Food for thought

Financial markets always take the least expected route....

EURCHF intervention closer?

Yesterday I posted my view about the intervention treat on the EURCHF and I also explained that if I was the SNB I would let the pair cross the 1.20 mark and intervene from below to be more effective. Apparently I am really a minority voice on this issue: today @DRodriguezFX  posted this picture on Twitter (many thanks!):

....

Economic updates: Italy and Canada

A quick look at the latest economic releases out from Italy ( when I published this article about the Italian 20 years cycle of financial crises I promised to keep you updated on the Italian Economy). As you know without growth the painful fiscal adjustment process undergoing in Italy may result in a useless exercise. In my opinion if Italy goes so does the Euro so the Italian credit market must be closely tracked.
The latest economic figures out from Italy now: January Service and Manufacturing confidence surveys both points to a deteriorating economic picture and unemployment is raising (see charts below).

Service sector (above) retail sector (below) Business confidence survey Jan 2012

Knocking at SNB doors: Swiss Franc floor tested

Knock Knock ....Mr Market is knocking at SNB' doors (today 1.2042 given on EUR/CHF ).

That the EUR/CHF could test the 1.20 floor following the resignation of Philipp Hildebrand was to be expected  and here we are now: less obvious (perhaps) is what's gonna happen now.

Friday evening

Another solar flare from Sunspot 1402, few minutes ago: this one is really big:  a class X2.  Fortunately Sun Spot 1402 does no longer face directly the Earth so the upcoming geomagnetic storm will not be so severe and the market may be spared another time. Nevertheless I remain in "risk off" mode for the week-end...

By the way Earthquakes are also likely with this kind of solar activity ( I think there is a connection between the two phenomena): there was one in North of Italy (the second in a 48 hours) M5.4 ...the windows of my office trembled for few seconds....no major damages thanks God. We are not used to this stuff int his area, a rare event.

Less about astrophysics and more about the markets next week....time to rest now: have a nice week-end!

Wednesday post FOMC update

Yesterday geomagnetic storm was a moderate G1 class, however the "panic buying" mode we saw today on the market is consistent with increasing emotional participation and in these situations fear can return just as quickly. Risk is not "off" for me....note in the chart below how the daily range is already increasing while the VIX is forming an hammer and stocks are running in long term resistance on a weekly chart up against a 5 year bearish trend-line from the 2007 top. In this early part of 2012 the stock market and risky assets in general are climbing the proverbial wall of worry but that should not make you think that they are immune from reversal of fortunes. Volatility could return any moment and the nature of the upcoming price reaction will tell us more about what to expect next, it may result in a moderate correction foreshadowing additional recovery later or it may provide us with an early warning signal for later.

The geomagnetic storm was weak but an uptick in volatility should be expected since emotions are running high and the daily range is already increasing.....

VIX candlestick tentatively forming an hammer re-gaining its BB bands

SPX on a weekly resistance (the last one...)

Tuesday Closing Update and Geomagnetic Storm Warning

A strong geomagnetic storm is ongoing since a CME hit our geomagnetic field earlier today:

Induced Ground Current in Lofoton Norway courtesy of Rob Stammes

Courtesy of NASA

 What all this has to do with the stock market? My opinion: look at the chart below it is self explanatory...there is a recurring pattern since last year (it has not always been so).

I expect an increase of volatility in the upcoming days this time again. 

You can track this stuff as usual with my solar monitor page.

Monday quick update

Last Thursday we warned that a solar flare was expected to hit our geomagnetic field causing a geomagnetic storm during the weekend and that this event could bring some volatility back, eventually.
The Geomagnetic storm hit Monday early Morning UT (Sunday late night ET):

Not surprisingly the VIX gapped higher early this morning:

Vix closed at 18% on Friday and opened at 19% this morning

Another Solar Flare was unleashed today and it should get here late tomorrow or the next day....

Now, I do not know if this is going to be enough to reverse the risk appetite that is driving risky assets higher since the beginning of the year, I honestly did not expect this strength: I expected the SPX to find more resistance in the 1290/1300 but here we are with the ES at 1313 advancing with no volume and with every small dip being bought systematically. Most of  the reasons for me to be skeptical are still there yet the market inches higher .....we are still in a reversal time window and perhaps today's early selling is the beginning of something ...

ECB update: Deposit facility climbing back toward the 500B mark and current account 30% higher than required....European banks do not really seem in a hurry to put their cash at work...I continue to think they know something we do not know. If they do not trust each other why should we trust them?

