Tuesday, December 16, 2014

Could this be it?

I've often said (in this blog) that when the end comes it will come from an unexpected direction.  First off, those who are losing in the oil price "war" are producers - they are many, but they are still far fewer than consumers.  So this correction left a lot of very big losers and many many small winners. This morning the Russian Rouble ceased to be convertible, and "trades" will be unwound.

Russia was always on the edge, its been playing political hard ball for some months/years now. Russia has been funding its world stage presence with oil at $105/bbl.  As the saying goes: "being elegant is expensive", but being a bully even more so!  Especially when a oligopolistic business system is driven by high borrowings -- driven by a desire to limit dilution, but also driven by a junk bond market primed for risk and yield -- in a world of very low yields junk bond financing is attractive.  Russia borrowings were not cheap before -- the prime rate was around 6% a few weeks ago, it jumped to 10% about 6 weeks ago, when the run on their currency started, yesterday they went to 17% in a "shock and awe" exercise -- that failed (it was a good try).  Now short term loans are priced at 19% -- impossibly expensive for a very leveraged economy.

This morning, the Russian rouble ceased to be convertible -- this may be temporary, but it complicates things immensely; lenders have made loans in Euro or US dollars (they didn't want to take any currency risks), with conversion out of the door, these loans/bonds are in technical default -- as the borrowers cannot repay their loans in foreign currency.

My guess is that some "Megabanks" have taken on some massive swap exposure (between the bond holders and issuers) taking-on that Rouble risk (as a nice little earner).  Don't know how this will work out for them?  The biggest derivatives players are: Citibank, JP Morgan, and Deutsch Bank (no position).  Others will also have played -- and lost, but it will take a while for the dust to settle -- trust me it took months for my gang to figure out the "hurt" when Lehman went bust.  The easy part is the banks' mark to market reaction (try to delay).  I have no idea how these exposure will play out -- the real issue is that I am convinced that the senior management in each of these three institutions are equally clueless -- its just too complicated  -- also we are going to witness some massive imbalances in the derivatives books.  The Chinese proverb "may you live in interesting times" would seem to apply here.

It is amusing that Congress passed a new law last week to make derivatives trading even easier and less regulated, timing sometimes is everything.

So, what happens next, don't know (anyone who says otherwise a $#@&% liar), but we can make some broad assumptions:
  1. De-risking is on the cards 
  2. Yields (see one above) are certain to rise -- even for the best credits
  3. You sell what you can, not what you want
  4. Everyone is going to slow down its credit approval process
  5. The banks are going to be looking at where from the bad debt could emerge 
  6. This could slow down economic activity
Again, this could be very local (I doubt it) it could be a short term shock (I hope so) , but it could be something else.  So far the North American markets have been taking this whole thing as "not about us", but I doubt that this will continue, I could be wrong, but this is a massive change, Russia has zero good will in the West, and has even worked hard at making the west look like aggressors.

December 2014 could be a very interesting month -- stay tuned! 



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