Mr T: I Predict Pain

Thursday, March 03, 2011

So once again it is ECB day, when Mr T and the A-Team bitch slap punters for daring to bother trading in Eurozone asset markets. Since the crucifixion of Eurobears that entered the year all guns blazing in January, market participants have been generally trying to avoid selling the Euro, buying CDS protection or shorting Club Med bonds. Readers will know that TMM generally view "The Euro" and all things Eurobllx as one of those great religious debates that aren't worth expressing a view on, and even if one were to proffer an opinion as to whether it survives or not, those on both sides of the debate are deaf to opposing views. Suffice to say, the swing of the pendulum has swung toward those in the "pro-Europe" camp - if not for anything more than P&L cushions...

But we digress. Where punters *have* been trying to play the bearish Europe story is in the rates markets. For the past year or so, the ECB has repeatedly tried to exit its exceptional crisis-mode liquidity policy, through announcing an end to easy liquidity provision and hinting that rates will have to rise. Of course, the fiscal crisis in the periphery has on several occasions forced them to backtrack somewhat from this policy as wave after wave of EU policymaker incompetence has managed to screw up previous attempts at buttressing the periphery states. Of course, now, the ECB seem to be of the opinion that the war has been won, given that apart from the usual suspects (Portugal, Greece & Ireland), Euro-area capital markets appear to be performing pretty well. They also want to keep up the pressure on fiscal authorities to recapitalise their respective banking systems such that those entities currently unable to borrow in the interbank markets - such as NegativeAlphaBank Athens and All-In Bank Dublin - can.

Of course, the flaw in this strategy is that the results of the stress tests are not out for another few months, and given last year's fiasco, markets are bound to be rather more skeptical of the results unless they show a reasonable amount of new capital is needed. Additionally, markets are awaiting the reaction of the newly-elected Irish government to such results that are bound to show that the size of the black hole attached to the Irish banking system has increased to the point that it is not only the English cricket team that have been crushed by its gravity. And while EU policymakers appear to have managed to successfully manage expectations for a not-so-substantive "substantive" new EFSM package at the Ecofin meeting this month, TMM trust Merkel & Co. to monumentally screw it up somehow... after all, as the cliché goes, the trend is your friend.

On top of the above, as TMM noted earlier this week, while Germany is motoring ahead, ECB rate hikes have just the same negative effect upon the periphery in terms of higher financing costs as the evil anti-Euro speculators do when they sell Club Med bonds. With such intra-European divergence, TMM find it hard to see the ECB really doing anything other than talking tough to keep inflation expectations in check, with perhaps the odd hike later this year to show to wage bargainers that they "mean it". The move towards mopping up excess liquidity is likely to continue (see chart below from TMM's mates at Nomura) with 3m unlimited allotments ending, but TMM reckon that until said peripheral banking systems have been recapitalised (at least 6months away), that despite protestations about "liquidity addicted banks" that the ECB will have to keep at least the one week allotments and probably the one month allotments too.


And while Taylor Rules don't work as well in the Eurozone due to the ECB's reaction function being somewhat quaintly a function of money supply growth amongst other things, for what it's worth, TMM's model is shown below (white line) vs. the actual Refinancing rate (orange) and indicates that rates do not really need to rise given the Eurozone-wide output gap. But TMM admit, that this is unlikely to sway those arch-monetarists of the Bundesbank...

...perhaps it is interesting, then, that Darth Weber, erstwhile defender of the Monetarist Empire of the Eurozone has resigned and will not be attending today's meeting. Now, looking at what is priced into the curve is monumentally difficult given the subjectivity around how Eurozone liquidity conditions will progress over the coming months, with anything between one and three 25bps rate hikes priced in by year end, depending upon what discount (if any) one expects EONIA to fix at relative to the Refinancing Rate. And TMM reckon that, rather than being all purely rate hike expectations, the forward curve is more a function of significant risk premia resulting from the memories of June 2008, amongst other things.

TMM have thus far managed to sit on their hands (they have history with Mr T of the love-hate kind), knowing that many punters have tried to fade this over the past couple of months, and avoid buying the front-end, but it looks to them as though the risk reward for a punt on Trichet providing a dovish surprise today looks pretty good...

