Sunday, 22 July 2018

The debt-ceiling put

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Anthony Peters on the next round of childish playtime in Washington.

A father and son are standing in Washington, DC, looking at Capitol Hill. The boy turns to his father and asks “Dad, why does the Capitol have such a big dome?” “Well, Junior,” the father replies “have you ever seen a circus with a flat roof?”

While we in Europe are mainly looking towards the south-east corner of the continent for the news and “only” concern ourselves with the US once a month on Non-Farm Friday in order to find clues as to what the FOMC will do next – or perhaps more to the point, when it will do whatever it has to do what it has to do – the Republicans on the Hill are busily engineering the next debt ceiling crisis.

Markets are of course sanguine as the last debt-ceiling panic turned out to be a wet squib. A little bit in the same way as markets seem content that no matter how tight the situation with respect to Greece’s solvency may be – it is slated to make a timely payment of the €588m it owes to the IMF today – the rest of the eurozone membership will not let it fail, so there is confidence that after the customary period of rhetorical brinkmanship, the two parties in Congress will not let public sector workers go unpaid and will not permit Uncle Sam to default.

Altogether, it seems now that in the public sector finance arena Murphy’s Law, “Whatever can go wrong will go wrong”, no longer applies. The cost of disaster is too high which leaves President O’Bama with a level of comfort that if he leaves the Republicans to play in the garden and to run around screaming until it gets dark, they will eventually come in and eat their supper, wash, clean their teeth and go to bed like good children.

Yanis Varoufakis, Greece’s punchy finance minister, is living with the same expectations, despite Germany’s Wolfgang Schaeuble’s recent suggestion that Greece might find itself accidentally falling out of the single currency. It is hard to argue against this. As one Hong Kong-based chum of mine commented “Track day markets … lots of smoke and screeching tires but eventually everyone is back where they started.”

Well, Fed…

That is, if one does not include Wednesday’s FOMC meeting, how things are looking. Reading other peoples research which I do from time to time – nothing to be said about a bit of light entertainment – one would have to conclude that a June tightening is as certain as night follows day. The Eurodollar strip vaguely agrees with the June contract on 3 month dollar Libor now an elegant 24bp above the spot value of the one which expires on Wednesday and thereafter it marks a steady increase to 1% as at one year from now.

That, however, reflects 3-month interbank money and not Fed Funds. The Fed will, in my opinion, err on the side of caution for once it pulls the tightening trigger, there is no way back. The Chinese administration has used the occasion of the CPPCC as a platform to formally downgrade the GDP growth forecast to 7.0% which, along with the strong dollar, could slow the recovery process in America.

We did discuss last week the option of the Fed tightening once in order to declare the end of the money-for-nothing period, but then added a rider that further rate rises will be entirely “data dependent”. I like the idea but, as I already noted, I am not sure how that might go down in the real world. Curves are still all over the place and although the long end has backed up nicely – the long bond was at 2.22% at the end of January and is now at 2.67% – it is still below the 2.75% it closed 2014 on and a country mile away from the 3.97% high at which it closed 2013. The Fed has plenty of options, the most probable of which will possibly not even be alluded to in the post meeting conference. Transparency is great when all is well, but if the news isn’t good, a bit of smoke and mirrors goes a long way.

Franc-ly CoCo

I also note a new development in the SFr market. This morning Swiss Raiffeisen has announced an AT1 in Francs. Given the position of CS and UBS at the leading edge of the CoCo market, it surprises that in the domestic currency there is little to show. Luzerner Kantonalbank did an AT1 a couple of weeks back but the bank carries no credit rating. Raiffeisen can issue even deeply subordinated paper at Baa3 which is investment grade and given the near impossibility of finding positive yields in Switzerland, this thing should, for all intents and purposes, blow out. I shall be watching this one with great interest.

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