Front end spread widening: not just a regulatory thing

The DOJ taketh away, and the DOJ giveth back.  While the $14 billion charge from the Department of Justice represents a Sword of Damocles hanging over the head of Deutsche Bank, yesterday's comments that the fine could be reduced if certain malefactors are named and shamed (and then, presumably, prosecuted) brought some badly needed relief to the tottering German lender.  While it's certainly right that legitimately criminal behaviour be punished, the experience of the foreign exchange market suggests that banks and regulators may decide to shoot first and worry about proof later.  These days, working at a big bank must feel like Stalin's Russia, only without the warm and fuzzy feelings of happiness and security.

While DB did manage to rally back to flat yesterday, market attention appears to be drifting towards an emerging credit premium at the front end of money market curves.    Much of the focus seems to be on the US, though that widening can largely be explained by the money fund reforms which were discussed in this space a couple of months ago.

However, it would probably be wrong to attribute all of the widening to US regulation.   Front end euribor contracts have sold off recently, which is more consistent with concerns over the European banking system (cough, DB, cough) than US money fund reform.


Indeed, whites/greens is now slightly inverted; although this is not unprecedented in recent history, it doesn't seem particularly healthy.  Macro Man has mentioned the ERM7/M9 spread previously; you now get paid a bit to buy the front and sell the back, which is probably a very good trade in the long run.   There's nothing to say that it cannot invert a bit further of DB worries intensify, however, so scaling in probably makes more sense than a one shot entry point.

Speaking of one shot, that's all your author has in him after a long day of meetings on Tuesday.  Normal service resumes tomorrow.
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checkmate
admin
September 28, 2016 at 8:38 AM ×

For clarity on my exchange of posts yesterday re DB et al. I don't think the high probability outcome is some massive market sell off. It might be one outcome worth mentioning, but it isn't the one I would deem worthy of putting my money on. Indeed if I was pushed to it I'd say expect the UK Equity market to be broadly flat for the last quarter Sep to Dec. That's about what it has done for 3 out of the last 4 years.
My personal position has been and remains long retail , eg TSCO/SBRY et al for the 2nd H skew in seasonality and equally long Construction eg GFRD, KIE et al and I still like LGEN no fundamental reason not to on earnings and yield. Still like pricing pass through for SKY. Leery of Home builders,banks, miners,oil.
Broadly want to be risk on where I see an Autumn govt budget most likely to give the economy a boost. Still don't like vast array of bonds regardless of recent fear inspired mean reversion on the safety stuff. Hard to find value and I have more concern over them than I do over selected equity picks.

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amplitudeinthehouse
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September 28, 2016 at 9:45 AM ×

I've been sitting on DB shares for ages. I can tell you this, save your money if you think this investor is going let a single solitary Hotel & Resort share into his portfolio going forward. That's for cool kids!

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amplitudeinthehouse
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September 28, 2016 at 10:04 AM ×

Yeah, Tinkerbell, we've game too!

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Corey
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September 28, 2016 at 3:21 PM ×

Maybe, maybe not. US MM fds are chock full of Euro fin subs. So, naturally I would expect some kind of knock on to the parent.

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Macro Man
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September 28, 2016 at 3:25 PM ×

@ Corey If that was going to be an issue, it would have manifested itself when US FRA/OIS started widening a few months ago. In fact, it has only happened in Europe since the DB penalty was announced, which certainly implies a greater likelihood of causation there.

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checkmate
admin
September 28, 2016 at 4:31 PM ×

There she goes, off to head up the LSE and screw with the brains of the next set of economists. It's not that hard to understand how we fall into a 'group think' mentality.
http://www.telegraph.co.uk/business/2016/09/28/qe-is-here-forever-says-bank-of-england-deputy-governor/

Message to BOE when I want a gas boiler installed I don't call for a joiner. When I really want to increase demand I don't call for the BOE to zero sum policies that simply redistribute wealth whilst possibly tacking on a very small wedge of GDP. bang for buck the transmission data over the last two decades should be enough on it's own to tell us we are pushing water uphill using these policies. You know what happens to water when you stop pushing or can't push anymore. Yes indeed.

