Entries in liquidity (4)


Q2 2015 Commentary: the pruning knife vs two issues

Updated on Saturday, July 18, 2015 at 11:27AM by Registered Commenterhb

Updated on Monday, July 20, 2015 at 02:53PM by Registered Commenterhb

Our market outlook is simple. Nothing will happen between now and November 8, 2016, that is, nothing particularly good. Anticipate no reform of policy or regulations...  tax, fiscal, monetary, environmental, energy, labor, or educational matters. We may see futile, symbolic, political gestures, and we will most certainly see Obama launch a last wave of initiatives, mostly by Presidential fiat, and some will likely be materially destructive. A cynic might argue Republicans have incentive to let them roll, to sit and watch the rubble in advance of the elections. But who among us would be a cynic?

Meanwhile the big economic picture remains the same. Our national problems remain unsolved, and so they compound, become more deeply embedded, more complex & costly to remedy.

Click to read more ...


Observations on foreign bank liquidity

Today's WJS  advises that

For the past three months, European banks have been largely unable to sell debt at affordable prices to investors, who are wary of the banks' vulnerability to risky euro-zone government bonds and other loans.

At $34 billion, the amount of senior unsecured debt issued by the Continent's financial institutions this quarter is on track to be the smallest of any quarter in more than a decade, according to data provider Dealogic. - Europe's Banks Face New Funding Squeeze

Let's see ... from more than $250 billion in QI and QII in 2009 to $34 billion.

We looked at the short end of the curve and see that the foreign financials have racked up a 28% decline in outstandings since the peak in June (see the big red arrow below).

Bloomberg reports

The eight biggest U.S. money-market funds reduced their investments in French banks by 46 percent to $42 billion in the past 12 months, data compiled by Bloomberg and published Sept. 9 in the Bloomberg Risk newsletter shows.

This is particularly precarious for banks, given that liquidity pressures over year end can be stressful even in good years. Saavy liquidity managers are starting now to fund through year end, but there is, evidently, a substantially declining bid for even the shortest of foreign financial paper in our domestic markets.

Where does it go? The Euro commercial paper market is simply too small and, oops, low-to-no bid there anyway.

Below we present outstandings of various segments of the US commercial paper market:

This is the US$ funding crisis everyone's been anticipating. Last we heard France was trading around 1.96% for 5 year credit default swaps, and Italy about 5.03%, so its not clear that sovereign support for the banks will bring much to the party. The Germans need to play.

If there is some good news it is to be found in the blue & green: there is a growing supply and demand for non financial domestic commercial paper. It's good to see some credit creation, however modest and the financial outstandings seem, well, sideways is good enough.


The ECB thing

The inquiry:

This is what I've gotten so far... let me know if this makes sense. 

The gist is that the central banks of the world, implored no doubt by the ECB, intend to create programs to allow banks cheaper access to short term USD funding.  The ECB already does this but will now extend the duration of their loans.  One of the concerns the ECB is juggling has been the pending liquidity crunch in Eurobanks holding a ton of bad Sov. paper.  These banks haven't been able to access repo funding markets at rates that weren't damaging their already fragile capital levels (leverage was so 2007... right?... right?... oh...) so the central banks of the developed world have essentially colluded to provide funding at rates and durations at which the free capital markets would not provide.  I am not clear on the time frames here...

WWB response:

The ECB does not have enough liquidity or capital to replace the US$ liquidity lost by the euro banks… that to include the Euro and US repo markets; the ECD markets; the ECP markets; and the USCP markets (probably not available for euro banks now I suspect (hit CP GO for a look) or if it is it won’t be next week). One questions whether the ECB + Germany + France + Othereuro + [limited?] US support is adequate.

So, the US Treasury, Fed and few remaining semi- solvent euro sovereigns are probably funding for now the Euro Central Bank via some non-visible means like private gold loans or swap lines of various types or other undisclosed transactions, this a bridge to the unstated & unknown Uber plan… a mega GLOBAL TARP, a liquidity facility underwritten by undercapitalized sovereigns to prop up the Euro banks with no capital and a boatload of bad sovereign debt.   

The reason you can’t conceive of how it works or makes sense is that it doesn’t. It cannot work unless Germany, France and all the others including the US all play for size (recall the word “overwhelming” by Timmy G, you know the fellow who said there was "no risk" of a downgrade for the US?). You are thinking, "no way US taxpayers would support committing of huge amounts of scarce US (read that taxpayer) capital to such a venture!"

Consider that Timmy G, Fed, and Treasury are not concerned with that quaint notion. It is likely we're already in for size, such and duration to be expanded and defined later. Since it's election time, and Congressional inactivity is always a good thing, how about a Congressional hearing? A little transparency on swap or currency line usage or risk limits? 

Back to the ECB thing. This is the final rounds of injecting CTBPApynm (Capital To Be Pissed Away, perferably yours, not mine) before the euro thing likely grinds to a halt. 

They may have bought some time … a few weeks, possibly days, or months (who knows since there is no disclosure of the means, magnitude, or duration of the temporary support)… to raise capital for the banks which, if successful, will also be CTBPA. 


  1. inject temporary capital
  2. threaten negotiate with Euroland
  3. hope you can get out
  4. discover you can’t
  5. repeat 

Repeat, that is, until the a) viable sovereigns (France & Germany & some US) go all-in or b) until you hear “BLAMMO” which will be the sound of serial Euro bank failures working their way up the collateral base, which will be insufficient. In the latter case, the losses will be realized by commercial entities and specific sovereigns to the fullest extent possible. Those sovereigns will then default or restructure because they’re broke and also have no access.  In the former case, the standards of living will decrease by a significant multiple of the unrealized losses. Think of that as a reverse, large scale negative Keynesian multiplier less further large scale costs for friction, agency, and corruption.



