Author : John E. Charalambakis
Date : December 15, 2012
The renewal of the swap lines among the major central banks was a footnote for the financial markets and for the financial publications in the last couple of days. However, and as we have pointed out in the past, it is one of the most crucial lines that has sustained EU’s banks and has assisted them in meeting their liquidity needs. The others news that dominated the headlines ranged from the Fed’s target of the unemployment rate (around 6.5%), and its renewed commitment for quantitative easing (QE). At the same time the EU agreed on the first steps related to its banking union aiming at breaking the link between the banks and the sovereigns (i.e. setting up a mechanism to bail out failed banks while also setting up regulatory and supervisory councils), and agreed to have the ECB as the supervisor of the largest banks. The fact is however, that such banking union is envisioned for the second half of 2014 at the earliest, while the most important issues have not even been touched yet. Hence, we tend to believe that for now it is nothing but a smoking mirror in the hope of avoiding another crisis. Moreover, the EU summit put off all major decisions related to fiscal and economic convergence. The EU though decided to release a tranche of €34 billion to Greece (part of its commitment to the Greek bailout). The latter is thought to help Greece make the much needed growth turn around. Given the above developments, the Euro strengthened while EU-related fears subsided. This is called the miracle of smoking mirrors during this festive season.
Since September 6th of this year, when Mario Draghi (President of the ECB) promised unlimited (quantity and time wise) assistance to the countries that needed it in order to save the Euro, the spreads in the EU have fallen significantly. It needs to be noted that not a single Euro has been given as assistance since then. The power of moral suasion (a.k.a. smoking mirrors) at work! However, the fact remains the same: Spain and Italy together will face the demons of a sovereign funding gap of at least €470 billion in 2013. It seems that we have forgotten that the mailman always rings twice. Now, when we count the EU’s banks’ funding gap, the total exceeds €750 billion.
Without having addressed the root of the crisis, and for the sake of political expediency (recall that everything is politics, but politics is not everything), the countries’ banks will resort to the ELA (emergency liquidity assistance) program of the ECB now that the latter has the Fed’s angelic commitment for another round of swap lines, while the countries themselves will resort to issuing Treasury Bills in order to temporarily address their funding needs. Prosperity bought on credit at its highest. Handel’s Messiah should be heard from EU cathedrals when this mispricing of risk and capital misallocation takes place. Uncle Sam has delivered and the Fed’s balance sheet is sterilized with the swap lines, while EU’s dream-turned-nightmare will be shown in theaters again soon. For now the angelic demons will be dressing up for the festive carols.
Let’s now review a special section of the upcoming Basel III regulation regarding banks capitalization. According to Basel III (which is expected to take effect early 2014) gold will be considered a “zero percent risk-weighted item”. There are seven implications from such treatment:
Now, as for the overall markets we anticipate that 2013 will be a decent year for equities, especially in the US, and possibly China. Bond markets will be a year closer to their endgame, and thus we anticipate for sovereigns to be just OK while corporate bonds – given the equities’ direction – will also experience decent returns, in terms of yield. Real estate, especially in the US should be more than fine. The angelic tone of Fed’s messages and subliminal lines point out to the upward trend. The change in the Chinese guard and its commitment to spur growth through credits and special programs should suffice to extend the Chinese wall of steroids, so that for the first time in four years the Chinese equities markets are destined to exhibit positive returns.
The main reasons for the US optimism lies in seven basic facts: