So after having taken a short break from the printing press (no, not central banks), we decided to look back at the week that was. After all, a lot has transpired over the past week or so, and we cannot understate the significance of some of those events. This update is more of a mixtape rather than a proper note on market events. We never claim to be experts in all fields of our commentary but we nonetheless try to provide good insight and color into the many events that have happened in the last 7 days or so. Besides global events and happenings in the financial markets, we also had an eventful week with our portfolio; having correctly called a bottom in global oil prices on 29 January, profiting handsomely in so doing. Apart from our call on oil, a handful of our trades have moved in our favor towards the end of the trading week.
IS sets Jordan and the World on fire
First of, we would like to express our solidarity with fellow Jordanians in light of what was an extremely inhuman act by the terrorist group IS. We don't know about our readers, but we have viewed the gruesome and horribly graphic video of the terrible immolation. Although we managed to sit through the entire length of the clip, we urge viewer discretion because honestly, we have not seen anything as disturbing as this.
We shared on social media how we felt the world was largely irresponsible on its collective part of being blasé towards something so untoward humanity. We join the world in condemning this inhumane act. The pain and suffering felt by the victim cannot be measured; the death was from an overload of pain, if that speaks anything about the act. You could almost hear the silent screams of harrowing and unimaginable anguish ad the victim is consumed in flames and baked alive.
There has been almost too much happening on this scene that we have to at least make a point, and direct some attention that is rightfully due. This isn't an just act of terror, far from anything that can remotely be deemed as a religious act. It is but an outright crime against humanity, a crime of the greatest evil. The brutal murder of the Jordanian pilot, whom we believe was fighting a legitimate war against global terror that has been escalating in both worldwide relevance and presence, comes after 2 Japanese hostages were murdered alive with their heads decapitated on tape.
The greater good of the world cannot slip into cowardice, but must step up its efforts by many fold; if not, evil would have won another psychological battle.
Terrorism isn't just a physical threat. The prevalence of the world's most dangerous organization didn't reach it status with just bombs and bullets, but by molding and manipulation of very ductile human minds. Radicalism and jihadism remains the greatest threat, a threat that will gain traction on an exponential scale if not curtailed right this moment as we speak.
The BBC has some good commentary of why the terror group's propaganda campaigns of spreading fear have been successful. Deemed the Asymmetry of Fear, IS has been successful in broadening its influence and operations because it has mastered the art of manipulation.
It knows that it cannot match its international enemies in terms of firepower, so it resorts to cunning tactics of terror. Reader will not know, but IS terrorists once used so called "scorpion bombs" in their offensives in Iraq. These bombs were basically barrels filled with large black scorpions, catapulted into populations of civilians. These bombs were obviously not devastating, but they were immensely effective in spreading terror because most people are terrified of gnarly scorpions, such is the terror that is now all too synonymous with IS.
Sadistic media content like the one the terror group released 4 February instantly strikes fear and horror within the viewer. Once that is achieved, the group's goal would already have been reached. It is mission accomplished for them. This is why experts are urging the public not to fall to their emotional whims; it is of course easier said than done.
Jordan's King Abdullah hails in our eyes as a leader of his people; his country's military has carried out multiple air strikes against IS strongholds mere days after moaning the death of its pilot. The Jordanian public has itself seen a schism that is getting more apparent by the day. On one side stands those that support the war against IS, calling for swift revenge. On the other side stands those that question Jordan's involvement in the war against IS in the first place. The majority stands in the former group, the government included.
We echo what experts have been saying, that the war against terrorism cannot all be physical. The convoluted and sinister ideologies that have been fueling the spread of jihadism and terrorism globally, are harder to bust than the underground bunkers and terrorist hideouts. We call for smart tactics because it has been readily proven that muscle and gunpowder hasn't been all that effective in eradicating the dark forces of IS. A concerted effort by the global superpowers and NATO nations is the first prerequisite in any material advancement over terrorism. The state of affairs right now remains disheartening. Efforts are fragmented at best, with nations pulling out as and when they desire. We are certain that this episode of horror isn't an isolated one, and neither would it be the last. The world cannot choose to stand idly by as evil unravels in front of their eyes.