Credit Market: today credit was leading the spy in my convergence model

Over the last three days Credit has catch up with stocks filling a 1 month gap of under-performance:

On longer time frames stocks still look expensive vs credit in my model.

Market Closing Notes

Ending a long streak of inactivity today a Sunspot (n 1401) erupted releasing a M3 class solar flare directed toward the Earth: it may cause a geomagnetic storm over the next 48 hours. Two things to be noted here: when  the solar flare was released the SPY topped. Remember that increasing solar activity (beyond certain levels) is associated with increased volatility and if the Sun surface wakes up we may see more fireworks ahead (see chart below). Also the Sun is squaring Jupiter and Saturn from a geocentric point of view with Mars about to turn retrograde making the the time window from today to next few days a good candidate for a reversal.

Liquidity Flood

Some of you may wonder what's going on? During the last 24 hours it' s all "risk on" mode across the board.
That's a because of the liquidity flood from the ECB effective yesterday the Reserve requirement was lowered to 1% freeing some 100B Euros and today the Deposit Facility is also 100B lower than yesterday. This flood of liquidity is creating the perception that all is fine and the worse is beyond us. Wrong: it's just liquidity improving spreads and financing conditions from a very bad situation creating some sense of relief.

Deposits Dynamic and Reserves Coefficient Drop

Looking at the latest Bank of Italy data (Nov11 from the BOI January 2012 Statistical Bulletin) the Italian Banking System is still slowly loosing deposits:

Italian  Banks Liabilities with Italian Residents: Total Deposits (Residents) in Blue, Checking account in black dashed (red is banks' own corporate bonds)

In Italy the bleeding is slow so far but in Greece it look restless: 

Greek Total Deposits

Greek Total deposits % change

Greek Households deposits stock

In the meantime the ECB is doing all it can to prevent the meltdown: the upcoming reduction in the minimum reserve requirement rate is expected to free additional cash/liquidity  in the banking system ...the reserve requirement drops to 1% from 2% TODAY! There is not a lot of comments about this last ECB extraordinary measure....strange ... personally I think this is huge.

 Banks will no doubt like the more relaxed reserve requirements......depositors would probably like to see an INCREASE in the reserve requirement rather than a reduction  to feel safer...... 

In any case....the Deposit Facility usage hit another record today (it stands at 528B today): the more cash they give to the bank the more they deposit back to the ECB....what do they know that we do not know?

 1 year Yield on Greek government bonds this morning is around 420%.....the market is telling us that the real haircut will be around 70% ...how many chances that find a voluntary agreement at 50%....if that was true everybody would be buying this paper:

1y Greek Government Bond yield

Do not worry they will keep saying "it is all going to be fine".

Behind the scenes

By looking at the recent price/volume patter of the ES March contract it would seem that higher prices are used to unload stocks....signs of distribution and slowly deteriorating technical picture despite the price advances.

Note the volume bars pattern: the higher the prices go the smaller the green buying volume

RSP lagging SPY: fewer stocks participating 

and finally: European Banks still hoarding cash at 0.25% overnight (more than 500 B).... what do they know that we do not know?

Still feeling suspicious here.

Weekly closing roundup

Today we got what we were waiting for: the first sign of technical weakness of some sort after the strong start of the year. Today I focused my attention on the initial sell off with  increasing volume: the afternoon volume-less squeeze to me is more a confirmation than a reversal of the initial move. The charts that I am going to post below point to a deteriorating  short term technical picture: the first signs that bears may soon take control of the market.

ES March contract: eventually rising volume on red candles

AUDUSD still "triangulating"...non confirmation

Copper (usually tricky) upside breakout 

USDCAD still "triangulating"...non confirmation

XLB looks like a breakout but need more time above the red line to be confirmed

Credit looking a bit stretched

As you must have noticed on the above charts currencies and credit look less exuberant than stocks and copper and I trust more the FX market in these situations of non confirmation.

EURCHF

Do not forget to read my post about the Swiss Franc Peg and to vote in my personal EURCHF poll (top corner, right column of the blog): I think that I will post follow-through comments to the Swiss peg (or floor if you like) because I notice it draw a lot of attention (increasing website traffic).... by the way: today the SNB reported some preliminary figures for its 2011 results (for those of you who did not know this: the SNB is listed on the Swiss Exchange and its stock price is probably the best barometer for the peg).

