Wednesday 8 September 2010

Back to the frontline after some summer R&R...

Vix at 23.80 looks cheap again, not as cheap as on the 10th of April when I expected a volatility spike which happened in May, but at the current levels it definitely looks interesting.

Updates on European bond spreads and CDS:

10-year Ireland-to-Germany bond spread has risen to a whooping 376 bps. This spread is larger than during the financial crisis in May when the spread peaked at 306 bps.

10-year Greece-to-Germany bond spread is now 946 bps, just below the peak level of 963 bps in May.

10-year Portugal-to-Germany bond spread is now 351 bps, just above the peak in May of 349 bps.

Crossover 5 year CDS is at 505 bps as of the 8th of September and Europe Itraxx Main 5 year CDS is at 111 bps. CDS indices are widening again.

We also learnt from an article in the Wall Street Journal from David Enrich that in fact there wasn't much stress in the stress test for European banks...Why I am not surprised...

"An examination of the banks' disclosures indicates that some banks didn't provide as comprehensive a picture of their government-debt holdings as regulators claimed. Some banks excluded certain bonds, and many reduced the sums to account for "short" positions they held—facts that neither regulators nor most banks disclosed when the test results were published in late July."

For an in depth analysis of the sovereign debt risk, please have a look at the following link to the excellent Calculated Risk Blog:

In terms of Job losses, the recession is in fact a depression, no doubt about it:

"In August 2010, the number of unemployed for 27 weeks or more declined significantly to 6.249 million (seasonally adjusted) from 6.752 million in July. It appears the number of long term unemployed has peaked, but it is still very difficult for these people to find a job - and this is a very serious employment issue." Calculated Risk Blog.

For those who have missed the macro pictures from the data released last week.

Meanwhile Gold is still trending upwards while financial stocks are getting pounded:

Great report to read: Latest BIS report

"US households increased their indebtedness from close to 100% of disposable income in 200 to more than 130% in 2007. Similarly, over the same period, British and Spanish households raised their debt by approximately 60 percentage points to more than 160% and almost 130%, respectively, of disposable income."

The private deleveraging story will take a while to disappear as indicated in the latest BIS report.

"In 17 of the 20 systemic banking crises in our sample that were preceded by a surge in credit, there was a subsequent reduction in private sector indebtedness. On average, the ratio of credit to the private sector to GDP fell by 38 percentage points after these 17 crises, returning to a level similar to the pre-boom situation. The decline in debt ratios is due in approximately equal parts to a fall in (nominal) credit outstanding, GDP growth and inflation."

Until all the toxic assets have been recognised and remove from the impaired balance sheets of many financial institutions, we will have weak lending in a weak economy.

"The Japanese experience offers a key lesson for policymakers on how to reduce private sector debt: fix the banking system first. This involves the early full recognition of losses and the restructuring of bank balance sheets. The latter requires raising the necessary amount of capital. Only then will banks be able to provide new loans."

Canada has shown, as posted in a previous post reviewing the Canadian approach to debt reduction, that debt reduction can generate healthy growth in the long term. It is therefore much better to take much needed short term pain for long term gains. Unfortunately, as I have stated before, this sound policy doesn't mix very well with politicians short term electoral views.

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