...they are sure they will be truly regretting this by the end of the day...

UPDATE: Ouch!

Where the hell did THAT come from? Darth Weber may not be getting Mr T's chair, but he hardly needs to be as the BundesECB meld appears to have already occured. Doc Trichet is taking us Back to the Future of 2008".

TMM probably in similar mood to Portugal, Spain and Italy and are wondering what Ireland's chances are of lowering their bailout interest rates...

The Good ship TMM after an encounter with U-ECB:

Posted by cpmppi at 11:30 AM  

24 comments:

pigs ahoy!

Anonymous said...
2:42 PM  

We recommend TMM repair to the local hostelry for an Irish Car Bomb (for the uninitiated, a Bailey's dumped in a pint of Guinness). It will all look better after that.

Big figuritis setting in again, a run at 1.40 in the cards, in spite of signs of life in US employment?

Leftback said...
3:00 PM  

I am surprised too. But what do I know? If ECB is determined to screw EUR short this morning, it apparently succeeded. Now, what could push Irish to default, if they ever go that far?

Anonymous said...
3:05 PM  

Was reviewing the relationship between European core inflation and Oil today. At best oil impacts core with a very long lag, at worst there is no relationship at all. Clearly the July 2008 rate hike by the ECB may be one of the biggest policy errors in history. But it did not stop a sharp rise in the EUR and European short rates leading into the annocement (and JCT believing that he did the right thing). Still, I am very sympathetic to a long dollar position. JCT's policy error may end up being the gift that keeps on giving.

Off to the sub-continent next week to see some cricket. What a fantastic match last night ;)

I know, I know. The burnt stumps still reside in England..

Skippy said...
3:11 PM  

Skippy, see you at the World Cup, mate.

Surely, Tricky was simply pulling off yet another ECB masterpiece of jawboning today. They MAY raise rates. In other news, PIIGS may fly.

We also have this bollox hitting the news stands today in Noo Yawk, straphangers were eagerly learning of the dollar's demise, prompting LB to ponder once more the relationship between sentiment extremes and market turns:

Dollar's Reign Ending?

Leftback said...
3:17 PM  

You were brave today.."ouch".
I'm far too much the coward to call Mt T looking at the context we're currently in.
I wouldn't try to call King next week either.Events move on and King may well have had to move on with them.No doubt he won't wis to have ,but soemetimes we all have to do things we don't wish to and that may well be where King is now.
Let me put it this way,it's so hard to call I wouldn't bet against it.

Anonymous said...
3:24 PM  

You got the call on 5y UST spot on, TMM.
Nice one!

Anonymous said...
3:41 PM  

LB, I hear you. I suspect another peripheral event will prevent Mr.T from action.

I have detected a few similar articles recently as well a nd suspect that sentiment is reaching an extreme similar to November 2009and November 2010.

I also still sense a strong belief out here in Asia in DGDF. Despite the recent equity outflows, the belief in all things EM/Asia and commodities is still very strong among Asian investors.

Skippy said...
3:51 PM  

This is just unbelievably stupid.... I don't even trade Euribors for a living but this makes me think that we are in for a policy error (tightening) followed by a sovereign crisis (covered many, many times on this blog) followed by god knows what (sovereign default shitshow followed by run on European banking system?). I would love the Ber-nank to exit QE2 and even raise rates to normalize capital markets but this is just absolutely insane.

Seriously re-evaluating everything of a risk-on nature I own right now.

Nemo Incognito said...
3:54 PM  

Skippy viz commods out here - mate, I have some stories.If you think public markets are nuts you have no idea what supposedly big and smart funds are doing viz a viz paying up for el crappo rare earth deposits with spivvy promoters.

Nemo Incognito said...
3:58 PM  

Show me a hole in the ground and I'll show you an Excellent Adventure in Rare Earth Mining. Presence of spivs always an indicator of incipient toppiness.

