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A Possible ECB Intervention In The Corporate Debt Market

Written by A Forex View From Afar on Monday, March 30, 2009

Following the European Central Bank’s tradition to pre-announce its important decisions, the Vice President, Lucas Papademos, said last week that the central bank could start buying corporate bonds. This comes after Mr. Trichet announced, at the last interest rate meeting, that the bank is preparing to adopt a new set of “unconventional” policies.

According to Mr. Papademos, the ECB could intervene in the secondary corporate debt market to bring yields down. A similar decision was taken by the Bank of England, which decided to use up to 75 billion pounds to buy corporate debt, and more recently, by the Bank of Japan. At the same time, the Fed decided a slightly different approach, to buy government debt and mortgages.

Most likely, the ECB are preparing to take this stance because they cannot intervene in the government debt market, unlike the other central banks. This happens because the ECB is formed by 16 countries, and such a move would raise many technical and fundamental problems regarding what country’s debt to buy, and in what quantity.

In Europe, a staggering majority of private loans are issued by commercial banks. As the credit crisis struck the financial world, banks began de-leveraging their balance sheets and cutting back on new lending programs. A possible ECB intervention would loosen the tight credit conditions, to some extent.

Market participants expect this measure to be announced this week, at the ECB press conference. However, its effect in the currency market is still unknown because of the lack of any further details about the plan itself. However, if the ECB disappoints, the euro will probably see strong selling pressure.

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The U.K. Dilemma

Written by A Forex View From Afar on Thursday, March 26, 2009

Even though the U.K. economy is shrinking at a very fast pace, around 1.5% in Q4, the U.K. Prime Minister gave in to the idea of a new stimulus package.

Currently, the country’s outlook is rather gloomy, having the most important economic indicators near record lows. Retails sales continued to decline in February, while sales of small stores dropped the most since 1986, when records first began. Mortgage approvals are holding barely above record low levels, while unemployment claims jumped in February the most on record sending the jobless rate to a decade high. Private forecasters have said that the U.K. economy will shrink between -3% and -4% this year.

Despite the very poor outlook surrounding the economy, the governments’ hands appear to be tied. Both the Chairman of the Bank of England (BoE), Mervyn King, and the Chancellor of the Exchequer, Alistair Darling, have expressed their concerns about the deterioration of the public finances.

On top of this, yesterday, the U.K. Treasury failed to sell all the intended gilts at auction for the first time in seven years. This shows that investors are finding the debt issued by the U.K. government overvalued.

Every time the Treasury fails so sell its debt, it adds an additional burden on the taxpayers’ shoulders as investors request higher yields to be paid. A new stimulus package would imply that the Treasury has to sell even more debt, something that would have a substantial effect on the gilt’s value.

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German Economy Set To Contract?

Written by A Forex View From Afar on Tuesday, March 24, 2009

The latest forecast for Germany points out that the economy might contract a whopping 6% this year, as the credit crisis reduces foreign demand for German made goods.

Commerzbank, one of the leading German banks, said that the German economy might contract 6% to 7% in 2009. At the same time, Deutsche Bank and BNP Paribas project a 5% contraction in 2009 for the German economy. The German Institute for Economic Research estimates that the economy will contract between 4% and 5% this year.

By far, these estimates are the worst for any European economy, including the much-spoken-about Eastern Europe. Among the developed countries, only Germany and Japan share such an downbeat forecast.

As was said before, the export component is the biggest drag on the German GDP. Until now, exports have dropped by 20%, while the outlook clearly lies to the downside. Even if the global economy would miraculously bottom, demand and thus exports would still need some time before picking up again. Exports account for almost 40% of the German GDP.

Obviously, Germany is not the only victim of the credit crisis in Europe. Today, the Czech government collapsed, by gaining a no-confidence vote from the parliament, while just yesterday, the Hungarian government resigned. Wonder who will follow next?

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The Toxic Asset Plan

Written by A Forex View From Afar on Tuesday, March 24, 2009

Today, the equity markets around the globe rallied as the Treasury was unveiling its plan, meant to save the financial system.

Overall, the plan looks simple, since its only scope is to provide liquidity in the secondary market. This is because the Treasury treats the current credit crunch as a liquidity problem, and (still) considers the banks’ assets fundamentally sound.

The newly announced plan proposes to use the taxpayer’s money to leverage the investors’ funds, up to 6:1 for a loan, and 1:2 in order to buy the assets. In addition, these loans will be insured by the FDIC, so in essence, investors would support only a very small fraction of the actual cost of the distressed asset.

However, this still does not guarantee that investors will overpay for these assets, because the private investors will be the ones to suffer the first losses. Therefore, it will be in the investors’ best interest to come up with a low bid for the toxic assets, reducing their risk exposure.

