Thursday, December 15, 2016

Call # 1 : Long Position in the Germany’s Stock Index - DAX

The loose fiscal policy announced by Donald  Trump, increasing expenditures and cutting taxes, will increase the US public deficit and will require an increase in the supply of bonds by the Treasury,  that will steepen the yield curve in the USA. This policy would be implemented in an economy that is close to full employment, with little or no slack, with obvious inflationary consequences.

This, in turn, would lead to a tighter monetary policy by the FED, as announced yesterday . The increase in US interest rates, combined with an accommodative monetary policies in most of the G7 countries, is leading to an appreciation of the dollar. Besides that, we can observe positive impacts on economies highly dependent on exports like Germany. 

For all the above reasons, we believe that the DAX index will reflect this and so our call is a long position today at the level of 11.300 points.

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Mr Trump and the US Stock Market

Ever since Donald Trump's election in early November, markets have clearly understood the impacts of its announced expansionary fiscal policy. Its intention to stimulate economic activity through a tax cuts and increase of expenses, will certainly raise the need for public sector financing. This, in turn, will induce an increase in bond sales, increasing long interest rates, a phenomenon already seen In the behavior of the yield curve. This movement, in turn, led to an appreciation of the dollar against other strong currencies, magnified by accommodative monetary policies in the Euro Zone, UK and Japan. It is important to mention that the Fed's action on the basic interest rate amplifies this trend.

The stock market is, however, still with a lot of uncertainty and where we have many questions. If there was great certainty at this time that the new Treasury Secretary's goal of doubling the current GDP growth rate would be achieved, the major stock indexes would have already risen more consistently. What are the factors that are triggering this question?

The basis of Trump's policy lies in the Keynesian belief that the government, through expansionist policies and its multipliers, manages to expand GDP unequivocally. This result, however, does not reproduce with such certainty if examined in the light of modern or stochastic macroeconomics, based on the hypothesis of rational expectations, where the expansionist effect will only happen if the government is able to "surprise" the agents.

In the US case, it is possible that such an effect occurs. This is so because the agents' information set is not as sharp as it is in other parts of the world, where people are more used to this type of policy. In Brazil, for example, which has just gone through an unsuccessful experience, recently the announcement of such an attempt would certainly cause disappointment and not euphoria.

Thus, although it is possible for a stock market to observe a boom in the US in the beginning of Trump government, in the medium term, if the announced "mix" is maintained and protectionist practices are adopted, the outlook is not encouraging.

Thursday, July 25, 2013

All That Is Solid Melts in the Air: The End of the Quantitative Easing (QE) Policy in the United States

In early 2010 when Bernanke came out to announce QE2, our main concern was the future impacts on inflation, assuming that QE meant an increase in base money due to an increase in M1. However, we were all wrong. Bernanke and the US Fed did not implement the so-called ‘traditional’ QE, the one we have observed in U.K. or Japan. In both countries, QE works through the purchase of long term bonds and the sale of money supply in its mostly liquid form – what we call M1. 

In contrast, the United States Central Bank decided to take the risk free route. The US QE (except for Q1, that lasts from October 2008 – through mid 2009) basically is a tool to shift expectations without producing, by its own actions, any real effects. This means that on the one hand the Fed purchases (QE2 and QE3) securities (with amounts and durations previously announced) and on the other hand it takes that extra M1 out of circulation by paying commercial banks interest rates on excess reserves. In turn, the extra amount of money going into the system is withdrawn because banks would rather lend at 0.25% to the Fed than lend to the public at a similar rate with the chance of not being paid back.

But then readers will ask: so why is the Fed doing such policy? In our view, this is the safest policy one can ever implement. The ‘classic’ quantitative easing policy carries lots of negative impacts. It may produce growth but at a cost of greater future inflation in the future. Besides, if the Central Bank keeps the securities up to maturity it means it is monetizing the debt. And, unless the system is under a depression with deflation, deficit monetization is highly inflationary.

