ECB - Bond markets weigh risks of eurozone QE

Bond markets weigh risks of eurozone QE 02-18-14 EURO2DAY

At last, after resisting for so long, the European Central Bank looks closer to implementing its own version of quantitative easing to spark growth across the eurozone.

WILL IT DISLOCATE THE BOND MARKETS ?

Some investors and strategists are asking this very question as they raise their expectations of QE, the once extraordinary policy that is now the standard monetary response to low growth and inflation. The US Federal Reserve, Bank of England and Bank of Japan have all resorted to QE to boost growth.

THE "WHAT EVER IT TAKES" PROMISE

The problem for the eurozone bond markets is that QE could undo the gains since ECB president Mario Draghi triggered their recovery by pledging to do whatever it takes to prevent the collapse of the single currency in the summer of 2012.

Mr Draghi's promise has brought peripheral bond yields, which have an inverse relationship with prices, down sharply and narrowed their spreads against Germany, the benchmark market.

POTENTIAL PERIPHERAL SPREAD WIDENING

Steven Major, global head of fixed income research at HSBC, warns:

"QE is a potential risk for the eurozone bond markets. It is a step into the unknown and could lead to spread widening among the peripheral markets against Germany."

This threat of widening spreads would reintroduce the problems seen at the height of the eurozone crisis as it would make Germany more competitive with lower borrowing costs at the expense of other economies. Mr Major worries that this spread widening would be inevitable.

This is because the ECB would have little choice but to buy government bonds to bring about the stimulus required to lift inflation. Other bond markets, such as asset backed debt, are not big enough to enable the central bank to buy in a size that would make a difference - and buying government bonds almost certainly means purchasing more German Bunds than other debt, pushing Berlin's yields down at a faster pace.

BOND BUYING BREAD DOWN

Investors and strategists expect in a €400bn programme:

• About 30 per cent of the bond buying will be in German Bunds .
• About 20 per cent in French OATS,
• 18 per cent in Italian BTPs,
• 12 per cent in Spanish Bonos,
• With the rest being bought in the other much smaller debt markets

Laurence Mutkin, global head of G10 rates strategy at BNP Paribas, argues that the purchases will have the opposite effect. That buying a larger proportion of German bonds will actually help narrow yield spreads between Bunds and peripheral debt.

"It's not about quantum," he says. "It is about the size of the available float."

For example, the German market is much bigger and deeper than the Spanish market. This means the ECB could afford to buy a smaller amount of Spanish bonds to move yields further than in Bunds.

LEGALITY OF OMT

For others, issues over the legality of a bond buying programme is a greater concern.

The German constitutional court has asked the European Court of Justice to make a ruling on outright monetary transactions, which Mr Draghi introduced as a backstop to the eurozone in the summer of 2012.

Although outright monetary transactions would involve buying government bonds, it is not the same as QE as it would be introduced in "the event of a run on one or more of the debt markets".

The ECB could successfully argue that QE, which involves buying a range of bonds to lift inflation, was within their remit as it is designed to bring about price stability. But, the legal wrangling is still creating confusion.

One bond investor at a big German asset management group says: "I think the legal situation complicates everything. Markets don't like uncertainty. It is that simple. The lawyers don't seem to care about this. It is very frustrating."

He thinks QE is inevitable, whatever the lawyers say, possibly as early as the second quarter of this year. The ECB will have little choice but to follow other central banks and join the QE club if low inflation persists, he says.

Harvinder Sian, co-head of European rates research at RBS, agrees: "The risks are probably greater by not doing QE, than doing it - and it looks likely it will happen."

But QE is not the endgame, he adds. "QE is another stage in the road to recovery for the eurozone. But it is a policy that highlights the problems in the region. With the amount of public debt that most economies are still carrying, the eurozone crisis is far from over.

SWAPS - SEFS Implementation Begins

Swaps market prepares for its big bang 02-18-14 EURO2DAY

The US swaps market is expected to begin a shift away from the predominance of telephone trading this week as it joins the 21st century in a move towards more tightly regulated electronic trading venues.

The changes are being ushered in by global regulators in the wake of the financial crisis, and come into effect on Tuesday, as trading of over-the-counter derivatives moves on to so-called swap execution facilities - Sefs.

Long viewed as a shadowy area of the financial market, OTC swaps trading has been dominated by large global banks and investors since its inception in the 1980s, but the collapse of some banks in 2008 revealed serious shortcomings within this bilateral system.

The efforts of regulators led by the US Commodity Futures Trading Commission has been to open up the swaps market to greater competition and price transparency. Last year, the credit risk between buyers and sellers of standard swaps was mutualised via centralised clearing houses, setting the foundation for rapid paced transactions on Sefs.

While Sefs facilitate electronic and voice based transactions, many in the industry expect the share of computer driven transactions will quickly escalate from their current very low level.

The biggest concern facing the market is whether banks, investors, clearing houses and operators of Sefs are really ready for showtime.

Jamie Cawley, chief executive officer at Javelin Capital Markets says the mandated era of swaps trading on Sefs, "will be a bit more dramatic than people think".

He adds: "A number of market participants recognised long ago the inevitability of Sefs coming and have prepared for this. Others, however have not."

Ahead of a hard Sef deadline, the CFTC has announced a number of temporary measures aimed at providing relief from possible last minute problems that could hamper an orderly start for Sefs.