In this case, banks will not be tempted to sell their assets. It would seem that, if these assets are really worth something (the Treasury treats them as fundamentally undervalued), why would banks want sell them at huge discounts. Secondly, many of these assets are still overvalued on the bank’s balance sheets. Even if the bank would want to sell them, they would have to write-down their value first, something that might not be too good either for the bank or for the overall system because it will trigger systematic write-downs.

With a bit of luck, maybe the new asset plan will get some traction in the financial markets otherwise today’s rally might turn around very quick. Additionally, as some market commentators have pointed out, it might be among the administration’s last shots at saving the financial markets.

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One-step forward or one-step back?

Written by A Forex View From Afar on Friday, March 20, 2009

The Fed’s decision to buy up to $300 billion of long-term Treasuries and double the purchases of mortgages to $1.45 billion was a surprise to most market participants.

The surprise is even bigger, if we add that just two weeks ago the Chairman of the New York Fed, seen as the second man in Federal Reserve, said “at this point in time the Fed has judged buying long-term Treasuries is not the most efficient means of easing financial market conditions”. This is a huge change in just two weeks, and it certainly raises some questions as to why the Fed made this decision, if it is not efficient.

Moreover, Mr. Bernanke has build an academic reputation as a supporter of the inflation targeting regime, which implies that the central bank must be as clear as possible in its actions. The Fed’s past actions have proven that the central bank follows these general guidelines, since the central bank has anchored expectations pretty well (until now).

In the last few years, the Fed has gone through some major changes with Mr. Bernanke at the rudder, and has mostly, managed to break free from the Greenspan era, when market participants focused on how many times the Chairman blinked, or where he looked when he spoke, rather than what he actually said. Mr. Greenspan spoke most of the time in “riddles” that gave some major headaches because the message was never fully understood.

The decisions taken yesterday (to intervene in the debt market without anchoring the market’s expectations first) remind us of the Greenspan era, something that is not very positive from my point of view. Yes, it was a true shock and it had clear effects in the financial markets, but it is still a question of how positive these effects will be in the long-term. If, supposedly, the market/economic conditions continue to deteriorate, the market will expect the Fed to provide another shock. If the FOMC fails to provide it, the financial markets will be very disappointed.

Another problem with the Fed’s statement issued yesterday is that it does not clarify how they have chosen the sums. Why they chose $300 billion for Treasuries, and $750 for mortgages is still unknown, but my guess if that the officials will clarify this at some point in the future, since this is not such a major issue.

The overall conclusion would be that the Fed had communication issues yesterday, and from my point of view took a step backward instead of the forward. Referring to the actual decisions taken yesterday, the markets still need time to clarify how effective they really are.

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U.K. Financial Regulations

Written by A Forex View From Afar on Wednesday, March 18, 2009

The era of “free and unregulated” markets and financial institutions may be over, or at the least, its sunset is quickly approaching as regulators try to avoid further crises in the financial system. The U.K.’s Financial Services Authority released a 122-page report today, which included some of the new rules that will shape the U.K. financial system in the coming years.

The two most important conclusions of the report were that the European Union should form a new regulatory authority, which would supervise the European banking system for systematic risks and exposures. The second important change highlighted in the report is that a clearinghouse should be formed for the mortgage market.

The new regulations package comes as an increasing number of U.K. banks have failed and required to be nationalized by the government, including the biggest national banks. Before the credit crunch, London was seen as the second biggest financial center in the world, closely following New York.

One idea that might prove to be very beneficial for the financial system is that the regulator arm of the law, the FSA, should also regulate financial products and not just financial institutions. This would imply that regulators would have direct access to the investment vehicles that first drove us into the credit crisis, something that might prove to be beneficial over the long term.

Other proposals included in the FSA report suggest that banks should limit their borrowing cap, in an attempt to reduce the likelihood of overleveraging loans, while at the same time, banks should increase the percentage of high-quality assets (theoretically, government issued debts). Among other things, these two decisions would reduce substantially the bank’s profit margin, but it would also increase the overall safety.

However, rules are meant to be broken or at least to search for a way around them. I entirely support stricter rules over the financial markets, but regulators should act preemptively, something that hardly ever happened until now.

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Fundies and Trading
There is a constant question from some traders as to why anybody would ever need to consider the ‘F’ word when trading. Fundamentals: what is so damaging at looking at both Technical charts and having a Fundamental filter to gauge how many Lots to put on? Why is it that accepting that Technicals give us price points to trade, but Fundamentals determine the direction that we travel is so difficult for some traders to accept? Without a Fundamental Filter very few pure Technical traders would have seen this Dollar move coming today.

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