To his credit, Bernanke is by far the most knowledgeable scholar on previous QE experiences. However, the ongoing US QE has never been implemented elsewhere before. The point we are trying to make is that the Fed is trying with the ‘unconventional QE’ to influence expectations. In other words, the growth registered in the US since 2009, the decrease in unemployment, the improvement in industrial production and the greater consumption has been highly influenced by the Fed’s policy. This means that when such policy indeed comes to an end it is possible that we observe a reversal of the ongoing recover. A policy that is solely based on expectations is not capable to produce long lasting real effects. The end is near, however, not because of unemployment (that is resilient and almost not influenced by expectations) but mostly due to core inflation that has already reached 2%. As Bernanke recently explained the 2% is a threshold, not a trigger. So, they may bear high inflation and low growth when ‘unconventional QE’ comes to an end.

A very powerful lesson from Economics is one that says: “there is no such a thing as a free lunch”. Maybe it is attributed to Friedman but the fact is that all economic decisions involve a trade-off. In the ‘unconventional QE’ policy there is no trade off. It is a win-win situation. This is so because the US QE has been able to produce growth without leading to too much inflation. It is also true that the US is the only country, on earth, that even with the greatest financial crisis of the 21st century has been able to display positive growth rates since 2010. It remains to be seen if such performance will sustainable without producing inflation or high unemployment. 

We should not dare to challenge economic theory. Trade-offs will continue to exist till the end of times. Hence, some type of trade off will occur in the US economy. The Fed could have chosen to bear the costs (hence the trade-off) in the early days when QE was first introduced, like Japan and UK. But it chose to postpone. Hence, what we may observe in a very near future is an increase in inflation, a decrease in growth with unemployment unable to achieve levels lower than the current ones (around 7%). In brief, the US QE is what Marx & Engels and later Marshall Berman coined ‘all that is solid melts in the air’ in an allusion about the contradictions of capitalism and the fact that it had lost its ways.

Sunday, July 22, 2012

"Desejos" por Victor Hugo

Desejo primeiro que você ame,E que amando, também seja amado.

E que se não for, seja breve em esquecer.

E que esquecendo, não guarde mágoa.

Desejo, pois, que não seja assim,

Mas se for, saiba ser sem desesperar.

Desejo também que tenha amigos, que mesmo maus e inconseqüentes,

Sejam corajosos e fiéis,

E que pelo menos num deles

Você possa confiar sem duvidar.

E porque a vida é assim,

Desejo ainda que você tenha inimigos. nem muitos, nem poucos,

Mas na medida exata para que, algumas vezes,

Você se interpele a respeito

De suas próprias certezas.

E que entre eles, haja pelo menos um que seja justo,

Para que você não se sinta demasiado seguro.

Desejo depois que você seja útil,

Mas não insubstituível.

E que nos maus momentos,

Quando não restar mais nada,

Essa utilidade seja suficiente para manter você de pé.

Desejo ainda que você seja tolerante,

Não com os que erram pouco, porque isso é fácil,

Mas com os que erram muito e irremediavelmente,

E que fazendo bom uso dessa tolerância,

Você sirva de exemplo aos outros.

Desejo que você, sendo jovem,

Não amadureça depressa demais,

E que sendo maduro, não insista em rejuvenescer

E que sendo velho, não se dedique ao desespero.

Porque cada idade tem o seu prazer e a sua dor e

É preciso deixar que eles escorram por entre nós.

Desejo por sinal que você seja triste,

Não o ano todo, mas apenas um dia.

Mas que nesse dia descubra

Que o riso diário é bom,

O riso habitual é insosso e o riso constante é insano.

Desejo que você descubra ,

Com o máximo de urgência,

Acima e a respeito de tudo, que existem oprimidos,

Injustiçados e infelizes, e que estão à sua volta.

Desejo ainda que você afague um gato,

Alimente um cuco e ouça o joão-de-barro

Erguer triunfante o seu canto matinal

Porque, assim, você se sentirá bem por nada.

Desejo também que você plante uma semente,

Por mais minúscula que seja,

E acompanhe o seu crescimento,

Para que você saiba de quantas

Muitas vidas é feita uma árvore.

Desejo, outrossim, que você tenha dinheiro,

Porque é preciso ser prático.

E que pelo menos uma vez por ano

Coloque um pouco dele

Na sua frente e diga "Isso é meu",

Só para que fique bem claro quem é o dono de quem.

Desejo também que nenhum de seus afetos morra,

Por ele e por você,

Mas que se morrer, você possa chorar

Sem se lamentar e sofrer sem se culpar.

