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Erwan Mahe's  Instablog

Erwan Mahe is an asset allocation and options strategies adviser for the largest European Asset Management firms. Publishing macro-economic research, he has been managing leading European financial brokers since 1987, and sold his company, Paresco Futures, to the OTCexgroup in 2005. He is now... More
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  • At the ECB Circus, Mr T has spoken…
    As you may have noted in the early note, I am once again surprised by the reigning schizophrenia from Frankfurt. I am even surprised to find myself surprised again!
          It is harder to following the ECB's reasoning than to understand the itinerary of a spoilt child, much less in Esperanto.
     
     
    So here are a few extracts from Mr T's comments :
     
     
    TRICHET: WE DID NOT WANT TO CHANGE IN ANY RESPECT YIELD CURVE 
     
    ---> However, that is precisely the result of the LTRO decision, with a bear flattening, confirming that:
    * December will be the last 12-month LTRO;
    * it will be at a variable rate
    * the 6-month LTRO in March will also be the last. 

    If he did not want to trigger a change on the yield curve, what was he trying to gain by eliminating any visibility for banks on the euro-area?     on 2010 (average of weekly refi rates)     

    In any case, I remain convinced that this will convert much quicker than people realise into bull flattening!
     
    It waas perhaps difficult to admit that these measures were, in fact, meant to punish certain euro-area governments (Greece, Ireland, etc.) and banks load with carry trad (Greece, Landesbanks, among others)!

     
    TRICHET: MONETARY ANALYSES BEEN GOOD GUIDE FOR RATE DECISIONS
     
    What is the term for problems of muddled memory (interest rate hike in July 2008 and constant lag behind curve)?
     
     
    TRICHET: TRUST SINCERITY OF TREASURY SEC, FED CHAIR ON DOLLAR
    TRICHET SAYS HE `TRUSTS' SINCERITY OF U.S. COMMENT ON DOLLAR
     
    You'd better hurry up Mr T, because if you wait too long to post your letter to Santa Claus, he'll be gone delivering his gifts to all the other nice boys and girls.

    TRICHET: WE EXPRESSED OUR VIEWS VERY VERY CLEARLY ON CHINA TRIP
     
    Well, that seems to have led from a very, very clear response from China:
    Chinese Premier Wen Jiabao
    “Some countries are now calling for Yuan appreciation while imposing trade protectionism on China, which is unfair”.
    “A stable Yuan is helpful to development of the Chinese economy and the world' economic recovery."
     
    And what about the outcome of the celebrated trip to China by the European troika:
    Luxembourg Prime Minister Jean-Claude Juncker?
    "I can't say that I'm more optimistic than I was before I came here,"
     
     
    TRICHET: DECISION WE HAVE TAKEN ARE EXACTLY APPROPRIATE       
    TRICHET: MEASURES WE TOOK TODAY EXACTLY RIGHT COMPROMISE        

    Aside from the obnoxious and self-satisfying nature of this statement, which is a classic sign of lack of self-confidence, it would have surprised us if he had declared that their decisions and actions were exactly wrong….
     


    Disclosure: Disclosure : Long 20 years OAT 0% Coupons, EDF Corp 5 Years 4.5%.
    Tags: TLT, SPX, economy, currencies, bonds
    Dec 03 01:33 pm | Link | Comment!
  • ‘Shichisho Hokoku’: The Japanese also have a right to Stealth QE!
     
     
          First, a little translation.
          ‘Shichisho Hokoku’ represents here the war cry of Japanese Samouraïs, usually translated as "Serve the nation during seven existences". It was popularised by writer, Yukio Mishima, who committed suicided according to the Seppuku ceremony in 1970, anguished by the lack of the population's reaction to his calls for the restoration of the "Japanese spirit", which he considered to be corrupted by American influence.
     
          Stealth QE refers to a quantitative easing that authorities do not want to recognise as such, thus furtive. The expression came into use following the ECB's 7 May 2009 decision to offer eurozone banks 1% financing facilities on a year in unlimited quantities.
     