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Anonymous
admin
September 28, 2016 at 5:35 PM ×

re: us mmf's

fwiw, vanguard prime holds no euro bank paper. ca/aud/skr banks yes but no eur directly.

unsecured inter bank lending in us/eur/gbp has been dis-intermediated, on purpose, by the cb's.

if there's case for funding stress, i'd look elsewhere.







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Leftback
admin
September 28, 2016 at 5:59 PM ×

DBK share price is still telling us everything we need to know, and has been making new lower lows and lower highs for months and months now, with occasional relief rallies. Mondays are usually the big down days, and the insiders are always dumping shares long before tiny punters are awake. The echoes of 2008 are there if you care to listen.

Those familiar with German politics will know that it will have to be a VERY SERIOUS CRISIS before Mutti can authorize what seems now to be an inevitable bailout, expect something along the lines of TARP - with extreme dilution of common shareholders, conversion of existing preferreds to common (NBG, C and BAC style), government stake holding and maybe some tasty new preferred offerings, warrants (GS style) etc made available, mainly for the Uncle Warrens of the world to enjoy. Nobody will see any divis for a year or two, though.

So yes, I think this is it - we see the Rubicon crossed this October (sub-€10 share price), and then we see a mini-crisis unfold that would be mainly an acute issue for Swiss, Austrian and German regional, and perhaps Eastern European lenders that are almost inevitably DB's major counter-parties, with collateral damage across the major EU banks. Likely there would be another Eurodollar squeeze, with associated commodity and EM bleed/crash. Expect a yen rally as everyone de-risks [note: this includes Jim Cramer and 12yoHFM, huddled together under the desk].

Before things get too hairy, Mutti will huddle with Schäuble and the Germans will manufacture a very unpleasant sausage that will then have to be fed to the German electorate. This will be the end for Mangler's political career, already foretold by the regional election in Berlin which was an unmitigated disaster. The German people know what is coming. Who's Greek now?

If/when this happens I'd suggest being out of/short of commodity FX and long USD, the long bond and JPY. Comments? Remember that not only did people not think LEH would go to zero, the same people were not aware of the contagion risks. Central banks are scared of a Black Swan, and although this seems obvious, a DB bankruptcy is the Swan they are scared of.

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Anonymous
admin
September 28, 2016 at 6:21 PM ×

Problem is after the GFC, everything is Lehman - I do not trust extrapolations using such recent history, generals are always fighting the last battle so if DB is Leh, then we have the best possible generals righting it lol

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Leftback
admin
September 28, 2016 at 9:14 PM ×

No event is ever exactly like the last one. Maybe it's more like Citi than Lehman. The frightening thing is some people would make an argument that DB is actually more systemic, in global terms, than Lehman was. This is why a failure is unthinkable, and a government-sponsored rescue seems inevitable, but b/c of politics we would have to have a really big crisis first.

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Anonymous
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September 28, 2016 at 9:51 PM ×

Looking for a trading floor/group somewhere between midtown NYC to Stamford CT where my expertise & yours can hopefully benefit each other profitably.
https://www.dropbox.com/s/y6faohkvrg6e39v/newhome.docx?dl=0

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Anonymous
admin
September 28, 2016 at 9:52 PM ×

http://medical-dictionary.thefreedictionary.com/internal+squint

I wonder where Drudge got the picture of the lady in the red pants suit this afternoon. Esotropia or internal strabismus, when it comes on in adulthood, is of significance.

(Hint: It is the right eye.)

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checkmate
admin
September 28, 2016 at 11:07 PM ×

Oil amusing kneejerk reaction. Saudi/Iran agree to reduce by what 750k barrels a day ,but Russia not a party to the deal already produced 400,000 barrels a day extra since August and presumably now as an opportunity to fill an even bigger vacuum in the market without being punished on price. Will they do it and does the Pope speak Latin two questions for the day?
So next question is what happens when people who actually analyse the impact of these events past the headline kick in with their view?

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Robert Smoak
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September 29, 2016 at 6:09 AM ×

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