The Daily Shot - 12/14/14

From: "The Daily Shot" <thedailyshotletter@xxxxxxxxx>
To: <thedailyshot@xxxxxxxxxxxxx>
Date: Mon, 15 Dec 2014 01:25:34 -0500
The Daily Shot™

 

 

Greetings, 


I’d like to start tonight by discussing the situation in the Eurozone. If Mario 
Draghi was lacking ammunition to initiate an outright quantitative easing 
program in the Eurozone, he certainly has it now. Even the staunchest opponents 
will have a tough time arguing against the need for a more aggressive approach 
to monetary easing. Here are five reasons:

 

1. As discussed last week, the take-up on ECB's TLTRO offering fell far short 
of the ECB’s goals. The initiatives announced by the ECB last summer, including 
ABS and covered bond purchases, are simply insufficient for the type of 
monetary expansion (of about €1 trillion) the central bank would like to see in 
the Eurozone.

 



Eurosystem consolidated balance sheet (source: ECB)

 

2. Some Economic data out of the Eurozone shows recovery stalling. Falling 
Italian industrial production and weakness in French labor markets are just two 
examples.

 



Source: Investing.com

 

3. With the collapse of oil prices, the Eurozone is bracing for deflation. 
German 5-year breakeven inflation expectations are now at zero. And Europe's 
central bankers are fearful of repeating Japan's decade-long struggle with 
deflation.

 



Source: @PlanMaestro

 

4. While the euro has declined significantly against the dollar, it remains 
quite strong on a trade-weighted basis. This is putting downward pressure on 
prices (via cheaper imports) and is disadvantaging some of the Eurozone-based 
exporters. A more aggressive easing effort would force the euro lower.

 



TWI = "trade-weighted index" (source: @TenYearNote)

 

5. Finally, the euro area's sovereign risks are resurfacing once again - 
triggered by new political uncertainty in Greece.

 

The Guardian: - Mounting concerns over Greece’s ability to weather a 
presidential election, brought forward in a surprise move by the prime 
minister, Antonis Samaras, continued to unnerve investors ahead of the first 
round of the vote in the Greek parliament next week. 

 

Under Greek law failure to elect a new head of state by the ballot’s third 
round on 29 December could trigger a general election. The stridently 
anti-bailout main opposition party, Syriza, is tipped to win that poll. The 
radical leftists have made a debt writedown and the end of austerity their 
overriding priorities if voted into office. 

 

Although Samaras called the election in a bid to expunge the political 
uncertainty engulfing Greece, the slim majority held by his government, 
compounded by the leader’s repeated warnings of Greece leaving the eurozone if 
Syriza assumes power, has accelerated investor nervousness.

 

The nation's stock market is down 20% over the past 5 days as investors flee.

 

red = Euro STOXX 50, blue = Athens Composite



 

 

And Greek sovereign debt sold off sharply. In fact the 3-year government paper 
yield went from roughly 3.5% in September to 11% now. This situation alone 
would make most central bankers consider some form of monetary easing.

 



 

 

Mario Draghi now has five solid reasons to argue for QE and many expect the 
central bank to announce such an initiative in the next 2-3 months. However, 
while most economists covering the euro area agree on the need to take a more 
aggressive monetary action, the problem of implementation remains. Since the 
Eurosystem's (ECB's) balance sheet is in effect owned by member states, many in 
the core economies are worried about having to become the proud owners of large 
quantities of their pro rata share of periphery nations' debt. For the Germans 
in particular, the ownership of such debt is a major issue. A solution that is 
even remotely politically palatable across the Eurozone remains elusive. The 
ECB's independence and the euro area's legal structure is about to be tested 
once again.

  _____  

 

In Japan the Tankan survey shows more trouble with growth. While Abe’s party 
just won a landslide victory, there is a tough road ahead to get the recovery 
going again. 

 



Source: @TomOrlik

 

Meanwhile the 10-year JGB yield is now below 39bp and falling – 

 



  _____  

 

A quick note on India. As predicted, Indian longer term rates are declining on 
lower inflation. 

 



 

But it’s not just inflation that will bring rates lower. The economy is cooling 
a bit (see industrial production vs. expectations below) and we are likely to 
see the RBI benchmark rate also fall and the rupee weaken somewhat as a result. 
In spite of some currency risk I would be constructive on longer-dated 
government bonds at near 8% yield.

 



  _____  

 

I was a bit surprised to see how levered Chinese equity investors are becoming. 
This could be troublesome on the way down.

 



Source: @pdacosta

  _____  

 

Back in the US, the Federal Reserve has been aggressively testing the various 
monetary tools that will give it additional flexibility during the rate 
normalization process. In addition to the Term Deposit Facility, the Fed 
recently started testing the term reverse repo facility (Term RRP). 

 



Source: NY Fed

 

Note that this is in addition to the Overnight RRP. The Fed will provide a 
total of $300bn under the program, with the first such offering completed on 
Dec-8th. It was a 28-day "secured deposit" paying 10bp (annualized) for $50bn

 



 

At the same time the US Treasury has issued a larger than usual amount of 
treasury bills recently. Since the Term RRP with the Fed is effectively the 
same as purchasing a treasury bill (particularly at 10bp), the Fed's $300bn 
program (combined with the existing facilities) effectively "crowded out" the 
bills market (as discussed last week). This ended up pushing short-term 
treasury yields higher - while yields on longer-dated treasuries kept falling.

  _____  

 

While the DXY index has stalled, the trade-weighted dollar index continues to 
rise. This is driven by recent declines in Canadian dollar and the Mexican 
peso. This dollar strength will continue to pressure commodities.

 



 

In part as a result of dollar strength, US import prices fell 1.5% in November, 
the biggest decline since June 2012. This will cap price increases and put the 
Fed on hold for some time.

 



  _____  

 

Nevertheless some continue to argue that the Fed is on target to tighten in the 
middle of 2015. The argument comes from expectations that wages will begin 
rising next year. And some of those expectations come directly from US 
households.

 



Source: @greg_ip  

  _____  

 

The impact of energy market adjustment on the US economy will not come from 
reduced production – not initially. The hit will come from a sharp drop in 
investment and the various knock-on effects. I spoke to someone based in 
Houston who argued that the regional economy there is “diversified” – financial 
services, construction, manufacturing etc. Let’s see how well those other 
sectors hold up when energy investment dries up.

 



Source: @Jesse_Livermore  

  _____  

 

Now some food for thought. According to the latest Yale study, Americans are 
split over the KeystoneXL pipeline proposal and only 1/4 think it’s a safe way 
to transport heavy oil.  This prompts two questions:

 

1. Is rail transport any safer? Because that’s what the pipeline is supposed to 
replace (partially).

2. If the current price regime persists for a long time (which is what the 
Saudis are planning) is the pipeline economically viable? For example a great 
deal of Alberta’s tar sands have a break-even cost of around US$63.5/bbl. As of 
right now, WTI futures trade at $58/bbl. Why would anyone pay to transport 
crude to central US via KeystoneXL just to sell it at a loss?

 



Source: @YaleClimateComm

  _____  

 

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The Daily Shot - 12/14/14

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