The Rearview Mirror – October 2016

The Rearview Mirror
The Rearview Mirror

Christian Zorico (162)



bridge_by_motowncinderellaEverything started with the 8th of September, when Super Mario calmed down the market expectations by sending a clear message to the governments. Now it is time to act, fiscally speaking. Hence September will be remembered as the month of Central Banks interventions. Thanks to Draghi speech, a bond selloff sent the yield of the 10yr German Bund to the highest value, of 0.08%, after the Brexit-decision. Yet, by the end of the month the situation appeared completely different. Due to the Deutsche Bank’ troubles, together with Kuroda and Yellen appointments’ reactions, the 10yr German Sovereign benchmark touched a low of minus 0.12%.

In particular the situation became crucial since the surge in safe sovereign assets experienced during last week of September left almost a third of European Governments bonds ineligible for the QE purchase program.  To translate this in numbers, $2.2 trillion equivalent of debt were trading below the yield of minus 0.4%, which is the limit set up for the institutions’ deposit rate.

21st of September was the day when both BOJ and FED with their announcements have driven the market price action for the rest of the month. First of all, Kuroda surprised again investors by announcing a new way to stimulate the Japanese economy. With the so called “yield curve control” he tried to steepen the yield curve by freezing the 10yr near zero. In the end,it was a frustrating attempt given that it lasted a few minutes and then we still continued to see a flattening of the curve. The aim was clearly to help the banking system ease the pressure on poor margins, but the final result was to kill a market that appeared already dead-man walking. In fact, the S&P/JPX JGB VIX, a measure of implied volatility for 10yr Japanese government bond futures, dropped 1.17 points on Wednesday, setting the biggest decline since December 2008. On the same week the index tumbled 1.70%  to close at 1.95 percent on Friday.Inv70

Is it the end of capitalism? This is the first question I would like to address to readers in this article.

Then the Central Banks movie continued with the speech of the FED chairman Yellen. The picture that came out from the September meeting is quite dovish. Still policy makers expect one quarter-point rate increase this year but at the same time officials lowered down their expectations for hikes in next year. Again, a good reason to buy duration.

But in this environment everything could change in a moment, and as soon as the word “tapering” is again on the table for Europe, investors get slammed by the fear of holding piles of debt with zero return.

As I am writing I am seriously asking myself if “tapering” is real or not. Certainly the main issue for Deutsche Bank is not only related to the US fine. Of course it counts, but the problem here is not only the solvability of the German biggest lender, rather than growing concerns about the profitability of the entire financial system. Indeed no matter if the tapering is real or not, a more steepened curve is decisive for the survivorship of the insurance companies and for the banks.Otherwise a change in their historical business model is necessary. At the moment they can only declare the aim to reduce their cost structure, by cutting the number of employees.

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