SNB stock charts from the Swiss Exchange

According to these preliminary results it looks like the SNB made approximately 8 Billions CHF on its"FX trading" (they lost 26B in 2010): can't wait the final results in March/April to get more information...my preliminary thoughts are that they must have an average cost around 1.16 EUR/CHF but there is a margin of uncertainty because we do not know the exact breakdown of the reserves by currencies and more importantly we do not know how much exposure and p&l is the result of derivatives position. Since most of their FX reserves is invested in Euro Bonds it will also be interesting to learn more details about the country allocation (I doubt we will get this kind of details). Irony of the day: the same day that they make public their Fx trading performance for 2011 with the stock price raising in response we have S&P downgrading half Europe and spoiling the party.....tToday the EURCHF rate touched its lowest level since September of 2011 at 1.206 and I expect that the SNB will soon fire some ballistic missile if we get closer to 1.20 just to make sure to remind us that Mr Jordan is still "utmostly determinate" to defend his creature.

CHART OF THE WEEK
Outlook of the 50% haircut "voluntary exchange" of Greek government bonds? Today the IIF decided to take a "pause for reflection" : read the press release here ...or alternatively just take a look at the chart below and do some math .....1year yields on Greek government bonds traded above 400% this week.

Chart Courtesy of Bloomberg

The market is telling us that the haircut should be closer to 70/80%... the fact that the IMF and ECB  get 100%  make all this  really unreal... anyway: more talks next week accordingly to a Reuters article 

In the meantime the Greek default is getting closer: from Zerohedge: "Greek debt likely unsustainable even with haircuts".

Have a nice week-end! 

EURCHF: Swiss Franc Peg with Euro an analysis

The recent resignation of SNB chief Hildebrand has drawn attention back to the EURCHF peg. Is the EURCHF peg sustainable? Is it credible? Will it last? Does it make sense? I will try to answer to these questions with the classic WSW approach: macroeconomics analysis, cycle analysis and traders' common sense (something that central bankers often seem to have lost on their way...) .
Having worked for an hedge fund in Switzerland some years ago and living just 30 minutes driving from Switzerland provides me with a particular perspective: if anything I have a good feeling of "real-life" purchasing power parities... something you can only have if you live close to a border.
Where do we start with this analysis?
Let's first read what the SNB has to say about the CHF  (from the last SNB quarterly bullettin):

 "..Even at the minimum exchange rate of CHF 1.20 per euro, the Swiss franc is still high, and should continue to weaken..."

.....

from the SNB 3/11 quarterly bullettin

The SNB couldn't be clearer than this: they think that Swiss Franc is overvalued and they are ready to defend the 1.20 EURCHF rate with the utmost determination. What else could they say having spent a fortune to buy these Euros.....? Now,  regardless of the name of the successor to the resigned SNB chief Hildebrand, I asked myself if all this make sense and if it is credible.....

Fist of all I wanted to understand if the CHF is really so overvalued (vs. the Euro) in nominal terms and more importantly in real terms. As far as the nominal EURCHF rate is concerned (chart below) the 10 years moving average is 1.499 or some 25% higher that today (EURCHF=1.21) : a 25% nominal appreciation in 10 years is not really a shocking number to me (it seems a lot if you look at the chart of the last 12 months but if you consider it on a 10 years long perspective it starts to look a different story).

EURCHF weekly chart last 10 years: this pair is just 25% below its 10 years moving average.

Now what do you think of this 25% nominal appreciation of the CHF if I tell you that during the last ten years the Eurozone cumulated inflation rate was 15% higher than the Switzerland accumulated inflation rate over the same period? That simply means that in real terms the CHF appreciation versus the Euro is just 10%.
Which data did I use? I downloaded the Annual rate of inflation from the ECB website for the Eurozone and I used the S. Louis Fed database for the Swiss annual inflation rate. The 2011 final inflation number is an estimate (see table below).

If these are the data why all this noise about the Swiss Franc being so overvalued? 10% is not 40% in my book. But these data seem really out of consensus if you think that all Cost of Living standard measures show that Switzerland is 40% more expensive than Europe. There is something missing here: either I am badly wrong or the Cost of Living indexes miss something important. Just to make sure that you have a complete picture, below I show you the Eurostat last survey of comparative price levels in Europe for 2010: 

Source: Eurostat

Eurostat and the SNB say that the CHF is hugely overvalued on the contrary I only see a 25% nominal appreciation of the Franc against the Euro with a cumulative 15% lower inflation rate (bringing the total in real terms to a modest 10% real appreciation). There seems to be a contradiction in all this....I had to dig deeper and I found out that the Swiss disposable income was 35% higher than the Euro zone one in year 2000 and it was 45% higher in year 2010 (OECD data see table below).

