Bernanke operates a super-put option for equity markets and Ireland may regret upsetting Roman Abramovich

Today is an opportunity to take stock of the tumultuous events of this week. There has been much more than a move by the US Federal Reserve, and if I may be permitted an aside thank you to those who have contacted me saying I predicted it pretty well. If we go back to before it we cam recall that central banks in India and Australia raised interest rates because they had inflation fears. As they preceded the US announcement we cannot say that they were caused by the US central bank saying.

measures of underlying inflation are somewhat low

However they were made in an atmosphere where we have rising commodity prices combined with the central bank of the world’s largest economy saying that it might move to raise prices or inflation or both. As we go forward this will be an influence in the “Currency Wars” which the extra stimulus by the Federal Reserve has turned up a notch and I wonder if we will see “Inflation Wars” develop.

The Bank of England,European Central Bank and Bank of Japan

All of these have had policy meetings over the past 24 hours and in terms of overt policy moves we got nothing at all. Their policies remain unchanged. Some expected action from Japan but I was more interested in the ECB as there is a lot going on in Europe as I will discuss later in this article and much of it,sadly, is rather self-inflicted. However there are several things to note.

1. Whilst the Bank of England took no new action it still has £200 billion of assets mostly UK government bonds on its balance sheet.

2. The Bank of Japan has planned new asset purchases of its own for a while and is widening its definition of what it will buy for example it will now purchase some real-estate investment trusts. I wonder if it will end up actively purchasing equities which has a lot of implications.

3. As he battles with various contrary strands and problems the President of the ECB Mr.Trichet took a swipe at the US Fed. ““The non-standard measures are by definition temporary in nature.” An interesting phrase when the US is making its own measures look ever more permanent! In essence the ECB is looking for the exit from its own measures and may well be heading north when the Fed. is heading south. Such views are prevalent in the world’s currency markets as the Euro has risen by around 18% against the US dollar since June.

So the theme going forwards is likely to be a clash between the Federal Reserve and the ECB.

Is there now a Bernanke inspired super put option for US equities?

This is an issue which as troubled me I would say for fifteen or twenty years. The debate started then as to whether the US Federal Reserve under Alan Greenspan would act to stop any sustained fall in US equity prices and rumours of such a strategy became known as the “Greenspan put” . An example of this would be cutting interest rates to support stock markets which of course has certainly happened. At the beginning Quantitative Easing was not explicitly thought of so you could say that the situation has expanded to that extent and why I call it a “super-put” now. However even then there were rumours at times of actual purchases of US equities by the Federal Reserve. My boss at that time (hello Rupert if you are reading this) certainly believed it for example.

If you look at recent moves by central banks around the world you can see evidence for this theory. The Federal Reserve has announced all sorts of extraordinary moves which it expanded on Wednesday and look at my point 2 above for plans for the Bank of Japan. Of course you could use Ben Bernanke’s own words as he has written an article for the Washington Post suggesting it is one of his objectives.

And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.

In reality whilst there are some wealth effects on consumption they have proved weak and hard to measure. I do not believe that higher stock prices will help much and of course they are coming with higher commodity and oil prices which is inflationary. Returning to the theme let me explain what a put option does. It protects you against falls in a market and so the theory here is that equity investors are being protected against falls by the actions of the US Federal Reserve. Usually you have to pay a price or premium for a put option and I suspect that we will find it in the form of higher inflation.

If we return to the super-put theme and look at equity markets with the Dow Jones rallying 219 points yesterday and the Japanese Nikkei rising nearly 3% and the UK Ftse 100 up by 113 points they seemed to like something…

Commodity Prices , Oil Prices and Gold prices all rise

This is one area which is doing its best to give Ben Bernanke the inflation that he apparently wants. Of course price rises in this area leave US consumers with less money for other purchases so there is at best scrambled logic at play. But commodity prices have rallied in response to the actions of the Federal Reserve. The CRB spot index which I follow has risen to just below 500 after settling around 490 earlier this week and is up 26% compared with a year ago.

The oil price has surged this week and is up by 6.1% already in November and it has been on a rising trend for a while. The price of a barrel of West Texas Intermediate crude oil is now around US $86.4 which means that we are now up on the year around 7% after falls earlier this year. The rally has coincided with speculation about and the reality of QE2, although there are other factors too.

Gold bugs are happy too as we are back to new highs and at the current price of US $1387 per troy ounce we are some 33 dollars above the pre-FOMC benchmark I established. The rally is even stronger if you allow for the fact that the gold price fell in the run-up to the FOMC meeting.

Spencer Dale who is a member of the UK Monetary Policy Committee headlined a speech recently as “inflation,inflation, inflation” but I do not think he meant commodities,oil and gold all rising together.

The Euro zone problems: its currency and its politicians

Here there are two clear issues. The contrast between the ECB which is looking for an exit strategy from its measures just as the Federal Reserve is looking for an entrance has led to the Euro rally to around 1.42 versus the US dollar. This must be hurting the European economy and particularly those in difficulty. The effective or trade-weighted exchange rate has risen by around 7% from its low of early summer 2010. Put another way these are the impacts of the “currency wars” on the Euro zone.