Lee Olesky, chief executive officer at Tradeweb says: "It's hard to measure readiness collectively across the market, there will be bumps in the road as the market makes the transition to Sef trading."

Meanwhile there has been a scramble among some clients to sign up for Sef access, particularly at Bloomberg, whose data terminal is ubiquitous across trading floors.

"We are seeing quite a sizeable chunk of people coming on to the platform," said Ben Macdonald, president of Bloomberg's Sef. "The Sef is part of the terminal and it's very integrated into our clients' work flow."

For interdealer brokers used to high commissions from executing billions worth of notional derivatives over the telephone on behalf of banks amid a raucous trading floor atmosphere, the winds of change are certainly blowing.

Michael Spencer, chief executive of ICAP, the biggest interdealer broker and which began in the 1980s with a specific focus on the then fledgling interest rate swaps market, is under no illusions that the old ways of doing business are ending.

"The market in interest rate swaps is still predominantly voice brokered but it's not where we see it in the longer run," he says.

ICAP, which already has large electronic franchises in Treasury and currency trading, is expected to be more able than many of its rivals to weather the increasingly competitive landscape, as the likes of Bloomberg, Tradeweb, MarketAxess, the CME Group and a host of start-ups vie for a slice of the swaps market.

As swaps begin trading on Sefs, an early shakeout is expected among the 20-or-so competing platforms.

Rick McVey, chief executive of MarketAxess, says the proliferation of venues, all interpreting the rules differently, will cause problems for dealers and investors. The high cost of running a venue will also be significant, he adds. "By the end of the year we will be down to around seven venues," he predicts.

Mr Olesky says, based on the current size of the swap market, that it is hard to see demand for more than several Sefs across different asset classes.

Tradeweb, which has been facilitating US electronic derivatives transactions for more than eight years, is looking to provide investors with a variety of ways to trade swaps on a Sef, from streaming prices, anonymous order books, to a request for quote function.

"We are not picking a particular model, the market will evolve," says Mr Olesky. "We have prepared ourselves for a number of outcomes and protocols given the different types of customers in the market."

Mr Cawley said: "Sef volumes will increase and it remains to be seen whether customers and dealers use voice or trade electronically on Sefs, but the market will be forever changed

RETAIL CRE - Financial Crisis II Coming

The US just released US Retail Sales and the details warn of an alarming problem. 2008 may have been a crisis brought on by US Residential Real Estate but 2014-2015 may be another round brought on by US Retail Commercial Real Estate. The Fed, Banks, Insurance companies, REITS and most importantly, the Shadow Banking sector are well aware of this.

JOBS versus SALES - More than Hiring for Christmas Sales

This graphic is based on just published US Retail Sales numbers:

The chart above — from Neil Dutta, head of U.S. economics at Renaissance Macro — does an excellent job of illustrating that recent retail sales data just don't square with recent jobs data.

"Something has to give. There is a widening disconnect. Either retailers stick with it and stay confident on the expectations that sales will improve, or they will be forced to cut employment dramatically."

THE BIGGER PICTURE

Then I read that Bill Ackrman is dumping all his Commercial Real Estate Holding: What Does Bill Ackman Know About The Future Of Commercial Real Estate? A man that knows JP Penney and the Malls!

But .... ITS MORE THAN JUST A "MALL" PROBLEM

MACRO ON:

THE RETAIL CRE DOMINO

the looming domino they see in the US Retail CRE (Commercial Real Estate) space due to the advancement of online and robotic technologies. The rapidly advancing ramifications are both startling and alarming.

EXAMPLES OF EXPLODING RETAIL SERVICE AUTOMATION - Will reduce Employment and Square Footage

1. Store Replacements: Redbox Model
2. Instore Kiosks
3. Applebee's "Waiter Terminator"
4. Smoothies "Automated Dispensers"
5. McDonalds's "Smart Restaurant"
6. The "Brown Truck" Store

AN 'OVER-STORED' AMERICA

The Retail building boom in America has created yet another bubble - The Stealth Retail CRE Bubble.

SHADOW BANK FINANCING

The Shadow Banking system has 'morphed' since the 2008 financial crisis. Gordon T Long in the video below explains why Commercial Real Estate financing is presently seriously exposed to a crisis in short term funding disruptions, in a similar fashion to Residential Real Estate prior to the 2008 crisis. He shows the new instruments that are now being used and why they will be the new acronyms of the next financial crisis.

MACRO ON:

LOOMING US RETAIL IMPLOSION: An Urgent Re-Think Required  

There is a looming US Retail implosion on the horizon and a complete re-think of the foundation of a 70% US Consumption Economy is urgently required. For thirty years analysts have predicted the demise of the US consumer. They were so consistently wrong that the mantra "Don't Bet Against the US Consumer" became a staple of investor wisdom, similar in reliability to "Don't Fight the Fed!".

The US Consumer as the engine of global growth has powering global credit creation and expansion as a result of the corresponding growth in US deficits . Now at 70% of the US economy, as compared to 50-55% for other developed economies and less than 35% for emerging economies, the question is no longer a matter of is it sustainable, but rather what will be the fallout now the inevitable has finally arrived?

It is clear the US consumer is tapped out a result of the US middle class being 'gutted' with job lose, low salaries, exploding healthcare & educations costs and pensions now an endangered species. However, our Monetary, Fiscal and Public Policies are only making matters worse.

THE BOTTOM LINE

A US Recession threat could briong the whole US Retail CRE House of Cards down