Sunday, 20 May 2018

Playing the gloom for a trading gain

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Get ready for an about-turn in sentiment, says IFR editor-at-large Keith Mullin

IFR Editor-at-large Keith Mullin

IFR Editor-at-large Keith Mullin

ARE WE REALLY heading towards Armageddon or is everything being a bit overdone? There was certainly a sense of barely-contained panic in the air on Thursday and Friday as we headed into the make-or-break Greek election.

With Greece undoubtedly the focus event, the state of the Franco-German axis is also weighing on minds.

It’s getting more and more fractious as Angela Merkel and Francois Hollande trade increasingly barbed comments on a range of issues, from moves towards fiscal union with centralised budgetary control, and the policies and policy mix required to turn the EU economy around, to the knotty issue of euro bonds, euro bills, the debt redemption fund and a banking licence for the ESM that will enable the rescue fund to up its firepower by borrowing from the ECB.

Beyond that, French parliamentary elections, and the results of Spain’s government-commissioned bank audit – which will determine the scale of the country’s bail-out lite – are also on the agenda. Who’d be an investor in the face of so many cross-currents?

As luck would have it, leaders of the G20 along with observers from the IMF, ECB et al will at the very least all be together as a Mexican beach in Los Cabos, site of the G20 Summit, becomes the nerve centre of emergency policy response if it’s required.

Back to my opening question. I have a feeling that the panic and disaster scenarios have all been a bit over-engineered. Talk of the Greek bailout agreement being torn up; Greece exiting the euro; restrictions on ATM withdrawals and capital controls introduced; banks being shut; a destructive transmission effect that forces Spain and Italy into bailouts that are beyond the capability of the bailout mechanism to cope with, given the magnitude of the task: it’s pretty scary stuff.

I COULD BE completely wrong, but I have a sneaking suspicion that trading into the start of the coming week and beyond could be a bit of an anti-climax. For a start, central banks worldwide have acted in a quasi co-ordinated way to stop the rot and are standing by to pump liquidity into the system and basically do anything that’s needed.

The Swiss National Bank and the Bank of Japan are poised to intervene heavily in currency markets to prevent their currencies soaring on safe-haven flows, in the process curbing speculative behaviour. The Bank of England is kicking off its Extended Collateral Term Repo Facility on June 20 (monthly auctions: minimum £5bn at 75bp) and along with the UK Treasury will unleash a £100bn scheme to pump medium-term credit into the UK economy.

Meanwhile the European Central Bank will lend liquidity support to EZ banks as required, while ECB president Mario Draghi also implied the bank was willing to cut rates. The Bank of Greece has the facility to inject cash into Greek banks via the Emergency Liquidity Assistance scheme.

I reckon the overwhelmingly bearish overall sentiment could well be played here for some flighty gains

The amount of official firepower out there to keep things orderly actually pushed equities, the euro and peripheral government bonds higher on Friday, with Spanish 10-year bonds falling back below that 7% barrier of unsustainability.

Also helping sentiment was talk that even if the Syriza party does come out on top in the Greek elections, the result is more likely to be a negotiated flexibilisation of terms than a redo of the deal’s core requirements. I suspect that Alexis Tsipras’ pledge at his last rally, “The memorandum of bankruptcy will belong to the past on Monday,” is likely to be political rhetoric.

Not surprisingly, there was a lot of position-flattening into the weekend as investors, spooked by all the talk of euro exit firestorms, sensibly took money off the table and covered short positions.

Here’s a thought, though: markets can and often do exhibit perverse and contrarian behaviour. The results of the Greek election could well be inconclusive; and there’s going to be a grace period of at least 100 days in any case while the new government is formed and figures out its stance on a whole range of issues.

If, at the same time, the Spanish bank audit shows that capital requirements are at expected levels or even lower, and the €100bn bailout isn’t taken up in full; and if the G20 at least makes some progress towards agreeing goals and a way forward on key issues at its Summit, we could get a rapid if opportunistic about-turn in sentiment and a pop in prices over the course of the next few days.

It’ll be a classic short-run fast-money trade, but on the basis that things are never as bad as they seem or indeed could be, I reckon the overwhelmingly bearish overall sentiment could well be played here for some flighty gains.

AND LAST WORD on Jamie Dimon. I was shocked by the performance of the JP Morgan boss’s interrogators at the Senate Banking Committee hearing into the credit derivatives losses. But this isn’t about the losses. For a bank the size of JP Morgan, they’re insignificant. The losses destroyed a chunk of shareholder value, but that’s an issue for the bank and its investors.

What the hearing failed to get to the bottom of was the egregious (to use a Dimon word) failure of internal controls at the bank. Dimon was happy enough to explain that the losses were the result of traders not knowing what they were doing, a risk committee that wasn’t independent enough, management that failed in its duty, and a broken chain of command.

That’s the terrifying aspect of this saga. What the Senators failed to ask and Dimon failed to mention was: why?

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