Market get mixed message from central banks

Most markets are looking for direction as central banks moved the goalposts over the last 24 hours.

Yesterday Fed chief Janet Yellen said that the central bank now sees an additional rate hike needed for next year as its policies appear to be working.

Laugh at that. The reason Yellen & Co are seeing improvement is because of the expectations of the Trump Administration’s pro-growth business policies.

And just Thursday morning, Bank Of England chief Mark Carney said the central bank will unexpectedly hold rates at 0.25% and will proceed with an $88 billion program of bond buying program because the outlook is far from rosy.

So who is right? Yellen or Carney? Neither?

Dollar strength will rule the day in 2017. So until that plays out growth in the US and globally will be curtailed as China, Japan and other export countries suffer the slings and arrows of currency revaluation.

The UK by beginning the Brexit talks with EU next year will be buffeted by a pound trading lower against the greenback.

The euro could also be trading below par with the dollar in early January as the ECB takes on a two-front war between the UK and its southern flank of Greece and Italy.

So King Dollar will rule the roost during the Trump’s Administration’s honeymoon period, which could hamper the push to keep jobs here in the US.

This makes the need for tax policy reform so much more critically important to get done soonest to stem the call for exporting jobs.

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Investors flock, while leaders flee

I’m having a difficult time figuring out what the markets see, that I don’t.

Yes we have President-elect Donald Trump coming into office in 6 weeks or so. The perception of regulation easing and increased infrastructure spending have many sectors soaring.

But we have other heads of state running for the exits this week: Italy, New Zealand, Bulgaria governments are in flux over these seemingly separate decisions to leave office early.

We also have the fall out of Brexit, Italeave and as always, Greece to deal with in early 2017.

Change and upheaval are not the things that put the Volatility Index near an all-time low and US indices both broad and narrow are hitting all-time highs.

Perceived regulatory rollback is the driver here in the US, but the demise of the euro could be on the table in early 2017, and that’s not in the market at all.

As I have often said the Dow is not the economy and like now, don’t march in lock step.

With ECB head Mario Draghi giving the market a mixed message this morning with further easing through 2017, but reducing the monthly stipend after March, we see the struggles within Europe.

Next week we have Janet Yellen and the Fed raising rates 25 bps, which could take some of the wind out of the markets, but the year-end window dressing for portfolio managers should stem the downward flow until early 2017. Just the same as last year’s market action.

 

It's Italy's turn to run for the exit

Italians will go to the polls on Sunday in the first step of determining the future of the country as part of the European Union.

Like Brexit, the Italians seem to be favoring leaving the EU over the lack of economic growth over the last 20 years partly due to the strength of the euro.

Italian Prime Minister Matteo Renzi is holding a referendum to change Italy’s constitution. A “Yes” vote essentially means Italians wish to stay in the EU, while a “No” vote can lead to the exit. The latest polls say the “No” votes have a 54% likelihood of passing.

Since Italy is the third-largest member of the EU, an exit-vote win will certainly have dire results in the market as global investors need to act as if the EU may dissolve over the next year as a result.

Certainly the cratering Italian banking system will be further impaired should the “No” vote carry the day. Monte Paschi bank in Seina will have a much harder time selling its bond offering which in needs to do in order to remain open.

Come Monday morning, the US futures markets will tell you very clearly how the vote went.

Deutsche is walking dead, but may not fall

When the markets question the viability of a financial institution, then that firm is toast.

The capital markets were the ultimate forum for picking winners and losers, that was until 2008, when the term “Too Big To Fail” came into vogue.

Once a firm is tagged with the TBTF label, markets no long can become efficient and take the financial institution out through bankruptcy or merger.

This is where you see Deutsche Bank today. In the past before TBTF, Deutsche would be in a liquidity squeeze as markets question the viability of the firm ( see Lehman).

However, there has to be an explicit backing by the German government in order for Deutsche to still have its doors open.

Yes we get headlines that Deutsche’s borrowing costs are going up, that other firms are poaching Deutsche’s bankers and that its derivative book has been reduced to 43 trillion euros from 75 trillion euros.

But let’s work the notional value of a 50 trillion euro book, which conservatively could be 5 trillion euro in exposure. Deutsche’s current book value would have trouble covering the $14 billion Justice Department fine for mortgage security fraud charges. So how can the bank cover a 1% move on 5 trillion euro?

If the market could clean out a troubled firm (see Citigroup), then we would not have had to go through the last eight years of economic malaise. But that’s not to be, as governments and central banks — not the markets — pick winners and losers.

So if the Merkel government has given the markets a thumbs up in backing up Deutsche, which is the only explanation, then we can welcome back the zombie banks in Europe.

Bank stress test graded on a curve

So news comes out today that Deutsche Bank received special treat from European regulators during this summer’s EU bank stress test in order to pass.
Germany’s largest lender was allowed by the European Central Bank to included the $4 billion gains from selling its stake in Hua Xia, Chinese lender, despite the deal not closing by the end of 2015.
While the deal was footnoted in the test results, other banks that had pending deals were not allowed to use those proceeds for the test.
“This [Deutsche’s treatment] is perplexing,” Chris Wheeler, an analyst at Atlantic Equities, told the FT.
“The circumstances mean that it is inevitable the market watchers will be suspicious and have some concern about the veracity of the results,” he added.
Deutsche Bank has failed US stress test two years in a row.
Meanwhile in Washington over the weekend the bank’s CEO John Cryon could not come to an agreement with Justice department officials in settlement talks over the $14 billion fine dealing with the bank’s handling of mortgage bond securities in 2006-2007 time period..
Shares of Deutsche Bank are down 43 percent this year.