The Greece - Troika Impasse
Moving on, we have been such a broken record by warning that the economic and political situation in Europe will get worse before it gets any better. Since the onset of Greece's dissolved parliament back in December 2014, we already knew that complications were bound to arise. For a primer, we encourage readers to read our various pieces on the continent if they haven't already done so:
- Greek parliamentary fire
- Grexit fears
- SNB breaks ECB's silence
- ECB's €1.1trn bazooka
- Europe frozen in coldest deflation ever
- And more to come
To be honest, after all was said and done, nothing has been achieved. Yes, Greece has now got a 40-year old man named Alexis Tsipras as its 186th Prime Minister, it has a new cabinet and parliament. What it hasn't got is a new tranche of bailout money from the Troika (that is the trio of European Comission, ECB, and IMF) when its current package expires end February. It also hasn't gotten any compromise from right and center-right politicians in Europe the likes of which are Germany's Angela Merkel and Wolfgang Schäuble, and the European Commission's Jean-Claude Juncker.
Greece's far left party Syriza promises to end austerity in the country. While this has resonated well with the youthful populace, it has gotten absolutely no love from the powers that actually provide Greece the kool aid that has kept it alive for the last 3 years and counting. We warn the Greeks not to bite the hand that feeds; unfortunately, that seems to be falling on deaf ears. To some, beggars can be choosers, you can have your cake and still eat it. Not. We will see in due time if this holds true.
The clock is ticking, day by day. Volatility is building in the financial markets. Greece has got no more than 20 days to construct a compromise between the Syriza's charismatic anarchy, the Trioka's conservatism, and the market's impartiality. From what we have been seeing, we doubt that this will end nicely, if at all. But taking into consideration how Greece has muddled through, kicking the proverbial can down the road for the last 3 years, we shouldn't be too quick to call bluff on Athens.
Markets are much less patient than that - Greek bank stocks and bonds have been hit by a speeding freight train; the Euro is in shambles and is ever closer to parity to the dollar; CDS spreads on GGBs are exploding on every failed effort to bridge the gap between Athens and Brussels, while the "d"-word (default) gets mentioned more and more on news wires. We have readied our popcorn, so have the markets... eagerly awaiting Tsipras' next move now that the ball is back squarely in Greece's court.
ECB shuts off direct funds to Greece
On the 4th of February, the ECB did the unthinkable when it cut off direct lending to Greek banks. The ECB's decision came without warning and was only hours after the new Greek Finance Minister Yanis Varoufakis met ECB President Mario Draghi to renegotiate on Greece's €240bn rescue package in which the country had planned to restructure some of its existing public debt. An insolvent Greece has now lost a very crucial line of liquidity in its endeavor to rattle the feathers of the Troika.
Specifically, the ECB lifted a waiver on all "marketable debt instruments issued or fully guaranteed by the Hellenic Republic". In other words, Greek debt securities are now no longer eligible for use as collateral when borrowing from the central bank. Readers will recall that we previously outlined the specifications of the ECB's collateral criteria, chief of which was a minimum credit quality rating of CQS3 and above. Private and public Greek debt had obviously not met these criteria but they were specially treated under a waiver of those conditions as part of the bailout agreement extended to Greece. Most Greek debt are rated as "junk" status by the major credit rating agencies and would ordinarily not be accepted as collateral with the ECB, if not for the special agreement that formed part of Greece's bailout program.
Now that the commitment of Greece to existing bailout pledges has become a prime question, the ECB can no longer assume that the nation will complete the latest review of its funding program and continue operate within Eurosystem rules. As such, the ECB has chosen to play safe by limiting its exposure to Greek collateral. Existing liquidity lines with the ECB will remain till the 11th of February after which they will migrate to the ECB's ELA facility (Emergency Liquidity Assistance). The ELA does not offer as competitive borrowing rates as does borrowing directly via the ECB's refinancing lines, but Greek banks will be left with little choice; pay much higher sub-prime rates on short term loans, or get no funding at all. Materially, the ECB's decision allows it to dispose the burden of funding financially weak institutions on the Greek National Bank instead.
What the ECB essentially implied was that they doubted Greece's ability to embark on the next tranche of its bailout program after the existing one expires 28 February. To us however, it is more like a question of will rather than a question of possibility. Regardless, the ECB has made its stance clear by its actions earlier in the week - lowering the blinds as a preemptive measure.
S&P downgrades Greece's credit rating
Greece cannot seem to get enough bad news. Late into Friday's trading, credit rating agency Standard & Poor's (S&P) downgraded Greece's long-term credit rating status to "B-", 6 notches into junk status, and placed the sovereign on CreditWatch negative for the short and long term. This comes 5 months after the firm upgraded Greece's rating to "B" from "B-".
What is perhaps more disturbing is the narrative behind the firm's decision to downgrade Greece's rating in which it factored in a heightened chance of capital controls and exit from the European Monetary Union:
"In our view, a prolongation of talks with official creditors could also lead to further pressure on financial stability in the form of deposit withdrawals and, in a worst-case scenario, the imposition of capital controls and a loss of access to lender-of-last-resort financing, potentially resulting in Greece's exclusion from the Economic and Monetary Union."
