Friday, 21 September 2018

On shrinking balance sheets and can kicking

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  • Peters 475px June 2014

The market is numb to ECB rhetoric and bored with stress tests.

The shadow of the rumour about the ECB winding up in order to begin to buy corporate bonds continued to spook the market on Wednesday where an all round positive day for equities was reflected in a solid but unspectacular performance for credit spreads.

Nevertheless, the S22 iTraxx Xover went out 353/355. This is a long way better than during the depth of the wobbles last week when it printed well north of 400.

Markets have a habit of believing what they want to believe and the corporate bond thing fits beautifully into the landscape. The ECB can deny all it wants to, the market doesn’t care. What’s the old bon mot, “Please don’t confuse me with facts, my mind is made up”?

The case for the proponents was supported from a not unusual corner when Austria’s Ewald Nowotny – always good for a quote – gave us the following gems: “The main concern of the ECB is that we have a shrinking balance sheet,” going on ”..and so of course the point is how to achieve growth of the balance sheet which I personally think is a legitimate point. Corporate bonds are one of the markets that are still open for this”. Fine so far. Then: “There has been no discussion about this in the Governing Council and no decision”.

He went on return to the most vexing of questions which faces the ECB in all and any of its bond buying programmes: How does one equitably weight the geographic spread of the bonds purchased? Too many questions, no usable answers, but it appears that a new generation of traders has found out that it is always good to buy the rumour and sell the fact.


Meanwhile, the release of the ECB’s Asset Quality Review is coming closer. There have been heightened expectations that the boat will not be rocked, or at least not enough for anybody to get wet. Focus will be on the Italian and the Spanish banking systems and one has to wonder whether there might be some correlation between the choice of the ECB’s ABS purchases currently being affected and the anticipated market reaction to the report, due on Sunday.

There is little doubt that the visibly weaker Italian banks will take a pounding but there is also some fear that German institutions, notoriously optimistic about their loan books, could be in for a shock. At the end of the day, however, there will be a “Yeah, yeah, sure….” response in the near certain knowledge that the hurdles will have been set in order to achieve the desired outcome. Previous stress tests have failed to convince and I can see no reason which this time it should be any different. The gallery, gentlemen, is getting bored and nearly asleep.

One of the features of the financial crisis was the stern resistance by the authorities to letting failed banks actually fail. There was always much talk of cans being kicked down the economic policy and deficit reduction roads – which they still are, even though the analogy has seemingly fallen out of favour – but the can kicking in the banking sector has somehow gone largely unnoticed. Some certainly lied and cheated their way through previous stress tests but the ECB has been much more rigorous this time in the assessment of the risk rating applied to assets. Hence the outcome of this round of investigations should be more convincing than previous, similar exercises but, as noted, the last thing the ECB would want to do is to scare the horses.

Locked and loaded

While Europe was in a good mood yesterday, the other side of the pond was deeply rattled by the events in Ottawa. Terrorist acts in the US since 9/11 can be added up on the fingers of one hand – with a few to spare – but there is an air of fear. The madder end of the radical right might see Ebola as an al-Qaeda conspiracy in the same way as al-Qaeda probably thinks it has been maliciously introduced by the CIA.

Although there is no clear evidence – or maybe no evidence at all – that the Ottawa shooter has anything to do with radical or any other form of Islam, the fear level in middle America has risen from “Keep that gun loaded” to “Shoot at anything that looks strange, other than Ronald McDonald”.

US equities traded poorly, largely as a result of the Ottawa events and their effect on the VIX index. It looked from here like the tail was wagging the dog again. The index has done a staggering bungee jump and its close on 17.87 points would, late last week, have looked like a pipe dream. Nevertheless, the close was 1.79 points higher on Tuesday which, in mathematical terms represents an 11% rise. I guess there’s no pleasing some people.

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