          In the case of the BoJ, its decision to offer Y10 trillion (€75bn) in 3-month loans at 0.10% to banks in Japan, with JGB collateral, amounts to financing the purchase of government debt on the cheap by the Japanese central bank.
          This approach allows the BoJ to escape from its self-imposed limitations by prohibiting itself from buying more JGB than exist banknotes in circulation. The question will remain for some time to come as to how they came up with this ridiculous idea in a world of fiat money. In any case, that is what has limited it so far in its QE programme stricto-sensu, which has therefore only increased to Y21.60 trillion from Y16.80 trillion in March.
     
          The BoJ has thus brought new support to the Japanese government debt market, by also influencing the short-term yield curve (the 3-month euro/yen rate has just fallen to 0.32% from 0.45% in the wake of this announcement)  and by relying on term structure. Governor Masaaki Shirakawa declared:
     
    The BOJ aims to "encourage a further decline in longer-term interest rates “
     
          So what was the purpose of the BoJ's emergency meeting this morning: to announced this Stealth QE, which we consider the most significant news of recent days?
     
          First, even if the BoJ, created in 1882, obtained independent status from political authorities following the reform of 1997, recent pressure from government officials for the central bank to take the measures needed to fight against the deflationist spiral seems to have been sufficiently strong for the Monetary Policy Committee to call this impromptu meeting, and announce this new measure.
     
          Above all, the convergence of several events seems to have convinced the BoJ of the severity of the danger, as Mr Shirakawa made very clear this morning, when he described a mechanism we have abundantly described in these lines:
     
    “Japan is in mild deflation"
    “It is also important to avoid a situation in which the decline in prices induces adverse effects on economic activity, which in turn leads to a further decline in prices, namely, a vicious circle between economic activity and prices"
      
          The events in question are obviously the financial mess in Dubai and the Yen's new 14-year record high against the dollar.
     
          The last time the US currency was quoted below 85 yen, as it was last Friday, was in 1995, which amounts to an over 30% revaluation since June 2007!
          At a time when its main trading partner in Asia, China, continues to peg to the dollar, the yen's newfound strength only intensifies the already well-established deflationist tendencies in Japan.
     
          And that's leaving aside the collateral damage to businesses dependent on foreign trade, like Panasonic, which plans to speed up its delocalisation to Indonesia.
          
          Dubai, in reality, is nothing more than a reminder, brutal but hardly surprising, of the violence of the de-leveraging process with which the financial world is confronted..
    (I will not go into the Chinese credit explosion, which is an isolated case, but whose consequences will be similar to those seen elsewhere).
     
          All it takes is to observe the regularity of debt to equity swaps throughout the planet to understand just how we have come along in the debt deflation process for over two years now.
     
    Earnings of the world's largest diamond miner plunged 99% this year and, confronted with a $1.5bn debt payment in March 2010, it has to raise between $1bn and $1.5bn in hard capital. The first injection of $500m from Anglo in February at 0% interest rate was not enough for the South African mining company which would have undoubtedly preferred extracting gold instead of diamonds this year.
    All De Beers now has to do is convince all the, now, goldbug hedge funds that diamonds are good protection against currency risk.
     
          Weakened banks continue to look for ways to strengthen their capital. Following the moves by Japanese, British and then German banks (not over), Austrian and Irish banks are ready to make their move.
          The sixth biggest bank in Austria, Hypo Group Alpe Adrian, has announced a loss of well over €1bn at the end of the year, following the €520m loss in 2008.  Bavaria, a very reticent region, is under pressure to come to provide it the funds, given the 67% capital stake held by the Bayerische Landesbank. The decision will be made on 10 December, at the latest; otherwise, HGAA will fall below the minimum required regulatory capital.
          Irish banks, Allied Irish and Bank Of Ireland, will probably have to be quasi-nationalised, since the government has no alternative but to transform its preferred shares into common ones to inject core capital into these establishments.
          They will have to contend with heavier than expected losses, and NAMA, the bad bank, will have to increase its Haircut rate on the toxic assets to be transferred to it. It appears that the level of toxicity was underestimated…
     
         
          I received a number of well-intentioned requests to size up the outcome of the European Troika's journey to China, initially covered by us ten days ago under the sub-title: What in the devil are they doing in this mess?, which was published published in full in China.
           As I seem to have lost my ambulance rifle several months ago with respect to the ECB, I think I will pass on this opportunity to repeat what I have said so often before…
          All it would take is an announcement of the end of the LTROs this Thursday or, worse, to add a spread to the one official projected this year to find ourselves ensconced deeply in the hole from Japanese is desperately trying to escape!
          But, at least, I can proud of having the world's strongest currency…
         