Hope Asian sentiment keeps re-pumping FXI and EEM, Skippy, so that I can serially short them over and over, it's delivered big twice already! Saffers looking good in the WC, Skippy. ABDV is in ominous form.

Leftback said...
4:07 PM  

Yeah,
I'm starting to wonder whether this is starting to look a bit like Feb 1994 given the surprise, with rate hike fears leading to a risk aversion event. Of course, to look at Spooz you wouldn't think that...

Right, after today's drubbing I'm off to the pub.

cpmppi

cpmppi said...
4:19 PM  

Skippy, Blimey, they get up early in Australia don't they - it's only 3am out there, isn't it? Come to think of it, that goes for all the other Asian commenters - what are you guys doing up so late?

Anonymous said...
4:29 PM  

And I'm joining cpmppi down the pub for a thursday special consolation bevvy. TMM will have sore heads tomorrow.

Polemic said...
4:49 PM  

TMM: As regards policy rules, have a look at EONIA or the min. bid rate vs the unemployment gap using OECD's NAIRU. Cheers and thanks for a super blog. /o

Otto said...
5:57 PM  

Skippy, we have just realized that Canada's #3 batsman Zubin Surkari (fine player, btw) is the young man once given out "timed out" when playing a 20/20 against us for Toronto CC b/c he was on the khazi and wasn't able to get his pads on in time after we took a couple of quick wickets..... there were some expletives.

Leftback said...
6:59 PM  

Is anybody but fx traders seriously buying Trichet's nonsense? Looks like the big losers from rising rates tightened against the bund today.

On a related knife-catching front, a little calculation I make that I pretend tells me how married investors are to their positions recently hit an all time low for the bund future (among others of the ilk). Typically a few weeks of lag.

Charles Butler said...
7:24 PM  

Thanks Nemo, I don't often get micro but nothing would surprise me. I did hear about a UK domiciled company on the verge of bankruptcy recently who changed their name to include "rare earths something or other" in the title and the stock price immediately rallied 200% (can't recall the company).

At anon 4.27pm. Yes I have trouble sleeping sometimes, but I am based in a small city state just south of Malaysia so it was midnight not 3am ;)

Skippy said...
11:29 PM  

ECB's assumption that the Euro capital markets exculding the PIGS are performing well, is like looking at inflation numbers excluding those that has gone up more than others.

Carry Trader said...
11:51 PM  

The Irish new govt has alot to do with this "quantum jump" - it's the german sado-maso way of saying: "zee, Mr kenny, 5.9% iz ok, cherman 10yr will soon be yielding 4%, we zuvver zoogether". but its too soon to short the idiots of 2008, there are too many hft algos in the forex market and now, its risk-on time becoz "Trichet" and "Vigilance" has been detected by the artificial intelligence algos in numerous press releases from reuters.

Anonymous said...
12:16 AM  

Great blog. Have a question on rate hike expectations if anyone can help, from an interested amateur perspective trying to understand/learn a bit more.

The US 3 month futures seem to imply a hike in November this year (just using simple interpolation of [100-price-libor] as I guess that's where they have to converge), but the US 1 month fed fund futures seem to imply a hike in feb/march 2012 (again a simple interpolation, but depending which month used and subject to exact date of the announcement).

So am I missing something obvious, like variations in the difference between libor and the fed funds rate, or other market technicalities, or just far more complicated to work out even a rough estimate than that – i.e. without getting into option probabilities (which was the only thing I could find on the topic when googling? Thanks for any input.

Anonymous said...
11:56 AM  

Anon @ 11:56am,

There are several technical issues around this that are far beyond the scope of a comment here. Suffice to say, the Fed Funds futures are easier to get rate expectations from. If you are particularly interested in this, send my an email at cpmppi at gmail dot com and I will send u some literature.

Cheers,
cpmppi

cpmppi said...
12:14 PM  

Anon

In addition to the literature, you might wanna look at this here site:
http://www.clevelandfed.org/research/data/fedfunds/index.cfm

Martinghoul said...
1:09 PM  

Martinghoul - thanks I'll take a look.

cpmppi - thanks also, I've emailed you.

Anonymous said...
10:44 PM  

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