Everyone is making a big fuss over the fact that four U.S. banks went 61 days in a row without any losses. Well, the better question in this environment is how did any bank manage to not make a profit on all 61 days? These big banks are borrowing from the Fed for nothing and can effectively sell low risk bonds back to the government for a 3%+ annualized gain. This is a no-brainer when it comes to making money. If you’re a big bank you’re just laddering into a massive fixed income portfolio without almost no risk. The confusion or misrepresentations made by many regarding this “phenomenal performance” is that these firms are just sitting around trading the Nasdaq 100 like Joe Schmo does at home. That couldn’t be farther from the truth. These firms make most of their “trading” revenues by playing market maker or “trading” in these low risk fixed income markets. They’re essentially just pairing buyers and sellers and scraping a fee off in between. Yes, there are other higher risk portions of their portfolios, but for the most part these firms are just vacuuming money up from off the NYSE floor at every twist and turn. It should shock no one that the big banks are making profits. A better question for the Morgan Stanley’s (MS) and Goldman Sachs’s (GS) of the world might be why they still have their bank holding company status? Allowing these firms to borrow from the Fed at 0% is a slap in the face to every other hard working financial firm.
LIBOR spread fears return
Dollar money-market rates to highest levels since August. The cost of inter-bank borrowing for three-month dollar funds increased to the highest level in almost nine months, as the IMF/EU’s $1 trillion financial plan for Europe failed to boost confidence sufficiently in commercial banks to step up their lending. The three-month London interbank offered rate, or LIBOR, for dollar funds increased to 0.43% this morning from 0.423% yesterday, the most since August 17, according to the British Bankers’ Association. Meanwhile, the three-month rate for euro, or EURIBOR, fell to 0.624% today from 0.628% yesterday, after soaring to 0.634% last week. Notably, EURIBOR established fresh lows each trading day over January 2010 to date. The differential between dollar LIBOR and the Overnight Indexed Swap—an important gauge of bank’s willingness to lend to one another—widened to 20.2 basis points (bps) today, the highest since August 21st. This spread soared to 364 bps after the collapse of Lehman Brothers in 2008.
It’s nothing to start panicking about, but this is the same sort of creeping activity we saw at the beginning of the credit crisis. As we’ve learned over the last few years, credit based recessions tend to be long and drawn out. The price action in credit spreads is also similar. Credit concerns tend to build momentum over a series of many months. The kicking of the can down the road has been a prime example. Eventually, the problem of too much debt always catches up with you. At this point, the slow uptick in spreads has to have some wondering if they aren’t foreshadowing another jittery period for credit markets?
The Euro/treasuries/gold trade
A fascinating trade is developing in treasuries and the gold market. We have this interesting correlation between treasuries and gold prices in recent months. As the Euro worries continue to develop both gold and treasuries have become safe havens. Of course, this has shocked the inflationistas of the world – many of whom are short treasuries and long gold, however, in this world of continuing low inflation treasuries continue to perform just fine. Aside from the firm fundamentals (U.S. government debt is not a concern and inflation remains low while the fundamentals for gold remain quite constructive) what’s become so interesting in this environment is that gold is acting more and more like a currency. In the long-run I feel as though this is entirely unjustified as gold will never serve as a reserve currency ever again. But we have what I believe is a unique window of opportunity here to buy both gold and treasuries as risk asset alternatives. It’s a beautiful hedge in a world that is grappling with the potential death of a fiat currency (the Euro) and continuing inflation or deflation. I don’t particularly like either treasuries or gold at this exact moment, but I will be a tempted buyer of both on any pull-backs. If the Euro crisis hits Defcon 1 (something I say is a relatively high probability event in the next 24 months) then gold and treasuries will soar.