The return of Swervin' Mervyn

Well, it didn't take long for the governor of the Bank of England to remind us why he is known is some quarters as "Swervin' Mervyn." A day after Merv appeared to drop the hammer on bail-outs and "the world owes me a living" financial risk-takers, news has hit the tape that Northern Rock, a prominent UK building society, has borrowed "a substantial amount" from the Bank in an emergency operation.

As of yet, official details- the amount and the rate- have yet to be officially confirmed. That hasn't stopped the press from characterizing the operation as exactly what King stated would not be forthcoming: a bail-out.

Now, in his TSC statement, King did suggest that the Bank has a role to play as lender of last resort to ensure financial stability:

"In addition, central banks, in their traditional lender of last resort (LOLR) role, can lend “against good collateral at a penalty rate” to an individual bank facing temporary liquidity problems, but that is otherwise regarded as solvent. The rationale would be that the failure of such a bank would lead to serious economic damage, including to the customers of the bank. The moral hazard of an increase in risk-taking resulting from the provision of LOLR lending is reduced by making liquidity available only at a penalty rate."

The problem, of course, is that the current standard BOE "penalty rate", 6.75%, is actually lower than the current interbank borrowing rate. So conceivably, Northern Rock could borrow from the BOE and lend in the open market and lock in a small profit- exactly the sort of behaviour that King decried in his statement.

Macro Man is willing to withhold final judgement until the details emerge. But if NR really did borrow at the standard "penalty" rate just before announcing that a) they expect to earn £500-540 million this year, and b) they expect new lending volumes to increase, it will be difficult to avoid the conclusion that Swervin' Mervyn has committed the grossest hypocrisy. (Interestingly, there are a number of anecdotal reports of large queues outside of Northern Rock branches, so perhaps NR's cure was worse than the disease!)

Of course, puzzling behaviour is not confined to the BOE. Serial whingers the Swiss National Bank have provided numerous reasons to scratch one's head over the past few years, and this week is no exception. The SNB hiked its LIBOR target rate by 0.25%, surprising some observers but earning a hearty "Bravo!" from Macro Man. Yet this morning the SNB set the 1 week repo at 2.08%, a whopping 0.21% lower than yesterday. So on Thursday, they hike rates (fully justified, given their currency concerns), but on Friday they cut rates?!?!?! SNB: WTF?

The continued strength of equities, carry currencies, and other non-CP risk assets is also prompting Macro Man to ask WTF. We are swiftly moving towards a scenario wherein a 0.25% Fed easing will be seen not as as a disappointment, and thus a reason to sell stocks, but as a provision of unneccesary liquidity, and thus a reason to buy. Macro Man was filled on his sale of ESU7 at 1490, so if this scenario plays out he may be stuffed. That the central bank of Turkey felt sufficiently confident to surprise markets with a rate cut yesterday- which was followed by a rally in TRY- is pretty clear evidence that contagion risks have, for the time being, subsided. It's just another brick in the wall of Macro Man's view that a Fed easing would be a mistake.

Today sees the release of a really interesting piece of data in the US. No, not retail sales, industrial production, current account, or even consumer confidence figures. All of these will be interesting, to be sure, but the cyclical data is less significant than usual, as Big Ben noted last week, while the confidence data is, in the short term, little more than a proxy for the stock market. No, the figure that Macro Man is really looking forward to is the import price number.

Specifically, the figure on import prices from China. When Macro Man talks to his colleagues about inflation, articulating his view that it is a large and growing problem for the US, he draws a lot of quizzical looks. One tenant of his view that real-world inflation (as opposed to the core PCE deflator, a measure that nobody pays) is that the deflationary impact of the BRICS has been replaced with an INflationary impact.

As has been documented previously, US import prices from China are now rising y/y: 0.9% at last count. On a more high-frequency basis, the 3 month annualized rate is up nearly 3%. What's particularly interesting is that both the y/y and high frequency import price data bear a startling resemblance to China's headline CPI. All the more reason, therefore, to take the recent acceleration seriously and disregard thos analysts who seem to think that food prices don't matter. All of this, of course, is an argument in favour of allowing the RMB to appreciate more quickly. To a degree, this is occuring- against the dollar. EUR/CNY, on the other hand, is back close to its post-reval highs.

Regardless, if an acceleration of non-oil import prices is met with Fed easing, it provides another reason to question why anyone would buy dollars any more. While EUR/USD remains near all-time highs on a spot basis, at longer maturities (such as those used by some sophisticated European exporters), this is not yet the case. Might they start getting sucked in to take advantage of current "value" before long?

Perhaps, though Macro Man is wary of talking his book too much. (And Brad, to answer the question you asked in the comments section a couple of days ago: I'd actually prefer PBOC to bugger off entirely. But if they are going to screw around and set the exchange rates of countries whose capitals are not Beijing, I'd just as soon they did it in my favour than not!)
For now, Macro Man is now going to wait: wait to see how the equity dynamic plays out, wait for an oppounity to sell more dollars, and wait to see who is bailing out whom.