There have been a litany of mistakes by Europe’s politicians in 2010 but there are two main ones which are becoming evident this week. The first has been the German inspired move to declare that in future in European rescues of countries private bond-holders will be made to take some of the pain. Many private bondholders have taken this as an invitation to stop investing in these markets leading to government bond yields in Portugal, Ireland Greece and to some extent Spain all rising. In Ireland this has become something of a rout even though the European Central Bank is rumoured to have stepped in as a buyer. My point is that this is a strategic success and a correct move but a tactical failure.

The next problem is the EFSF or European Financial Stability Facility. I wrote in an article on the 25th of June that it was not going to be of the size promised and have also written that it will be unwieldy and slow to operate. As it looks like more countries may need help others are starting to question it and wonder how it will work. I notice also that some are now questioning the interest rate at which it will be able to lend. Just to be clear it looked as though it would be around 5 to 5 1/4%. Now some think it might be 6% and Wolfgang Munchau has looked at it and as well as agreeing that there are size issues he feels that the interest rate charged may now turn out to be 8%! If you were writing fiction then I suspect such a manuscript would be turned down as being too far-fetched.

Will Ireland regret upsetting Roman Abramovich?

This may seem a curious question but Mr. Abramovich was one of the investors who are likely to be affected by Ireland’s “cunning plan” for bondholders in Allied Irish Bank. In the world in which we live where Mr. Abramovich is very wealthy and very well-connected I did wonder if this would turn out to be as cunning as many of the proponents suggested. I now notice that the Russian sovereign wealth fund will no longer invest in Ireland and as it happens Portugal and Spain. I did wonder about the wisdom of such a move and may be wrong as coincidences do happen but if Russia has been selling…….

Ireland presented her budget yesterday and it turned out in a strategic sense as I reported last week with 15 billion Euros of cuts and an element of front-loading. The real problem with Ireland suffering from a severe outbreak of cronyism will be summoning the will to actually do this particularly as many avenues are blocked by the Croke Park Agreement. However she has not lost her taste for cunning plans and indeed presented one with her budget.

Ireland’s government will not pay interest in 2011 or 2012 on promissory notes it is issuing to partly recapitalize three lenders. Essentially, in order to pay no interest for the next two years, the interest now is set to zero but the interest to be paid later on is increased by enough that the net result is the same. Oh and the interest assumed for later is at 4.7% which is around 3% below current market rates. As their credibility plunged the Irish government announced this wheeze had the approval of Eurostat so I guess what credibility it had can plunge with them too. This ruse “saved” about 1.5 billion Euro’s in these two years.

The net effect of all this is that Reuters report the ten-year Irish government bond yield is at 7.79% as I type this and this is some 5.42% higher than Germany’s.

Advertisements

8 thoughts on “Bernanke operates a super-put option for equity markets and Ireland may regret upsetting Roman Abramovich

  1. Hi Shaun,

    “All of these have had policy meetings over the past 24 areas…” Should that perhaps be “All of these have had policy meetings over the past 24 hours…” ?

  2. Hi Shaun,
    Another great post.
    Just a quick reply to some of your past comments,
    If the NZ media took exception to MJ then that was not evident here. The NZ rugby public and the media for local consumption certainly held him in high regard. He was viewed as the hard working no nonsense enforcer type that when the going got hard he got going. This was very evident in Wellington in 2002 ( I think) when you had two forwards in the bin however your scrum did not go backwards. You then went on the win the World Cup in OZ.
    I note you watched the Hong Kong game. I watched it to the end and I still cannot believe that we lost it. We had won ten in a row against them and we were just getting used to the habit. Eleven in a row would have rolled off the tongue well. It was disappointing to throw it away at the end.
    I wish your team well for tonight’s game. I am interested in how you think your boys will approach it. Will they try to slow it down and play a structured game or will they be a bit more adventurous?
    The week sure has been eventful. The effect of Helicopter Ben’s latest move on us down here is for the A$ and NZ$ to go to highs against the US$. The A$ is now at parity with the US$. Something that has not happened for decades.
    You may or may not be interested to know that NZ was the first of the OECD economy’s to go into recession and one of the last to come out. However it was thankfully a very mild recession. Since then we have had very low growth and consumers are paying off debt (either forced or voluntary). I believe we have a property bubble however this has yet to resolve itself. As low growth continues and now we have had a significant earthquake to deal with the property market is ripe for revaluation.
    Since the entry of the UK into the EU we have slowly and painfully reorientated our economy away from our traditional markets to now rely on the Asia Pacific. China has just become our second largest trading partner taking over from the US. Oz is by far the largest so we are becoming more directly and indirectly linked to China. So far this has paid off. Two other issues have helped us in that we have very low government debt and our banking sector (we are lead to believe) did not partake in the toxic debt feast. It is with trepidation that I watch the lack of resolution of the significant problems with the US, EU, UK and Japanese economies. Down here we generally believe that we are twenty or thirty years behind you lot up there. Maybe with our reorientation we might have caught up a few years. My only hope is that you lot do not make such a mess that you drag us all down.
    Sorry to ramble on however I thought you might like some lite relief.
    Cheers
    P.S. Thank you Mr K for the link.

