Wednesday, January 28, 2015

Crisis, fear and crying wolf

So looking at US news coverage Sunday and Monday left the impression that NY is entering a new ice age, when in fact they got a whole 12cm of snow.  Granted 12cm of snow for us Canadian is nothing much, but that the winds made things interesting at JFK, still one days Newyorkers are going to get fed up of all this "fear mongering" in the media (I hope).

I mean really, the whole thing was so overblown it demonstrates the limitations of 24/7 news coverage; Each station outbidding its ability to exaggerate the situation... one day a real bad storm will occur and then people will die, because once too many time the end of the world has been predicted.

Does anyone remember in 2004 and 2008 election cycles, the "red alert" for terroriste activity was going up almost every other day.  until at one point no one paid attention.  Especially once it was revealed that the one "red alert" had been declared based on two year old evidence.  Clear evidence that the "red alerts" were really a political tool!

anyway, once again Americans look like crazy people...well if the shoe fits.

Monday, January 26, 2015

Ok Greece now what?

A new prime minister has been sworn in as of this morning, his #1 goal is to negotiate new terms with ECB and all its creditors.  As of now, Greece outstanding foreign debt is around Euro 250 320 billion. which was a problem when the country was doing OK, but has become a bit of joke for a country that has seen its GDP shrink by nearly 33% over the past 7 years.

Greece is a shadow of its former self -- when money was free, and credit was available, they were able to spend nearly Euro 15 billion on olympic installation that were shut down the day after the olympics.  Now that's "olympic" spending.

To say that the Greece were profligate would be an understatement, but when you are spending other people's money...who cares.  Now, and this is an old saying: when you owe the bank $100 you have a problem, when you owe the bank $1 million, they have a problem.  Guess what, the ECB and all of Greece's creditors have a problem.  Over the past 4 years, European banks have been very good at dumping (onto the ECB) all their Greek holdings; at near par.  Europe has been happy to buy the stuff, because no one else was ready to buy that toxic stuff.  Now the ECB is saying that they are ready to accommodate Greece with lower interest rates, or maybe deferred payments.

Greece's reality is that with a population of 11 million, and a minuscule private economy (the government prior to the crisis account for nearly 60% of GDP), there is simply no way for Greece to pay back -- for the past 5 years its been an exercise in "extend and pretend", well the new Greek government has a mandate to change the situation.

First off they should ask for massive write-offs; my best guess is that I would aim for a 15c/dollar; so that Greece's debt is modified into a Euro 50 billion total debt.  I would also make this deal conditional on ALL creditors signing -- no one wants another hedge fund coming back in a decade asking for all its money back.

Second, I would ask for about Euro 10 billion in new credit, with a 10/15 year term.  Just to make sure that the country can move ahead.

Third, I would look at exiting the Euro entirely; Greece's economy (which is highly inflationary) is unable to deal with the Euro's fixed exchange rate.

The reason I say this is that at Euro 60 billion (about 40% of Greece's GDP) there's a chance that these creditors will be repaid.  The odds of this outcome are near zero, lets be clear this would open the door to Portugal and Spain -- Greece is a pimple in economic terms; as is Portugal, but Spain (nearly 6% of Europe's GDP) is another story entirely.  Because the problem of Greece (and Cyprus) are the problem of Italy, Spain and Portugal.  These countries lived well because they entered the Euro at too expensive an exchange rate, and that the structural reforms required to adjust to this high prices (without deflation -- the ECB is scared shitless of deflation) are simply not feasible.

So geopolitically what's next for Greece:  the simplest would be for Greece to start by exiting the Euro, and the saying that all foreign debt will have to be approved by the new central bank (a bit like what SAFE did in China), renegotiate with all creditors new terms -- between 10c and 20c on the dollar and see were that goes -- we are talking exchange controls here.