It is hence not a ridiculous rumination that we start to see bank runs and outright capital controls in the Hellenic Republic, as well as an exit from the Eurosystem or "Grexit" as it is commonly known to commoners. Why, because S&P has openly envisaged just that. It is only a matter of time before other rating agencies start to chime in how far deeper into "junk" status Greece has ventured into; thereby eroding what little is left of the nation's credibility (pardon the pun) in the private funding markets. And so the vicious cycle continues until the chain breaks.
The angst over unfruitful deliberations should continue to broil over the coming few weeks as more and more start to admit that they were dead wrong about the trajectory of Greece. The reason is simple: only few had envisaged a scenario where the nation is led by a radical leftist Government and a Prime Minister that wants to flip the tables on their heads. Caveat Emptor!
From Standard & Poor's Ratings Services:
Liquidity constraints have narrowed the timeframe during which Greece's new government can reach an agreement with its official creditors on a financing programme, in our view.
We believe the potential uncertainties surrounding the timing and success of such an agreement risk exacerbating deposit outflows, depressing investment, and weakening tax compliance.
As a result, we have lowered our long-term rating on Greece to 'B-' from 'B'.
The long- and short-term ratings remain on CreditWatch negative.
On Feb. 6, 2015, Standard & Poor's Ratings Services lowered its long-term sovereign credit rating on the Hellenic Republic (Greece) to 'B-' from 'B'. The long- and short-term ratings on Greece remain on CreditWatch with negative implications.
As defined in EU CRA Regulation 1060/2009 (EU CRA Regulation), the ratings on Greece are subject to certain publication restrictions set out in Art 8a of the EU CRA Regulation, including publication in accordance with a pre-established calendar (see "Calendar Of 2015 EMEA Sovereign, Regional, And Local Government Rating Publication Dates," published Dec. 30, 2014). Under the EU CRA Regulation, deviations from the announced calendar are allowed only in limited circumstances and must be accompanied by a detailed explanation of the reasons for the deviation. In this case, the deviation has been caused by the European Central Bank's decision to lift the waiver on the eligibility of Greek government and government-guaranteed bonds in Eurosystem operations and the absence so far of an agreement to extend Greece's European Financial Stability Facility program beyond its expected expiration date on Feb. 28, 2015.
The downgrade reflects our view that the liquidity constraints weighing on Greece's banks and its economy have narrowed the timeframe during which the new government can reach an agreement on a financing programme with its official creditors: EU member states, the EFSF, the ECB, and the IMF. Although the newly elected Greek government has been in power for less than two weeks, we believe its limited cash buffers and approaching debt redemptions to official preferred creditors constrain its negotiating flexibility. In our view, a prolongation of talks with official creditors could also lead to further pressure on financial stability in the form of deposit withdrawals and, in a worst-case scenario, the imposition of capital controls and a loss of access to lender-of-last-resort financing, potentially resulting in Greece's exclusion from the Economic and Monetary Union.
On this issue, the Feb. 4 decision by the ECB to lift the waiver on the eligibility of Greek government and government-guaranteed bonds in Eurosystem operations has transferred the responsibility of lender-of-last-resort financing from the European Central Bank to the Bank of Greece, Greece's national central bank, via its Emergency Liquidity Assistance (ELA) facility. It is our understanding that the Greek banks will be able to switch their current ECB funding toward ELA facilities, though the continuity and level of ELA financing to Greek banks--including the acceptability of Greek government Treasury Bills--remains subject to ECB approval. We would expect the ECB to curtail the liquidity provision to the Greek banking system (and, therefore, to its economy) if the two-month technical extension of the EFSF programme is not extended beyond its current expiration date of Feb. 28, 2015.
In its Feb. 4 press release announcing the suspension of Greek collateral eligibility, the ECB stated that "it is currently not possible to assume a successful conclusion of the programme review." We see the uncertainties connected to the provision of liquidity to Greek banks as potentially exacerbating deposit outflows, depressing investment, and weakening tax compliance, which are already deteriorating Greece's economic and fiscal profile.