    • Hi Bones and thanks for the compliment.

      I have found that I am ending up looking at more and more countries as times go by! Although with the cultural ties and the number of Kiwis over here NZ seems more familiar than some inspite of the distance. Thanks for the update on the economy. For what it is worth I am one of those who regrets the breaking of some of the economic ties as whilst we plainly need to deal with Europe I have always felt that we could have accomodated our Commonwealth links in a better fashion. The currency moves do give me a wry smile as they are a sign of the passage of time. When I started my career in the City of London it was a safe bet that the Commonwealth dollars, Aus Can and NZ would fall, how times have changed!

      As to the rugby from what I saw of last week’s international you were the better team and I was surprised later to see you had lost. As to English tactics today I am not sure that we have any, as in the MJ era we have mostly been tactically inept in my view. Actually some of that was true when we won the World Cup but under Clive Woodward we were strategically very good. Thank you for a reminder of Wellington 2002 when we drove the ball 80 yards with a 6 man scrum, I have long felt that it was at that point we won the World Cup in terms of momentum and belief with our best player Richard Hill leading the charge. Now a new Richard Hill would certainly gladden any English heart and his knee injury after 2003 cost us a lot and perhaps robbed him of some of the regard he should have received.

      I think our tactics should be a combination of forward power mixed with and this may shock you running the ball very quickly at times. We have picked a brutal front row but also men who can charge. Oh for the days when the rules allowed us to put the ball up our shirt and keep it! the front row can all run and we have picked a young lock Courtney Lawes who is a great hope for us. Sadly our other lock is not Simon Shaw or any of the other main alternatives. It is often said of managers that they struggle with their own position. As to our back row we have great hope for Tom Croft and Nick Easter is solid and Lewis Moody is fearless. But if you compare to 2003 they are not a unit like we had then.

      Our backs look underpowered against your centres who look brutes. However we have men like Ben Foden who can run and a fast scrum half and a finisher in Brian Ashton. So power matched by occassional really fast ball with our quicker forwards cole, croft and lawes in hot pursuit…

      Sadly I expect us to be ponderous and slow and make it difficult. A wet day at Twickenham may help us but I see McCaw pinching the ball a few times as he is top-class. Your flyhalf DC is peerless and I expect him to launch your centres. So I expect you to score tries and accordingly to win we will have to as well. I hope we realise that but I am not sure I really believe it. Thanks for the thought that we might play a structured game! It’s a long time since we managed that and oddly when we did we made the 2007 World Cup final…

      Whatever in sorrow or joy later I will hold up my glass to you when I am down the pub.

  3. Hi Shaun,

    thanks as always for your posts. With all the attention on Bernanke, don’t forget monsieur Trichet. He recently turned down a request by Bloomberg to release ECB documents on the Greek swaps.
    http://www.bloomberg.com/news/2010-11-05/ecb-rejects-request-for-files-on-greek-derivative-use-cites-acute-risks.html

    What I found, em, interesting, no, disturbing is a better word, is his reasoning for turning down the request:
    “The information contained in the two documents would undermine the public confidence as regards the effective conduct of economic policy,” Trichet wrote in an Oct. 21 letter in which he rejected the appeal. Disclosure “bears, in the current very vulnerable market environment, the substantial and acute risk of adding to volatility and instability.”

    Is this guy for real or he thinks he is playing the Central Banker in a Monty Python movie? If I told you a secret, you would be very worried and would not trust me. But, I won’t tell you, so you can keep trusting me.

    And could the situation with the Greek swaps (and those of the other Euro countries — Italy comes to mind) be so much worse than is already publicly known?

    js

    • Hi John
      Mr.Trichet has had a hard year where he has been forced into a four day u-turn on the Securities Markets Programme and has in effect found himself a puppet of the Euro zone’s politicians. After so many fudges perhaps he actually believes that there some “public confidence” in Greece, or indeed “effective economic policy” as his equilibrium must have been destabilised.

      I am afraid that those in authority seeem to keep thinking that cliques and cronies know better than everyone else when the evidence keeps pointing in the opposite direction. Here Ireland and Greece have been examples of bad news being drip fed out and public pronouncements attacking those of “negative” intent.

      As to Italy I have from time to time had a wry smile that she has sailed through all this relatively unscathed. With so much to do I have not had much time to analyse her except in the narrow money supply figures I was looking at in today’s article she was with the periphery and not the core countries which may gives us a clue for expected economic performance over the next 6 months or so. I have however written about Spain and can say that there are issues there but so far markets have not got on her case to any great degree.

      As to things being worse than publicly known I am sorry to say that this has been a feature of almost every step of the credit crunch.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s