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Macro Roundup: Swine at the Trough



February 28, 2012 – Comments (3) | RELATED TICKERS: USO , XOM , SAN

Even though a full 20% of German lawmakers abstained, the vote authorizing Greece's second bailout was passed in the Bundestag comme une lettre a la poste (lit. like a letter at the post office, a French expression meaning very smoothly.) Despite the bluster, German politicians are committed to European solidarity, after all. That and the integrity of German bank balance sheets.

Speaking of the devil's pact that binds government and banks, JPMorgan made an insightful comment on the ECB's LTRO program [Long Term Refinancing Operation – cheap three-year money lent to European banks in any amount], writing that "we view the 3Y LTRO as being directed more at solving the sovereign funding problem than the bank funding problem."

We don't know which goal the ECB had foremost in its mind when it launched the operation, but they've done a good job of killing two birds with one stone. In a faithful reproduction of the U.S. script, virtually none of the roughly half a trillion euros lent to banks in the first LTRO round made its way into the real economy. Instead, it has helped fuel a rally in European sovereign bonds that has lowered sovereigns' borrowing costs. Indeed, as the FT reports, Italian and Spanish banks posted a record monthly increase in their government debt holdings. The increases aren't trivial: Over December and January, banks in Italy and Spain drove these holdings up by 13% and 29%, respectively.

Aren't European banks supposed to be shrinking their balance sheets in order to meet the post-credit crisis Basel III capital requirements? Not to worry, Basel III looks at the ratio of equity to total risk-weighted assets. Lucky for banks that government bonds carry a zero risk weighting; they're risk-free, don't you know. Will the bond shopping spree continue? There's no lack of ammunition. Tomorrow, the ECB will release the total take-up for the second round of the LTRO. According to the FT, analysts are forecasting roughly the same total as the one achieved in the first round (€489 billion.) I think we could well see an upside surprise – when it comes to the carry trade, you can never have too much of a good thing. I wouldn't rule out a figure of €750 billion or higher. As I noted yesterday, there appears to be no stigma attached to banks that participate; when you're in front of a bottomless trough, you might as well keep eating. Let the feast continue!

The U.S. and Europe let the Iran sanctions genie out of the lamp and it's proving more difficult to herd than they had anticipated. It appears that the powers that be didn't consider that hemming Iran in might produce an increase in the price of oil. Well, it has and that process could well continue. No wonder twenty percent of the institutional investors surveyed by Barclays Capital picked oil to be the best-performing commodity of 2012 – the most popular choice (gold was second, if you're wondering.)

While an increase oil prices might be good for commodity investors, it does have other real-world implications. One analyst estimated that a rise in the price of oil to $150 would lob off two percentage points off U.S. GDP growth (points it can ill afford to give up.) One more reason to adopt a defensive mindset and investment strategy, as Bill Gross recommends in his latest Investment Outlook.

3 Comments – Post Your Own

#1) On February 28, 2012 at 1:30 PM, TMFAleph1 (91.82) wrote:

I forgot the all-important plug at the end of the article:

***That's all there is: Find out why investors shouldn't expect to earn more than 2% from U.S. stocks in the latest issue of The Real Returns Report.*** 

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#2) On February 28, 2012 at 4:22 PM, Teacherman1 (< 20) wrote:

I'm surprised that PORT hasn't popped up here objecting to that caption.:)

I know you were not actually referring to Germany, but since you start out talking about them, one could take it that way.

I suppose that with so many different opinions on what should be done, this is just an end run by the ECB to follow in the steps of "big brother U.S." and kick the can down the road.

This looks like a good way to lower the cost of being a member of the EuroZone, without making the lid so tight that the "austerity steam" blows it off; at least until Greece finally pulls a non-technical, full blown default.

Without providing the relief directly to the other members, they probably hope to be able to continue to "shame" the PIGS into facing up to the need to change the basic structure of their systems, like the other "I" that I left out did.

What do you think of the announcement by Ireland that they were going to put the "plan" to a referrendum, like Greece threatened to do and scared the "you know what" out of them?

While I don't always agree with your conclusions, I do enjoy reading your articles.

Keep them coming.

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#3) On February 28, 2012 at 5:20 PM, TMFAleph1 (91.82) wrote:

Thanks for your comment, Teacherman1. 

It appears that Europe has finally bought itself a little breating room with LTRO; however, it's a huge leap to imagine they will use it wisely!

I read the other day that some traders are concerned about the possibility of a credit event due to Greece's default (incidentally, S&P has already placed Greece in "selective default" due to the collective action clause inserted retroactively into the PSI.) I'm not sure why -- the process is moving forward in an orderly manner. If the CDS are triggered, that will show the sovereign CDS market is functional.

Spain, Italy and particularly Portugal are now in a race against the clock to implement economic reform significant enough to reassure the market. However, government action alone will not suffice. Banks must recapitalize their balance sheets. At the moment, the are opting to shrink them instead -- with a knock-on impact on growth.

Which brings us to the most confounding problem: How to spur growth. Austerity may be a way to remain at manageable debt levels, but it certainly isn't a way to achieve debt sustainability from an initial state of excessive debt.

The movie is far from over and my guess it that it will continue to generate periodic bouts of substantial volatility in global asset markets -- good news for disciplined, value-oriented investors and asset allocators. 

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