In Greece's case, we do not consider the ratio of general government debt to GDP to be the sole metric for assessing the sustainability of public debt. Although this ratio was a very high 178% at year-end 2014, other features of Greece's public debt profile are less onerous, in our view. These include its unusually long debt maturities--16.5 years for the total stock and 30 years on official bilateral and EFSF financing--and the very low effective interest rate. Including concessional interest rates, Eurosystem retroceded interest earnings, and the interest rate grace period on official debt, we estimate Greece's general government interest to GDP at year-end 2014 at less than 3% of GDP. We would also note that our sovereign ratings pertain to a central government's ability and willingness to service financial obligations to commercial creditors, which in Greece's case hold an estimated 17% of the sovereign's debt stock excluding ECB and other official creditor holdings of bonded debt. Debt redemptions owed to the private sector this year and next total EUR510 million and EUR1,090 million, equivalent to 0.3% and 0.6% of GDP respectively, well below redemptions owed to official creditors. The Greek government has repeatedly committed itself not to involve private-sector creditors in any further debt re-profiling.
Central Bankers never more worried
We say this with a smirk across our face. We have documented how dire the deflationary situation has been not just in Europe but for many parts of the world, with central bank after central bank ceding to an era where global oil prices may not see $100/bbl ever again, according to the Prince of Saudi Arabia. While we will not comment on energy prices as of now, we will not spare a word on reiterating how central banking is in an unmitigated crisis right now.
Unbeknownst to many, at least 16 central banks across the globe have either eased monetary policy or taken drastic actions in the less than 40 days that have elapsed in 2015 thus far. The current count stands at 16, but we expect this to rise further. The following list is quite something to behold. Rarely do we experience such a flurry of monetary easing so early in the year. It is not inaccurate to say that central banks are indeed the most worried in a long time.
The list of countries that have either loosened their monetary policies or taken actions to bolster falling consumer prices:
- Singapore: Unexpectedly loosened FX policy
- Europe: First ever sovereign QE (EAAP)
- Switzerland: Lowered neg. rates; abandons FX floor to Euro
- Denmark: Lowered neg. rates 4 times in 3 weeks to record lows
- Canada: Unexpectedly lowered rates
- India: Unexpectedly lowered rates
- Turkey: Imposed FX controls to stem rapid depreciation; lowered rates
- Egypt: Loosened FX policy; cap on USD deposits
- Romania: Lowered rates; imposes capital buffers against CHF losses
- Peru: Lowered rates
- Albania: Lowered rates to record low
- Uzbekistan: Lowered rates
- Pakistan: Lowered rates
- Russia: Unexpectedly lowered rates from post crisis highs
- Australia: Lowered rates to record lows
- China: Lowered RRR by 0.5%
Reuters succinctly sums up the banks that have eased so far in 2015:
Barely a month into 2015 and the direction of monetary policy around the world is crystal clear -- no fewer than 17 central banks have eased policy to some extent to counter the deflationary pressures from the collapse in global oil prices.
Below is a chronological list of the central banks' actions:
Jan. 1 UZBEKISTAN
Uzbekistan's central bank cuts its refinancing rate to 9 percent from 10 percent.
Jan. 7/Feb. 4 ROMANIA
Romania's central bank cuts its key interest rate by a total of 50 basis points, taking it to a new record low of 2.25 percent. Most analysts polled by Reuters had expected the latest cut.
Jan. 15 SWITZERLAND
The Swiss National Bank stuns markets by scrapping the franc's three-year-old exchange rate cap to the euro, leading to an unprecedented surge in the currency. This de facto tightening, however, is in part offset by a cut in the interest rate on certain sight deposit account balances by 0.5 percentage points to -0.75 percent.
Jan. 15 INDIA
The Reserve Bank of India surprises markets with a 25 basis point cut in rates to 7.75 percent and signals it could lower them further, amid signs of cooling inflation and growth struggling to recover from its weakest levels since the 1980s.
Jan. 15 EGYPT
Egypt's central bank makes a surprise 50 basis point cut in its main interest rates, reducing the overnight deposit and lending rates to 8.75 and 9.75 percent, respectively.
Jan. 16 PERU
Peru's central bank surprises the market with a cut in its benchmark interest rate to 3.25 percent from 3.5 percent after the country posts its worst monthly economic expansion since 2009.
Jan. 20 TURKEY
Turkey's central bank lowers its main interest rate, but draws heavy criticism from government ministers who say the 50 basis point cut, five months before a parliamentary election, is not enough to support growth.
Jan. 21 CANADA
The Bank of Canada shocks markets by cutting interest rates to 0.75 percent from 1 percent, where it had been since September 2010, ending the longest period of unchanged rates in Canada since 1950.
Jan. 22 EUROPEAN CENTRAL BANK
The ECB launches a government bond-buying programme which will pump over a trillion euros into a sagging economy starting in March and running through to September next year, and perhaps beyond.
