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A coordinated easing move by the world's major central banks was well received by most markets today. Lower interest rates can't solve all problems, however, and they won't fix the fundamental problem of bloated Eurozone government spending, but they can take the edge off the panic by backstopping the financial markets. 2-yr swap spreads are a good indicator of the tensions in financial markets, and today they dropped by over 10 bps in the U.S. Eurozone swap spreads remain quite high, however, as do yields on PIIGS debt. The wider gap between U.S. and Eurozone swap spreads indicates an increased likelihood that the U.S. economy will be insulated from the fallout of a PIIGS default, and that is a very positive development. With lots of recent economic indicators showing marginal improvement in the U.S. outlook, any steps taken to foster continued improvement in the U.S. economy also provide some indirect support for the Eurozone economy as it struggles toward a solution. A solution which in the end must consist at a minimum of restructured debt and meaningful cutbacks in government spending. There is no painless way to fix the PIIGS' problems, but avoiding financial market panic is a good way to allow the process to proceed.
The chart above show the ratio of the Vix Index and the 10-yr Treasury yield, which is a good measure of panic (a high Vix index signals panic) and despair (a low 10-yr yield signals little or no hope for growth). We're still in red-zone territory, but it would appear that there has been some progress toward a resolution.
15 comments:
I anticipate that the ECB will eventually purchase in excess of $7.5 trillion in European toxic debt, and that the US Federal Reserve will purchase about the same amount in mortgage debt -- eventually, the markets will give up on the monetary shenanigans of Fed and ECB, and the central banks on both continents will be intervene into the markets with cash, or face the demise of central banking as we know it -- remember, the central bankers do not want to see the Fed or ECB abolished...
I am amazed at how fragile the big banks are. Are they always a few days away from not having the cash flow to cover their short term maturing debt? How is it they are allowed to be this way? Why is lending long and borrowing short allowed? Why are they allowed to lever up so much?
It needs to change.
Today's coordinated effort and stock rally doesn't do anything on the margin but continue to kick the can down that road...
Europe needs a central bank that print lots of money, and stimulate their economy. So do we.
Unfortunately, the ECB is stymied by a rule that its only job is to fight inflation.
Euro stocks are down 60 percent since 2000.
Japan stocks are down 80 percent in last 20 years.
Fighting inflation is reactively easy. You just suffocate the economy, and declare yourself a success, and define success as zero inflation.
Growth, profits, jobs, innovation---all someone else's problem.
BTW, George Gilder once said we need commodity inflations to spur new production--if we asphyxiate the economy every time there is a rumble in commodities, we will ensure no one tries to up the supply.
Today's action is too small, and needs to be sustained. Yes, Europe needs to balance their fiscal budgets, but they also need huge sustained, monetary stimulus.
Investors invest, business borrow and hire when they sense boom times.
We could use some boom times.
As I predicted the financial powers that be, especially the major central banks will not let speculators and hedge funds using margin continue to pressure the Euro, Italian and Spanish bond yields and short the major European and US banks. The central banks know very well the short positions of these speculators and they wacked them good today.
One might superficially look at today's market action in stocks, commodities, etc. and think of all the money which was made.
But there were Billions for Dollars lost by speculators who were betting against the Euro, Banks, and Commodities. The short covering was furious today.
The central banks have drawn a line in the sand. They knew full well the effects that their combined actions would have.
PS: At major market bottoms it is always the same - DISBELIEF !! Just take a look at the comments on the "Forum" at Yahoo for SPY ETF - all negative just like the 4 comments before mine. At the beginning of a new bull market almost no one believes it.
Almost everyone expects the market to continue to decline. It was the same at the March 2009 bottom. It was just the same reaction when Mexico defaulted on its debt in August 1982. In the latter case, Paul Volcker reaction was to finally systematically lower interest rates to accommodate the crisis - having previously raised the Fed Funds rate to 20%.
AT least that it my bet and my position.
@William, your two comment postings above are instructive, thanks...
Thank you, Dr. McKibbin.
What most people don't understand is that WALL STREET gets it. Over time, it has learned that when the central banks put their foot down, it is time to change course.
Most investors will be shocked at the advance the markets will make. Look at Asia over night: the MSCI ASIA APEX 50 is up 5.5%; the HANG SENG CHINA ENT INDX upon which the FXI ETF is based is up 8.2%; the TAIWAN TAIEX INDEX is up 3.9%; the KOREA KOSPI 100 INDEX is up 4,2%.
The market reaction is not because what the central banks did was so monumental; but because the market now understands that the powers that be will do whatever is necessary to prevent a collapse of Euroland. (Actually, I don't believe that the financial situations in Italy and Spain were so terrible. The problem was mostly speculators hipping the issues.)
PLUS, most folks who could be frightened into selling have sold so the easiest direction for the markets are UP.
I doubt very highly that the ECB will do any such thing. The ECB is really the Germans, and they are extremely reluctant at this point.
The speculators are not to blame for this pressure. This is the doing of the lazy neighbors of the south borrowing till the cows come home.
This is going to end very badly.
The ECB and US Federal Reserve will "print" approximaely $7.5 trillion each to buyout toxic assets, or these institutions will risk being abolished -- that's the long and the short of it -- neither of these institutions can risk losing sponsorship from any of the world's sovereign states -- the money will be "printed" -- that's my view of reality right now...
First off, the "new" swap lines were nothing new at all, they were probably increased and the cost was lowered, but I doubt that its a 50 bps cut that will change anything here. I would agree with the insulation of American financial institutions from the European mess except for one caveat, and its important -- its derivatives. JPM revealed that its gross position was $5 trillion, the assumption here is that JPM has sufficient collateral in the event that a counterparty fails...that's a fragile assumption at best (maybe foolhardy).
I think the Germans are going in the right direction. They are combating deep seated socialist habits in most of these countries. As soon as the pressure is relieved, the politicians go back to their old ways of borrow and spend. Governments have now been changed and reforms will occur. But they need time to further implement fiscal policies. If an acceptable enforcement mechnism can be found, I think the Germans will relent and let the ECB monetize more of the debt. So I see some solutions emerging short term. Longer term, elections in Greece, Italy, etc. will likely cause more problems for the eurozone.
I agree with William. Deep pessimism offers longer term investors entry points that can yield above averge returns. Undertand what you own because you will be tested. Get some yield, and be willing to ride the wooly beast.
No one is going to abolish the central banks. The troubles with society is a result of personal corruption rather than monetary policy.
I agree with the solution in buying the assets, but you and I know that is not going to happen.
Note that if the the only two major sovereign states remaining in the ECB are Germany and France, then the ECB would likely be abolished by those two nationstates bilaterally -- herein lies the central challenge and dilemma for the ECB -- likewise, the US Federal Reserve cannot ignore the possible abolition of the ECB due to membership cancellations -- the ECB is the lender of last resort in Europe, and the ECB's very existence is at stake should the southern flank of Europe reject ECB demands that these nations to surrender sovereign rights in exchange for bailout funds -- in the end, the ECB, supported by the US Federal Reserve, will "print" whatever money is necessary to ensure the continued existence of central banking in Europe and the US -- the central banking problem in Europe is quickly transforming itself from an intellectual economics exercise, to one of realpolitik, which is something the Germans understand all too well...
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