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September 14, 2007 at 10:58 AM ×

How stock markets react would depend on whether a rate cut is seen as a saviour or a confirmation of bad economic times ahead...

CB

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Anonymous
admin
September 14, 2007 at 12:31 PM ×

More tough love from the King:

"The Bank of England relaxed restrictions on the amount of money financial institutions need to hold with the central bank, encouraging them to lend more to each other as it tries to reduce overnight borrowing costs."

"Commercial banks, which agree to hold a specific amount of money at the Bank of England at the end of each month-long maintenance period, can now undershoot that target by 37.5 percent and still earn interest at the benchmark interest rate, the central bank said today. That compares with a previous restriction of 1 percent."

``They've been more generous than we thought,'' said Philip Shaw, chief economist at Investec Securities in London, who expected the bank to widen the range to 26 percent.

http://www.bloomberg.com/apps/news?pid=20601087&sid=a4OX6orwTj88&refer=home

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Macro Man
admin
September 14, 2007 at 1:14 PM ×

I believe the relaxation of the reserve requirement by that margin was 'created' for this Northern Rock operation. But yes, even more evidence that Merv has indeed Swerved.

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Anonymous
admin
September 14, 2007 at 1:53 PM ×

That letter in full..

http://www.bankofengland.co.uk/publications/other/monetary/treasurycommittee/paper070912.pdf

We shouldn't but if we do here is how....

Still on a "sticky wicket with regard to justification " The rationale would be that the failure of such a bank would lead to serious economic damage, including to the customers of the bank." especially with The Rock paying out 108m in divis in a weeks time.

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Macro Man
admin
September 14, 2007 at 1:58 PM ×

I tried to link to the statement in yesterday's post, but I guess it didn't take. Thanks for linking directly to the BOE.

I suppose I just have difficulty in understanding why the BOE should lend to NRK at a non-usurious rate when the stock is still trading above book value (presumably the maximum threshold for a takeover bid in this market), and still plans to earn half a billion quid this year...

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Anonymous
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September 14, 2007 at 2:24 PM ×

MM,

The August import price number does not look at inflationary. A temporary quirk related to the August sell off in oil or some other reading of this?

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Macro Man
admin
September 14, 2007 at 2:43 PM ×

It looks driven by energy and industrial supplies. Import prices fom China, on the other hand, rose another 0.3% m/m, taking the y/y rate to 1.1% and the annualized 3m/3m rate to 3.7%.

So on the face of it, not inflationary....but the trend that I am following continues to percolate.

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Macro Man
admin
September 14, 2007 at 4:43 PM ×

I voted for 25. An interesting analogue poll would be "what should the Fed do"....

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Anonymous
admin
September 14, 2007 at 6:03 PM ×

At least Swervin' waited 2 days after his remarks ... I guess that's his version of the Greenspan put ....... does he work for McLaren by the way ?!?!?

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Anonymous
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September 14, 2007 at 8:24 PM ×

Seems to indicate that your financial health is not the issue just the willingness of the Chancellor to agree you're looking peeky. The CEO says he doesn't even need the facility yet but might do in future.

Thus timing with regard to possible Fed misdirection re: "global contagion" is a bit fishy.... they have the sniffles in UK... queues at the bank, prompted by the news that they do not no less need any money no less.

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Anonymous
admin
September 14, 2007 at 8:27 PM ×

On the other hand might demonstrate effectiveness of these "tools"

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jp
admin
September 15, 2007 at 1:57 AM ×

In the States too discount lending is growing. At its highest point since 911 and before that the S&L bailout.

http://research.stlouisfed.org/fred2/series/TOTBORR?cid=122

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Anonymous
admin
September 15, 2007 at 3:25 PM ×

We can dream right?

Dear Shareholders

Our temporary inability to fund certain obligations at the right price means that we will have to draw on earnings to finance a refunding excercise over the next few quarters and maintain a lower than planned volume of lending in our markets.

Some of this and the following two quarters earnings will need to be assigned to losses arising from refunding costs and we plan to suspend dividend payments over this period.

While Merv and the little Darling have been kind enough to offer us a cheap slug we feel that, should we accept, the short and long term effects on our business reputation would more than offset the temporary advantages that such a course would entail.

A reduced business volume will permit reductions in variable and overhead costs. Management salaries and bonuses will be cut and some staff reductions will be made in the funding part of our business. We plan to restore these as soon as possible.

Fortunately, we believe that these economies coincide with a tightness in conditions in our markets and that cost reductions will not impair our ability to resume market-paced growth once funding is in place.

I and the present senior management have agreed it is appropriate to suspend all our own remuneration until funding has been sourced. Once we have seen the company through this uncomfortable period we have agreed with the board that we should step down.

Sincerely

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quksilver
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September 17, 2007 at 2:10 AM ×

In case you didn't see it, IHT had an article this Sunday on Japanese housewives trading in currency markets...

http://iht.com/articles/2007/09/16/business/16housewives.php

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