Nouriel Roubini on the US$ carry trade

Nouriel Roubini has an article in today’s Financial Times that is a must read: Mother of all carry trades faces an inevitable bust , excerpted below. 

So what is behind this massive rally? Certainly it has been helped by a wave of liquidity from near-zero interest rates and quantitative easing. But a more important factor fuelling this asset bubble is the weakness of the US dollar, driven by the mother of all carry trades. The US dollar has become the major funding currency of carry trades as the Fed has kept interest rates on hold and is expected to do so for a long time. Investors who are shorting the US dollar to buy on a highly leveraged basis higher-yielding assets and other global assets are not just borrowing at zero interest rates in dollar terms; they are borrowing at very negative interest rates – as low as negative 10 or 20 per cent annualised – as the fall in the US dollar leads to massive capital gains on short dollar positions.

Let us sum up: traders are borrowing at negative 20 per cent rates to invest on a highly leveraged basis on a mass of risky global assets that are rising in price due to excess liquidity and a massive carry trade. Every investor who plays this risky game looks like a genius – even if they are just riding a huge bubble financed by a large negative cost of borrowing – as the total returns have been in the 50-70 per cent range since March.

People’s sense of the value at risk (VAR) of their aggregate portfolios ought, instead, to have been increasing due to a rising correlation of the risks between different asset classes, all of which are driven by this common monetary policy and the carry trade. In effect, it has become one big common trade – you short the dollar to buy any global risky assets.

He's got the broad structural issues right, although perhaps stated with a flair for the dramatic. Timing & rates of reaction are critical for these kinds of things: will we have a moderate point of inflection or a herd stampeding over a cliff?

A stampede will occur as closing long leveraged risky asset positions across all asset classes funded by dollar shorts triggers a co-ordinated collapse of all those risky assets – equities, commodities, emerging market asset classes and credit instruments.

I'm not sure any analyst, including the Roubini or the Fed, has a clue, or at least a valid one.  My experience in the global markets has led me to believe that >80% of any liquidity (sovereign or otherwise) is determined by no more than 15 players, 3 of whom are seated next to the door, proximity to which is in order of cognitive ability. The other 12 investors are watching them. This is the stuff of which catalytic events are made.  The rates of reaction can be a little slower here given the scale involved and limited options for alternative reserve currencies. But an observer of grizzly bears knows that big things may look slow but can actually move quickly, particularly when faced with threats or a prospective meal.  Big things can also can grind quite finely.

Some have argued that Fed policy distorts a variety of macroeconomic factors including inflation measures, that nominal Treasury bonds less TIPS spreads are artificially low (I'm less sure on that one but am unwilling to rule it out). Roubini below argues Fed policy has induced an artificially low global volatility (although equities recently seem to contraindicate) with a tsunami of liquidity and artificially low interest rates.

The structural aspects do seem to follow a certain logic of unintended consequences that derive from the Fed's strategy of trying to manage excessively large and stupid concentrations of risk (i.e. "too-big-to-fail") by further aggregating and centralizing even greater concentrations of stupid risk.

Now, the question is, if you're the Fed,

"You're thinking...now to tell you the truth I forgot myself in all this excitement. But being this is a .44 Magnum, the most powerful handgun in the world and will blow your head clean off, you've gotta ask yourself a question: "Do I feel lucky?" - Dirty Harry

Well, do we?

The unwind could get a bit bumpy, but the point here is not to scare people but to help.

From from a practical perspective, what does this mean for investors? Our framework of bounded asset allocations, efficient diversification, and prudent risk management in many ways accomodates many of the concerns implicit here. Appropriate asset allocation is the touchstone. It is not only a measure of expected returns, but a matter of risk management. And if you find yourself inclined to changing it or second guessing things in response to market activity or headlines, stop right there. It doesn't fit or you're mis-using it. 

Rebalancing is critical. In broad concept if you've had a run up of some 80-92% in equities over the last 12 months (for example China, Turkey, or Brazil) rebalancing as a mechanic would lead you naturally to sell some of the rockets and perhaps lead you to consider some that have fared less well (US regional banks were off some 27% over the same period). Similarly, foreign small caps are up nearly 50% over the same time period while US large cap value stocks weigh in at 2-4%. The same goes for fixed income: emerging markets debt and domestic high yield bonds have racked up 12 month returns in the low 40%'s, while US short bonds have gone sideways. A rebalancing in front of the US$ unwind may not be a bad thing. Rebalancing will naturally remove the excesses from the portfolio, a systematic sell high/buy low (for many of us a novel experience).  Generally, this takes the portfolio in the direction you are intuitively inclined to go, but in a bounded and disciplined way.

It is very clear that now is not the time to stretch prudence in reaching for yield. Take the market rates and live within prudent risk budgets. Now is also not the time to run short on liquidity.

Stay the course with diversification. The corelations are in the words of a trader 'all kinds of screwed up' by virtue of the artifice of the Fed. It is not clear to us that anyone has an elegant solution to model and correlation risk (just ask the rating agencies), but common sense can go a long way.

Lastly, as an enterprise and portfolio matter, take a look at counterparty credit risk profiles and potentially embedded performance risks. Like it or not you've got 'em. For example, make sure you understand the operational risks of your book... like hypothecation risk in your custody agreements. On credit/counterparty performance risk I remain suspicious of whatever is highly regulated, complex, and opaque...insurance comes to mind....and for that matter Congress as well.