Weekly Commentary on Financial Markets:
21 November 2011
by Jacob H Schmidt
Back to Rating Concerns
News of the week: markets impatient with lack of progress and extremely volatile; signs of serious disagreements between Berlin and Paris; Austria’s AAA rating at risk
Europe – Euro
The Euro crisis continues, with elections on Sunday in Spain leading to a change in government to the Popular Party. In Italy and Greece the new governments lead by experts – unfortunately sometimes called technocrats by the media – what a pejorative label for people who run for office out of duty and due to their expertise – will need time to implement policies. But the markets are impatient. And it seems the fellow EU members and international organisations as well. The debt auctions of last week in Spain, Italy and France were a disaster – placed little paper at high levels. Italian yields rocketed back to above 7%.
Austria’s AAA rating at risk (and many others’ as well) as budget deficit and debt burden rising. Talk in Austria of cutting some Euro 40 b in 3 years, agreement in principal to reduce debt – dubbed debt break or “Schuldenbremse” – but not sure how to do: cut expenses such as transfer payments, stream line admin or increase taxes. Rating review due before year end.
EFSF without progress, as funding is a serious problem. Talk is still of leveraging a base amount, but they cannot even raise the base amount. In the meantime the ECB has to do the job, risking to be in breach of their mandate. We also noticed a change in Germany’s way to communicate its conservative approach to ECB policy and the debt problem in general. Exclusion from the Euro, sanctions and German standards are the new vocabulary. There is also deterioration in the Paris – Berlin relationship.
My Grade: B
Slow progress but protests – we will need some kind of Marshall plan.
My Grade: C-
Results from the Joint Select Committee on Deficit Reduction aka Super Committee still focus, recent news from the progress rather disappointing: political brinkmanship part 2 (part 1 was in the summer).
My Grade: B
Focus on the banks which will need to raise a lot of capital to satisfy higher capitalisation requirements – capital adequacy according to Basel 2.5 and Basel III. Banks also need to write off more bad debt. So far all most banks have stressed that they will try to avoid public funds. We also noticed that many banks (e.g. UBS, Soc Gen et al) use the fair value accounting provision (mark to market) for the revaluation of outstanding their debt as an extra-ordinary revenue to show profits when in reality they lost money. While this is permissible under IFRS (157) we are critical of the repercussions.
My Grade: B-
No change in our assessment of markets: stocks, bonds, FX and commodities continue very volatile, driven by fear, sentiment and little liquidity. My Grade: B
US rates lower from last week: 1.98% on risk aversion from 2.07% for 10 year notes (vs last week); also in German bunds (1.97 vs 1.89%). My Grade: C+
Spreads wider again
Spreads in Italian BTP wider again, were at > 7% last week after rally to 6.45% for 10 year bonds. Greece 10 year at 28.19% (high 20s price level). Austria 10 year 3.39% (high was 3.6%), France OAT 10 year at 3.46% (high was 3.7% last week). My Grade: C-
Gold, Silver and other commodities sold off, Gold now seen by some as a risky assets. Hedge fund manager Paulsen sold USD 2 b in Gold ETF. My Grade: B
Volatility: VIX stable at 30 % from last week.
Despite difficult year in performance terms assets have swelled to almost USD 2 t. Hedge funds use lower leverage, due to more risk aversion (most funds bearish on markets) and prime brokerages reduction in lines. My Grade: A-
We are still slightly positive, but are conscious of the political and macro risks. Good markets for skilled traders and short term hedge funds as well as very long term investors.
We were – perhaps prematurely – optimistic of the developments in Europe, hoping that the expert – or technocrat – governments and new leadership of the ECB would lead to swift change and hence turn sentiment. We still believe that there is light at the end of the tunnel, but as Dr Woody Brock, a famous American economist and game theorist said in a meeting with me last week: “perhaps the light at the tunnel is an oncoming train”. Possible, it all depends on policy and implementation, there is no time to lose and little space for error. Decisions have to be made pretty quickly, mainly in terms of banks and the debt problem. We believe that the ECB and the EFSF have to act quickly, the EFSF to be used as a TARP for banks and the ECB to stabilise the bond markets. My grade: B+
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