Jan. 24 PAKISTAN
Pakistan's central bank cuts its key discount rate to 8.5 percent from 9.5 percent, citing lower inflationary pressure due to falling global oil prices. Central Bank Governor Ashraf Wathra says the new rate will be in place for two months, until the next central bank meeting to discuss further policy.
Jan. 28 SINGAPORE
The Monetary Authority of Singapore unexpectedly eases policy, saying in an unscheduled policy statement that it will reduce the slope of its policy band for the Singapore dollar because the inflation outlook has "shifted significantly" since its last review in October 2014.
Jan. 28 ALBANIA
Albania's central bank cuts its benchmark interest rate to a record low 2 percent. This follows three rate cuts last year, the most recent in November.
Jan. 30 RUSSIA
Russia's central bank unexpectedly cuts its one-week minimum auction repo rate by two percentage points to 15 percent, a little over a month after raising it by 6.5 points to 17 percent, as fears of recession mount following the fall in global oil prices and Western sanctions over the Ukraine crisis.
Jan. 19/22/29 DENMARK
The Danish central bank cuts interest rates a remarkable three times in just two weeks, and intervenes regularly in the currency market to keep the crown within its narrow range against the euro.
Feb. 3 AUSTRALIA
The Reserve Bank of Australia cuts its cash rate to an all-time low of 2.25 percent, seeking to spur a sluggish economy while keeping downward pressure on the local dollar.
Feb. 4 CHINA
China's central bank makes a system-wide cut to bank reserve requirements -- its first in more than two years -- to unleash a flood of liquidity to fight off economic slowdown and looming deflation.
Safe to say we're in pretty much uncharted territories. Europe is on the brink; oil prices may have found a bottom but will continue to stay relatively benign for an extended period of time; global central banks are panicking over something largely invisible to the public; the war on terror has never been more fervent, and so are the risks; Ukraine and Russia will only escalate further into armed conflict regardless of whatever is promised in words. It's difficult to make predictions in such an environment.
King Dollar is back and here to stay!
We have been harping on this topic for eons now, namely that the greenback will remain strong for a considerable time. It doesn't take a rocket scientist to figure out, that an increasingly hawkish Fed and a FOMC chairwoman who isn't afraid to buck the trend of the global monetary policy easing cycle as mentioned in the previous section, is inherently bullish for the dollar. While we will not opine too much on the topic in this piece, we will again stand in a limb and reiterate our stance - king dollar is back and hear to stay!
The US economy has been robust in more ways than which could reasonably be contestable. Sure enough, last Friday's non-farm payrolls data for January printed much higher than expectations, indicating that the 257,000 workers were employed. The market had collectively only expected a 234,000 figure which has proven benign in hindsight, although January's addition was lower than the staggering 329,000 jobs added in December last year.
We also note that in the past 9 out of 10 Januaries, the headline NFP had missed; the beat on Friday shows just how far on the conservative side economists have strayed regarding the strength in the US labor market. Most analysts were not expecting a beat on Friday's release. Outside the headline figure, the U3 unemployment rate inched up 0.1% to 5.7% from 5.6% in December, missing expectations of 5.6%. However, the labor force participation rate surprised to the upside, increasing by 0.2% to 62.9%, from the 62.7% seen in December.
On top of all that, the BLS also announced a whopping series of positive revisions for 5 out of the 8 months where revisions were made in 2014, recording a net increase of 245,000 jobs added on those revisions itself (2,952K to 3,197K). The most eye catching upwards revision occurred in November, when the post-revision number stood at 423,000 from the already impressive 353,000 figure, marking the second largest monthly job increase in the whole of the 21st century!
Apart from job revisions, the BLS also stated that it was revising upwards the average weekly earnings for all 12 months of 2014. It seems what was already a relative ebullient year for the American jobs market has bettered itself courtesy of those measurement parameters and assumptions. Although we don't entirely hold a skeptical eye in this, we have some reservations as to the implicit meaning behind them.
And the reason for all those revisions? The BLS states that updated population estimates will be used in 2015, hence the revisions to account for the change in measurement parameters. From the BLS itself:
Market reaction was swift and directional. We saw broad strength in the dollar and an equity market than took the elevator up. So far, the market has been taking the good news at face value and pricing in additional impetus for the Fed to embark on its tightening cycle via hiking the Fed Funds rate in either its June or October FOMC meeting. With every marginal data beat from the US, we expect the market to push forward its expectations on the time guidance on when it believes the Fed will begin raising rates.
Whether the strong dollar paradox implies in itself a tightening of monetary conditions remains widely debated but it has been all smiles so far. Trade the trend!