Desejo por fim que você sendo homem,

Tenha uma boa mulher,

E que sendo mulher,

Tenha um bom homem

E que se amem hoje, amanhã e nos dias seguintes,

E quando estiverem exaustos e sorridentes,

Ainda haja amor para recomeçar.

E se tudo isso acontecer,

Não tenho mais nada a te desejar ".

Thursday, June 14, 2012

US Quantitative Easing for Europe

The QE policy is done primarily to weaken the USD through the purchase of treasury securities. These bonds will shift the yield curve downwards, decreasing the yield. 

We have seen that the FED has been reluctant to implement another round of QE. However, since the FOMC meeting on April 25 the yield on the 10 year bond increased by 36 bp and the S&P decreased by 4.8%. People are buying bonds as a safe haven and as a way of profiting by selling the notes to the FED if QE3 indeed happens. 

The labor market data in the US has weakened. Unemployment increased, payrolls increased, jobless claims increased and retail sales were simply modest.

So any data to be released that is bad is interpreted by the market as an increase in the probability of QE. The need for QE was said by Yellen.

People are buying bonds. So, yesterday we had the weekly auction for the 10 year bond. The outcome was in line with expectations. Indeed, they sold 21 billion, with a bid/cover ratio of 3.06 and a yield of 1.62%, an increase compared to the last one when the yield reached 1.85%.

People are buying treasuries because if there is a QE they will profit from selling to the government. So, US treasuries remain a safe haven.

In Europe the situation hasn’t changed much. Today we had an auction by Italy who sold 3 year papers for 3.92% compared to 2.75% of the previous auctions.

On Sunday Spain receive a loan from the EU in the amount of 95 bn. The IMF reported that  the financial system corresponds to 275% of Spain GDP.

Bottom line: QE will not help weaken the dollar primarily because the European crisis is getting worse. The only way it will weaken the USD is if the crisis is solved.
Just take a look at the latest IMF report on Spain and answer if we are in a crisis or not:

Sunday, August 1, 2010

On Europe and US - Market Conditions

After my last post on the stress test i must confess i was gladly surprised with the quality of the stress tests. The methodology was uniform, the tests were rigorous enough and still a few banks failed.

Ever since July 23, Europe has been posting positive news. Either from the countries themselves - UK registering unexpected high growth and Germany with increasing confidence - or from the market itself. The Euro that has sanked to levels close to 1.15 dollars, has reached 1.31 last Friday.

On the US side, we had the release of the Q2 GDP. In turn, the US economy grew 2.4% from Q1 to Q2, on a annualized base. The ´so-called' market consensus was forecasting 2.5% for Q2. In any case, growth in the first quarter was revised up to 3.7%, meaning that growth has averaged over 3% for the first half of 2010. The comprehensive data revisions released with the report provide further evidence of just how severe the recession has been: the fall in GDP between 2007:Q4 and 2009:Q2 was 4.1%, making this the deepest recession since 1947.

According to Romer:
"The data revisions, together with recent estimates, also provide some important new information about longer-run trends. Revisions to both personal income and consumer spending have led to estimates of the personal saving rate in 2008 and 2009 that are substantially higher than previously reported. The average saving rate in 2009, for example, is now 5.9%, 1.7 percentage points higher than previously reported. In 2010:Q2, the saving rate is 6.2%. This higher saving rate is consistent with estimates reported in the Economic Report of the President of likely consumer behavior in the wake of the financial crisis. The higher level also suggests that there is room for further consumer spending growth as consumers become more confident, without returning to the very low saving rates of the past decade.

The revised data also indicate that productivity growth in 2008 and 2009 has averaged roughly 3%, slightly above the average from 1995 to 2007. Productivity growth fell sharply in 2008 (now estimated at an annual rate of -0.3%) and rose even more sharply in 2009 (at an annual rate of 6.3%). That the average over the recession and the first stages of recovery is equal to the historical average could suggest that the financial crisis has not damaged productivity growth (as some have argued)."

The Scenario for The First Week Of August
As of now, we believe that the market might observe an upward trend for August. In Europe there are a bunch of outstanding news regarding the fiscal austerity packages, the increase in confidence, the higher than expected growth in large countries like Germany. Also, we notice that the fear of the Greek sovereign default is finally gone for good.