     
    Some customers  option strategies:
     
    Bund
    Call ratio 124/125 January 1 by 2: 0.04, delta -3%, long theta 0.65 (P&L +5.5)
    Put Ladder 121.50/121/120.50 January: -0.01, delta +3%, long theta 0.30 (P&L +4.5)
     
     
    Eurostoxx:
    Put Ladder 2900/ 2700/  2650 December: 52, delta -30%, long theta 1.00 (P&L +10)
    Call ratio 2850 / 3000 décembre 1 par 2: 42, delta +21%, thêta créditeur 0.15 (P&L +17)
     
    Still some short tail risk positions, which may appear to contradict our global view of asset classes and implied volatilities levels, but these structures have performed perfectly in the past 30 months (with the exception of October 08!).

     
    Disclosure : Long 20 years OAT 0% Coupons, EDF Corp 5 Years 4.5%.
    Thaler's Corner.

     


    Disclosure: Disclosure : Long 20 years OAT 0% Coupons, EDF Corp 5 Years 4.5%.
    Tags: TLT, SPX, bonds, economy, dollar, gold
    Dec 01 02:45 pm | Link | Comment!
  • Naked Swimmers at Low tide on Debt and Credit deflation!
     
          Some may conclude that I have become obsessed with this issue since the death of securitisation in May 2007, given my Breton stubbornness in focusing on debt deflation, which has nonetheless proven to be a very useful look-out during these past two and a half years of turbulence.
     
          As the unfolding of this process appears as implacable as ever, I am beginning this Thanksgiving Day note with eurozone credit statistics, just released this morning, and will then discuss the "sovereign" events  (Dubai, Greece, dollar) which are now further heightening market anxiety.
         
          First, money supply as measured by M3, the ECB's famous thermometer used to gauge price stability and credit liquidity for which the central bank has set an annual growth target of 4.5%, came in at an annual +0.3% for October.
          This new disappointment, especially compared to the market's very low growth forecast of +0.8%, reveals once again an ECB slow on the uptake.
     
          As you can see in the graph, below, not only did the central bank pursue its tight money policy until July 2008, when all credit indicators (M3, lending to non-financial businesses and households) had already turned steeply downward, but, above all, it refused to carry out its later monetary and quantitative easing.
          Without falling into (the very tempting) ECB-bashing, we are still waiting for Mr Trichet to answer the question asked of him at a recent press conferences: Why is it dangerous to lower short-term interest rates to 0%?.
          His dismissive response, reflecting a real deficit in democratic accountability, consisted of simply stating that that was the ECB board analysis and that no further explanation was needed…
          I am leaving aside, for the time being, the new, quasi-schizophrenic insistence to feed daily the "exit-plan" debate, as Mr Weber-Pignon did again this morning.
          If it were simply a matter of a poor understanding of the mechanisms of these processes, the damage would be limited to the extent that officials can be replaced, but imagine that the designated heir to Mr T's position says:
     
    We should not be too optimistic in our future forecasts.
    Germany is on the brink of a self-propelled recovery.
    I will not express myself on ECB policy; we are in a period of radio silence (‘Purdah’).
    It is time to think about exit strategy.
    We must end the stimulus plan polemic.
    We cannot wait indefinitely before exiting (from overly accommodating policy).
     
          This leaves me speechless…
     
          Given the hike in the price of gold (about which no one really cares, except a few hedge funds), are they going to make the same mistake they made in the summer of 2008, when oil prices were rising, and accelerate the depreciation of the dollar (which hardly needs it at this time) and, thus, fuel commodity prices (safe haven investments) just that much more?
          On the other hand, the end result would give them additional arguments for hiking interest rates.
      
          In any case, the simultaneous release of M3 figures and statistics on household loans on the eurozone, with another annual contraction, -0.1% sur un an, this morning were a bitter pill. This may seem trivial, but this is unprecedented in the history of this series. In the pits of the recession of 2001, they continued to grow at annual pace of +5%.
     
          Loans to what is otherwise known as the "real economy", non-financial businesses, declined by an annual -1.20%, another "record", which compares to +15% in the spring of 2008.
     