OECD data in USD

The disposable income data tell me that the Swiss are 45% richer than their average European neighbors (they were 35% richer 10 years ago), they have better standards of livings and their average cost of living is higher now as it has always been for the past 10 years. Prices have not surged in Switzerland, they are growing less than in Europe ...you cannot simply say that the CHF is overvalued because a big mac costs 40% more in Switzerland than in Europe....it has been like that for the last 10 years and the recent CHF strength has only marginally increased the difference between the cost of living in Switzerland and in Europe. All this is to say that the Swiss economy may well still be competitive with the EURCHF at 1.2 and that the real loss of competitiveness due to the appreciation of the Swiss Franc versus the Euro is closer to 10% than to the 40% that some over simplistic PPP comparison may suggest. 

Obviously when the EURCHF reached parity last summer the loss of competitiveness was more serious than now, but the SNB intervention and the natural supply and demand forces reducing the Swiss domestic inflation (EU inflation is rising faster while Swiss inflation is turning negative) have restored a more balanced situation. 

Any analysis of the sustainability of the EURCHF peg  should start from the above assessment of the Swiss economy competitiveness at 1.20 EURCHF rate. My take is that at 1.20 the Swiss Franc is only slightly overvalued   ( approximately 10%).  

Over the last few months the Swiss economy has slowed down (see charts below) only slightly more than the EU economy:  

OECD data composite leading indicators

The above charts makes me think that the Swiss economy is probably slowing because the European economy is slowing rather than because the CHF is too overvalued .

Now some anecdotal evidence: I  live very close to the Swiss border with Italy and I do not see queues of Swiss cars waiting to enter in Italy to buy cheap goods, on the contrary I see queues of Italians cars waiting to enter in Switzerland to refuel unleaded gasoline at 1.7 CHF/liter ( in Italy 1 liter of unleaded gasoline is now 1.8 Euro/liter courtesy of the last VAT hike).

If I am right in my assessment, the SNB has stepped in drawing a line in the sand to defend the EURCHF 1.20 floor picking a level that probably reflect a modest 10% overvaluation of the Franc....I mean... offering to the market unlimited quantities of Swiss Franc which are only 10% richer than their fair value is a dangerous bet as I see it. The market will see 1.2 a cheap price to pay for Swiss Francs/safety if things get worse in Europe.

Now the interesting part of the equation: is the SNB treat to print unlimited quantities of Swiss Franc and defend the peg with "utmost determination" credible? To answer this questions we need to do some math and we will do soon, but first let me say something more general here: the free market system make sure that imbalances are corrected by demand and supply shifts, in case of a nominal overvaluation of a currency the domestic prices and wages tend to adjust to reduce the real exchange rate and this process was at work in Switzerland as well: now as usual, central bankers pretend to control the market distorting the natural supply and demand dynamics....usually (sooner or later) they get in trouble when they do this.

Now let's make some calculation and  a stress test for this 1.20 peg: (I mean a real stress test) assuming for example that a major Italian bank goes under, not one of the soft stress tests that bankers do to please their regulators. What I want to try to estimate is how many billions of Swiss Franc demand can generate a major bank failure and ultimately if printing a corresponding amount of Swiss Franc by the SNB would make its foreign reserve still manageable.  First let's take a look at the latest figures about the SNB balance sheet:

SNB monetary statistics Nov 2011

As you can see they have increased their foreign currencies reserves (bought Euros printing Swiss Franc) by 83 billions Francs (from January to November 2011) for an economy with a GDP of 550 Billions Franc that is roughly 15% of the whole GDP and more interestingly the outstanding amount of foreign exchange reserve is now 336 billions franc or 61% of the Swiss GDP . The outstanding amount of foreign exchange reserves is 36% of the Swiss M3,...to put it into perspective think about the Hong Kong dollar currency peg: the HKMA has absorbed a steady flow of foreign currencies over the last few years and has an unmatched reputation when it comes to defend a peg (the Hong Kong currency peg has survived all the major financial crisis of the last 20 years) well the total foreign currency reserves assets of the HKMA stand at 282 billions USD or 55% of Hong Kong M3 and 125% of its GDP. 

The Hong Kong example could serve as an indicator of how much the foreign reserve can increase relative to the GDP and to the other monetary aggregates, with one  important CAVEAT: the Hong Kong economy is much more flexible than the Swiss economy with higher wage elasticity. The HKD peg has absorbed well both inflation and deflation shocks over the years ...the same thing cannot be said in the Swiss case for a currency peg with a 5 months track record and with its chief architect who has just resigned....