In the US, the good news is more related to the GDP. Even if the GDP is a lagged indicator it is displaying that the economy is recovering. One might say that Q3 and Q4 are not going to be as good as Q2. However, the point is that people are already pricing this information whereas the Q2 info was not known by the market.

If you are in the market my call is to buy S & P or BMF. Have a good week!

Wednesday, July 21, 2010

A Quick Take On The European Stress Test

It has been a while since my last post.

I am always thinking that i should write on the two themes that i am following closely - Europe and the financial reform in the US. But then as I read my fellow bloggers - Rebecca Wilder, Mark Thoma, Yves Smith, Simon Johnson and James Kwak and so many others, I realize i have very little to add to the debate.

This time i think i might be adding something new, i guess. The core of this post is on the stress test. Enjoy!

The idea of the stress is to measure the banks’ performance in times of a recession combined with a sovereign crisis. Indeed, according to the Committee of European Banking Supervisors site also assumes an adverse scenario that leads to a hike in interest rates leading to a deterioration in the EU bond markets. This scenario assumes a 3% deviation of GDP for the EU compared to the EC forecasts over two years horizon.

Clearly, the idea of the European stress test, organized by the CEBS, is to be sure that banks have enough buffers to support a significant downward turn. It seems that it is only stress test equity tier 1 capital, not something else.

The list with all the banks that are being tested can be found here.

The market is signaling two important things. First, it will equally bad if all banks fail or if all banks pass. Clearly, neither scenario couldn´t be farther from the truth. Second, the Euro will get a boost of credibility mostly if there is transparency in the process.

While we hope for the best regarding the outcome of the tests, it seems that we might have a few critical problems. The major problem is that the CEBS announced that there is no need for countries to release the methodology of the tests. So, it may be the case that all Greek banks can pass the test according to the Greek methodology but fail under the German one, for example. How can we compare apples with oranges? By not having a unified methodology the CEBS is saying that the same countries that run a unified currency – the Euro – are so different income wise, GDP wise, trade wise, labor wise, tax wise, that they cannot bear the same methodology under a stress test. The question then comes: Why should countries that have different criteria for stress tests carry the same currency?

Bear in mind that countries are not required to release the methodology. But I hope regulators are aware that the key goal of this test is to enhance the Euro’s credibility and hence the more transparent it is, the more credible it gets.

The second problem with the Friday outcome is that there is no consensus on how a bank can get the required funding. So, for example, let´s it is indeed true that the nationalized Hypo Real Estate Holding AG failed the test. In this case it seems that the bank would need to raise capital in the market. Clearly, the bank will fail to raise the required capital. Then, it seems that the bank needs to ask for the local government. So, in the case Hypo Real Estate it would ask to be bailout by the German government. However, the missing aspect here is that it European Financial Stability Facility (EFSF) was created exactly to bail out the banks. The €440bn ($520bn) rescue package establishes a special purpose vehicle, backed by individual guarantees provided by all 19 member countries. But if the EFSF was created with the intent of bailing out the banks why can't member countries (and their commercial banks) access the funds right away?

In the United States one should remember that the outcome of the stress tests displayed a shattered financial system. No doubts in early 2009, the system was way better than September-October 2008 but far from being considered dynamic or healthy. However, in the US, the regulators were able to inject capital in the banks that failed the test. What would happen if the state banks in Germany and Spain fail the test? Will they be required to be shut down? In the US there was a strong consensus that the government was going to bail out those who fail the test. In Europe there is no such a guarantee.

I honestly cannot foresee a happy outcome for the European stress test. While people simply are no longer talking about Greece, Portugal, Spain and Ireland, I don´t think that the sovereign crisis experienced by Greece in May 2010 is gone for good. It is not true that what we have seen was simply a confidence crisis against the Euro and against Greece. While markets may remain calm for a while, the crisis we observed early this year displayed key problems and fragilities surrounding the Euro. Here are a few obstacles of the Euro zone: the fact that countries have high debt levels, that some countries chose to preserve the old ‘welfare state’ but also like to have a strong Euro, that the Eurozone will always have different labor costs, that the Euro lacks a unified fiscal stance and most of all, that it is impossible to group poor and rich countries under a single currency.