Some will say that leaving the Euro will be too expensive for Greece, well so far Greece has seen a social breakdown, a collapse of its GDP and a deeply frustrated population that is willing to look as some rather unattractive political parties.  So my view is:  I DONT KNOW HOW IT COULD BE MUCH WORSE THAN IT IS RIGHT NOW!

Greece has a new prime minister who campaigned on a promisse to leave the status quo, and to find a new direction for his country.  There are not that many options available:  Repay the debt is impossible, pretending is possible but the social cost is unacceptable; leaving the Euro seems to be too much but what's the option.  Will Europe agree to forgive Greece its excess without imposing strict controls -- that go back to the Prime Minister's promise?

This could be too much for the Euro!

Update:  Had to check this AM the amount of debt outstanding because of an article in the Financial Post (that got it wrong).  Total outstanding debt is around Euro 320 billion -- of which Euro 300 was refinanced (by the ECB) taking the debt away from banks/pensions/insurance companies, and making it a European wide problem.

Wednesday, January 21, 2015

Bad Bad news for Canada -- Surprise rate drop to 0.75%

Well that's a shocker, the Bank of Canada just decided to cut interest rates by 0.25% to 0.75% -- until recently, the BoC was talking of rate hikes.  Needless to say that the CAD took a bath this morning, its down to 0.80c to the USD.

The issue is that oil is a massive component of Canada GDP, inflation is about to get crushed into negative territory and Canada's housing bubble is about to hit home in a most unpleasant fashion.  Talking to banker friends they are very concerned, 14,000 jobs were lost last week, mostly in the oil patch, mostly high paying jobs, and mostly with guys who will be unable to recycle their skills (at the same salary).  Alberta, Saskatchewan and Vancouver are about to get hit with difficult housing markets.  On top of all that fun, the crackdown on Chinese fraud may hit the Canadian housing market -- Canada was/is a favorite destination for mainland Chinese looking for a bolthole -- demand for these high priced properties may be coming to a screeching halt (maybe temporary maybe permanent).  At any rate the BoC was spooked.

Lowering rates will hit the CAD big time, already its lost 3c over the past 72 hours (the trend is almost certain to accelerate).  On the other hand this whole dance began when the Swiss cut loose their peg to the Euro.  In the past few days we had:

Swiss giving up on the Euro
ECB monetising Euro50 bn per month of debt
BoC cutting rates by 0.25%

What's next?

My guess is the Feds will stand steady -- the USD is strong because the economy is doing well (GDP growth was massive in Q3 & Q4 2014)

ECB will look at its inflation numbers, but with a weakening Euro (its dropped from 1.25 to 1.16 over the past few months), Europe will be importing inflation (excluding oil) so they may feel OK not to cut rates yet

Japan doesn't matter

The Oil and Gas sector is about to get hit, first Canada, then the US.  First will be default on high yield bonds.  After that jobs are going to start to go, and production will fall, that should lead to an increase in oil prices.

If that's the Saudi's solution to competition, I find it hard to understand, because as soon as oil prices climb back up to $75/80 drilling in the Bakken will start again, oil sand production in Canada will resume.

Anyway, the fall out has begun, its not clear where this will end, but the short end pressures are adding up:  Canada is certainly feeling the pressures, Q1 results for banks (end of January) may see some fall out already -- although it may be too early

Monday, January 19, 2015

Negative Interest Rates

Unless you live under a rock, you will have noticed that last Thursday the Swiss central bank decided to remove the Euro peg.  The shock was massive in the F/X complex, especially the retail side that got "wacked" for using massive amount of leverage -- the end result several F/X brokers have gone bust (and at least one hedge fund).  The fact that the Swiss said, until the very last minute, that they would support the peg is normal;  the Bank of England did the same until two hours before it exited the Euro (Ok this goes back a few years -- decade maybe).  Bottom line the Swiss gave up when the could no longer afford the strain.