Anyway we now know that the reserves could grow more than a country GDP, but we do not know what that would mean in terms of impact on prices for the Swiss economy which is less flexible than the Hong Kong one, moreover  what if the reserve increase is very rapid? The Hong Kong reserves stock has been accumulated over many years, not in just few months. Should the foreign currencies reserves of the SNB grow so rapidly one would really start to question if that is sustainable....if I was the SNB I would already be very scared  and probably 50/70 billions more would make me feel on the edge: but I am not the SNB.

What kind of event could possibly create such short term demand of Swiss Franc? 

What kind of financial tsunami would  make the SNB printing presses over heated and possibly at risk of running out of ink? Now comes the scary part of the analysis:  you do not need a "financial Armageddon" to instantly create demand for hundred bilions worth of Swiss Franc in my opinion...I think that failure of just one major European bank would be enough. Think about the size of the European banks:  one major Italian bank (I will not name it) has approximately 450 Billions Euro worth of deposits (or 540 billions CHF): what if a bank like this goes under....wouldn't it instantly create at least 50 billions worth of Swiss Franc demand? I can imagine the queues at the Swiss/Italian border of desperate people trying to physically take their savings in Switzerland. See this is really a stress test: one that is based on a really stressful situation or dangerous event. I am not talking of chain banking failures or Euro breakdown...I am just talking of a single major bank going under, an event that could raise the fear level so much that some kind of bank run takes place on the border with Switzerland. Not such a remote scenario these days.
It does not take a rocket scientist to figure the size of the liabilities of the banking system in Europe when you know that the ECB current account size ( covering the 2% reserve requirement) if around 200 billions Euro. What if 1% of the deposits of the European banks fly to Switzerland? Greek and Italian deposits have already started to move ....

Negative growth of Italian Checking Accounts (Bank of Italy data)

To me the SNB is playing with fire, their "utmost determination"  is enough for normal condition but may well backfire should things get worse in Europe. Readers of WSW knows that there is a powerful 20 years cycle coming due soon for Italy  and we all know that Greece may go under in March or later this year....I thinks that this beg has good chances to go under, if not in March probably this summer.

Sometimes I wonder if the central bankers make "worst case scenario analysis", something that every normal FX trader would do:  "what if my position is wrong and the mkt goes the other way...?" 

If 1.20 EURCHF goes how much can the SNB loose on a 336 Billions (size as of now) fx position?

What if the EURCHF control is lost and it goes to parity again because demand is simply too much to be met with all the available printing presses?  

What if there is  a 15% or 20% loss to be marked to market on such a huge position? 

What are they going to tell to the Swiss people if such loss would materialize? The Swiss Franc is supposed to store the purchasing power of the Swiss people and print Swiss Francs to buy trashy Euros risking to loose money in the process is probably not the most intuitive way to store the purchasing power.
I am not surprised of all the noise about Hildebrand resignation.....there are billions at stake here, it is probably not only about his wife small trades in my opinion. On the contrary I was surprised that the market consensus almost immediately focus on Thomas Jordan (interim president and strong advocate of the peg) as most likely successor ....but yesterday the Swiss Government said that it may take months to find a successor (story here): to me it looks like someone else is doing the math in Switzerland. And the succession game if far from over as I see it. Going against the SNB is probably a good way to loose money in the short term and it is a sure way of loosing money should the "status quo" continue...but, a black swan  (not so black after all) event can easily change the odds and when the time comes when nobody know how to hedge risk, well you can count on the SNB printing unlimited Swiss Francs at 1.20: this is far better than the old famous "Bernanke put".

By the way: what are the other central banks doing? Printing Euros and printing USD (take a look at the chart below with the latest data in Billions available):

ECB and FED balance sheets in billions Euro and USD

The ECB alone has increase its balance sheet by 500 billions Euro over the last 12 month and it will continue...it does not seem to me a prudent exercise to engage into a print war with these "printing specialists"...in the meantime the ECB long term refinancing operation LTRO has been used by European banks to hoard cash :

European banks are not using cheap ECB money to buy European Government Bonds  or to lend money (as somebody hoped): they are hording it. If I could access this cheap ECB money I would seriously consider to buy some Swiss Francs....

Approximately 2% of this blog audience is from Switzerland: I welcome comments and feedback from our Swiss friends, they may well be more in touch than me with the feeling of the Swiss people with this issue: by the way by no means I intend to sound disrespectful of their institutions with this post, having worked in Switzerland I have learned to appreciate the Swiss way of doing things  and one day I would like to find a nice job there and go back there rather than living in the EU which continues to disappoint me!