          Bear in mind that, in the debt deflation process, the credit contraction phase stems from the:
     
    -          reticence of credit-worthy borrowers to take on more debt at prohibitively high real interest rates, given the low returns of investment projects; and
    -          reticence of banks with low core capital in the midst of de-leveraging to grant loans to clients who are now viewed as suspect.
     
          Central banks and governments can demand that banks do their job as much as they want: that is precisely what they are doing today, and probably better than they were two years ago.
     
     
    Eurozone: Loans to households and non-financials, and M3.
    There's a green shoot for ya…
     
     
     
     
          Speaking of banks' core capital, the Finance Minister from Rhineland-Westphalia, Helmut Lissen, says that WestLb should be sold in the first six months of 2010. With a more complex balance sheet, it will require help from a Bad Bank as the regional bank sector experiences a wave of M&A activity. Good luck!
     
          Dare I also mention that the current widening in debt spreads on the eurozone and the ECB's pre-announcement of its determination to shut of the spigot aren't going to help matters, given certain banks' reputation for being load with carry trade?
     
          If we account for the turbulence in peripheral countries (the Baltics, Central Europe, UC Rusal case) and the end of the guarantee on bank bond issues by governments in 2010, the credit outlook in Europe looks pretty gloomy.
     
          Lost decade? There we have it!
     
     
          Following the USA, China, EU, UK and Japan, Indian RBI Governor, Duvvuri Subbarao,  has just demanded that banks boost their capital reserves.
     
         
          In the meantime, in the United States, where the latest GDP figures prove that the economy remains under total government perfusion, new worries have been raised about the residential real estate outlook, despite the predictions of greenshooters of imminent resurrection. 
     
          First, there is the old story of ARM subprime mortgage options, the toxic instruments which enabled borrowers to put off until later the payment of both interest and principal, based on a much higher interest rate.
          The grace period for the wave of debt issues in late 2004 comes to an end at year-end 2009: the average value of all these homes is so much lower than the remaining principal to be paid that it does not take a rocket scientist to see what will happen.
     
     
          Oh, and here's an announcement likely to make waves: Fannie Mae has warned that it plans to toughen home lending terms next month, both in terms of "credit scores" and loan amounts granted relating to the revenue of borrowers.
          Check out this in detail, which constitutes only one of the episodes in the Cornelian choices with which the US administration must contend since the real estate credit market became quasi-soviet.
          Fannie and Freddie will continue to be caught between the hammer, represented by the search for earnings needed to re-privatise these structures, and the anvil, represented by the political need to support a residential real estate market that remains under perfusion whatever the costs.
     
     
          As for Dubai, I don't have much to add to IB Bloomberg alerts we have already sent on the matter about which you can now read in the press (this evening's edition of Le Monde).
          Our longstanding readers may recall our text almost a year to the day, on 12 November 2008 (see attached PPS file):
     
    Does anyone remember the name of the wise man who said that when a country starts building the highest building in the world, it is time to disinvest quickly?
    Especially, given the surrounding area (desert), they really had no need to build toward the sky!
    Perhaps with oil going at $50 per barrel, some buildings will go unfinished.
    Nice pictures nonetheless (attached).
     
          In this context, Mr Buffet's comment, quoted frequently in the wake of the Madoff revelations, comes to mind: When the tide goes out You Can tell ho Is swimming naked.
     
     
          In another symptom of the tulips syndrome affecting the gold market with Sri Lanka joining the gold ingot camp (India, Mauritius Island, Russia, China and just about all the world's major hedge funds), I recommend that following WSJ article, which reports that there is now so much demand for the physical stoking of gold in safe vaults from institutional investors that HSBC, the leading bank in this field in New York, is asking its retail clients to stock their gold elsewhere …
     
       **********************************************************************************  
     
     
          A whole lot of options activity here in the past few days, with huge hedges via Dec09 put ladders on the Eurostoxx (29/27/26.50 at 42.50, delta -29%) and purchases of January gamma volatility on the Bund, thanks to the gift made by the massive seller in the past 15 days of puts and, then, calls, from 6.30% to 5.2% volatility!
     
     
    Have a good day and Happy Thanksgiving on the other side of the Atlantic!

    Disclosure : Long 20 years OAT 0% Coupons, EDF Corp 5 Years 4.5%.
    Tags: TLT, SPX, macro, bonds, ; economy, currencies
    Nov 27 09:29 am | Link | Comment!
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