and lower income Americans will receive, at the pump, the equivalent of a major price increase and reduction of disposable income. Global recession is a lock. Where am I going wrong here?
Love this link…9/19/08; an announcement that helped cap off a ~850 bps rally in the SPX in about 3 days…ironically, to ~1255 from 1156….
http://www.federalreserve.gov/monetarypolicy/20080919a.htm
Brilliant B Ferro. Good move regardless of the why…
you once recommended to me…”…All you need to know was that the market preceived that it was going to do very good things for the economy, regardless of wheterh the mechanics of it really did anything beside swapping an asset with the private sector”….”you and I don’t get to decide what it should or shouldn’t be discounting correctlly….” the words were yours I’m sure you remember the rest.
Well..I took that and other experiences to heart. When you wrote that to me back in 2010 early 2011? don’t remember. Although I did print it…so I’d never forget the lesson I thought was there. I have no control over short term moves and trying to “hitch my cart to the answers of why” is folly. It is what it is…trade accordingly.
For me this news is welcomed. Regardless of the answers wether this solves anything. Answeres be dammed!
Thanks VII. Those words are always true – market post mortems don’t pay dividends, right? Who needs the explanation, just obey the market’s commands.
As it stands, the 30 week MA on the SPX remains decidedly negative, with price below it. The 12 month MA on the SPX has flattened out and has begun to turn negative and price sits below this MA. Both of these facts were decidedly different during the summer 2010 mid-cycle pause whereby the SPX’s weekly MA flattened out at worst (again, currently very negatively sloped) and its monthly MA remained decidedly in an uptrend.
Fundamentals are irrelevant because they are already dispalyed on the chart for you. Rather than waste time arguing bull or bear, the facts, those being actual prices and the MAs, continue to tell me the trend is down and that all rallies are counter-trend.
Seems like we could get further upside into the close today (1255-1265 on the SPX) or tomorrow which could be fadeable thereafter.
I’d point out that in history’s secular bear markets there have been 8 opportunities for the market to stage 3 straight up years. Only once has this happened. In other words, in 7 out of 8 times following two straight up years in a secular bear market (i.e., 2009, 2010) the third year has been down. The average loss has been 18% on the year (implying ~1030 on the SPX). The SPX closed 2010 at 1257 – this continues to be my line in the sand for 2011 and is a price I’m willing to fade should I see it again as I’ll place my bet on the 7/8 time thing all day.
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