More Steen Jakobsen, 01 December 201101 December 2011 Non-Independent Investment Research Like many others I was surprised at the one-two punch given by China and the global central banks yesterday. However, now I feel like as if I was flying transatlantic from London to New York and halfway through the flight the captain comes on the PA system and announces: “Ladies and Gentlemen, this is your Captain speaking - we have lost three of our four engines, but no need to worry as one engine should be plenty to get us to New York”.
The central banks are now the only source – or engine – of funding for banks. Yes, it means we now have even more guarantees of cheap money/liquidity in the system, but it’s still a scary, one-engine plane. The central bank liquidity is the one engine, while the private market that used to be the other three engines, has seized up and stop functioning. This is a negative 'crowding out' of private capital.
French banks alone are estimated to have seen their US wholesale funding cut by more than half over the last month and worse still, the average term of the funding is down from 44 days to less than 5.
Yes, the one engine is a magical one that can provide its own fuel for a time and may very well get us to New York, but it will arrive terribly late, and may have a hard time flying again if the public loses faith in its fuel source (printed money and promises).
The market loves cheap liquidity and has reacted positively to yesterday’s coordinated move on USD swap lines, but this debt crisis is a problem of solvency – not one of liquidity/printing money, which makes the intervention a de facto exercise of extend-and-pretend, version 5.0.
Looking into 2012, the massive funding gap for sovereigns remains, with no customers (private) willing to step up and buy the risk, which is now almost perceived to be toxic.France and Spain alone need EUR 500 billion for each of the next three years each year - will the ECB or a super vehicle be in place to provide life support to this market as well?
Most likely, but let us not fool ourselves – every time we crowd out private capital with public capital we increase the burden on the public (taxes!) and future liabilities. Solving debt with more debt remains a concept for fraudsters and executives of the Enron ilk.
In the pipeline, we also now have the expected discount window cut from the FED, which is now a mere formality as the US banks clearly can’t be required to pay more than foreign banks to tap the FED for greenbacks.
The math is simple: The discount rate is 0.75% - the new swap facility is 0.50% plus the OIS spread of 0.10% basis points (so 60 bps in all). So a new 25 bps cut will make it cheaper for US banks to borrow again and a full 50 bps cut to the discount rate will remove the penalty of going to the discount window as policy rates are at 0.25%. So a 25 bp cut is the 80% odds scenario, and will likely take effect before the new central bank USD swap line rates are lowered on December 5.
This all brings to mind that great old Dire Straits song 'Money for nothing' – and this is indeed money for nothing. For now the market is celebrating and enjoying the free microwave ovens and colour TVs and Mark Knopfler guitar solos, but unless this move is followed up by concrete steps to apply the debt brakes in both the US and Europe it will remain a desperate standalone effort that only buys a little more time.
The US S&P 500 could test 1250/1280 in this “Santa Claus rally”, but if it does, the market is a firm sell heading into 2012, which still looks like the perfect storm.
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