Little noticed by the punters at large is that the Swiss also reduced interest rates on deposits to -0.75% (yes Dorothy, NEGATIVE).  The is first mover advantage didn't last long already by the end of Monday (Europe time -- America is closed today) several other central banks had made the same change.  This is the rate the central bank charges the banks to keep deposits -- banks that deposit excess cash with central banks will now pay for that pleasure...

Needless to say that the only reason to go negative is fear of deflation.  To try to force money into the economy.   It also means that borrowing rates are about to drop too.  If the 10 year T-bond rate is around 1.81% this morning, my guess is that by tomorrow that will have dropped by about 0.5% -- the reason is that its the ultimate means of pushing borrowings.    More quantitative easing is ahead -- the Japanese on the other hand have announced that they're done! but interest rates there are already near zero -- 10 year JGB trading at 0.20% down 0.05% today.   All this with little to show in terms of growth (well wages are down 7% YoY, so that's an accomplishment of sorts)

BTW the drop of the US 10y T-bond is not my brilliant forecast, its common view on the street that bond yields are going one way, and that's down -- the magic number is apparently 1%.  I find that incredible when you think that inflation is around 2.5% to 3.0% right now.  Lending to the US government generates a negative wealth creation drag of 1.5% to 2% per annum.  It shows how bad things are going.

In fact, Q3 & Q4 2014 were great quarter for the US economy (not so much for the working stiff -- but the rich folks did ok).  I hear that soon this year the 1% will account for over half the global wealth.  Sometime one wonders what all those rich folks are bitching about, if you consider how well they are doing.

Anyway, the train is going forward, and rates are going down.  It worked so well for japan, the rest of the OECD has decided to join-in!

Tuesday, January 6, 2015


Never mind $55, oil prices are now down to $48/bbl which is the lowest it has been in nearly 13 years (ok in 2009 it also dropped to these levels).  looking at the press its hard to figure out what is going on, some say its the Saudi trying to either screw with Tar sands and fracking or playing political games with Iran others are saying its the collapse of the global GDP and others are saying that that its the Russians.

Others again say its a massive conspiracy by the banks and the futures markets...

One thing for sure, no one knows for sure, there is no doubt that Saudi have increased production, but did they do it to increase revenues or lower prices?  There are massive financial forces at play int he oil complex, but these are rarely long dated, and oil prices have been dropping for some months -- a trader that goes against the prevailing winds usually ends up jobless -- his positions get cut by risk management.

The most likely scenario is a global slowdown -- in fact what is strange is that despite much lower oil prices we are not seeing an economic kick -- a 50% drop in oil prices should result in an increase in consumer spending -- virtually everywhere!  Yet we are seeing some strength in the US economy, although inflation is still dropping.

What about China -- well the government is undergoing a massive anti-corruption drive, and the world just saw the impact -- gambling in Macao is off 35% month on month -- and Macao is a Chinese gambling den!

My instinct is that the drop in oil price is a consequence of many different, but self re-enforcing factors:  China is slowing, Japan is in free fall, Europe is trying to hold things together -- by selling all the silverware.  America is growing Q3 and Q4 2014 are looking like 4.5% (and maybe more) growth. The one bight spot, but then most "knowledgable" investment professionals have been saying that 2015 with low oil prices America would be a bright spot.

Back in Canada things are less rosy, already hit by low commodity prices (which account for 1/3rd of all GDP) Canada is reeling with the assault of low oil prices.

Some are saying that below $40 the rosy american scenario will turn dark with massive defaults in the high yield bond market... and low oil prices also mean very low inflation 0.1% in Q4/2014.  Its hard to believe that we are only a $8 away from these levels!

Bond prices are certain to fall, we should expect the US 10 year bond to reach 1.0% during the year.

OK that's my prediction for 2014:

If oil reaches $40/bbl then expect; massive high yield default for fracking borrowers (and maybe some issues with oil sands producers), rise in price for non-energy high yields because you sell what you can not what you want.  long term borrowing rates fall to 1%.  Then again, this could be the bottom and oil price could bounce back to the $80s in a few weeks -- no one knows you can only plan for contingencies.