First Impressions

Avoiding Unintended Consequences
Gary DeWaal

Note: DeWaal has been serving as guest editor of the John Lothian Newsletter this week. This commentary originally appeared in today’s JLN.

Well this week went by very quickly. And now it’s time for me to step aside and let the Jedi Master, John Lothian, return next week to his rightful role as editor of this daily news publication.

However, I am able to discuss one more topic while here, and today it is “unintended consequences.”

If I have one wish involving our industry it is that lawmakers and regulators not simply impose new requirements based on the political hot potato du jour. Instead they should step back and consider any new proposed measure holistically and endeavor to anticipate how fixing one issue may inadvertently cause many more.

Time has already questioned (or at least Michael Lewis has) whether the way regulators encouraged the dispersion of equities trading among numerous venues, including dark pools, was the most effective way to enhance price discovery. Did yesterday’s effort to promote fairness pave the way for smart low latency traders to take advantage of physical laws to access some trading venues faster than others?

Time will also tell whether it was preferable post the 2008 financial crisis to concentrate in just a few global clearing houses what previously was dispersed counterparty credit risk from OTC swaps. Would a better solution have been to leave the credit risk dispersed, but mandate trade and price transparency; daily mark to markets; posting of collateral to support trades; and licensing and capital requirements for swap dealers?

Will the effort to promote customer safety by requiring FCMs to post their own funds to cover clients’ temporarily unmet margin calls in fact prompt FCMs to require at least some customers to post more funds with them and thus increase (not decrease) these customers’ exposure to their FCM?

Time will tell too, whether measures proposed internationally to slow down low latency trading, or to restrict the quantity of certain products permitted to be traded by certain market participants (i.e., through position limits) truly enhance liquidity and maintain narrow bid ask spreads.

Unfortunately lawmakers and regulators don’t have crystal balls, and can’t always predict whether measures they institute to correct one problem won’t create another. But this is why it’s important not just to consider the costs and benefits of each new proposed law or regulation, but also the likelihood that a proposed new rule will have a unanticipated detrimental impact on another area of regulatory concern. Only after it can be assessed that it is more likely than not that a new measure will not have such an extraneous unintended consequence, should the rule be implemented.

Otherwise, in just a few years, lawmakers and regulators may have to address still more unintended consequences (although it may give Michael Lewis plenty more opportunities to write more books).

Ok, enough of my musings. John, welcome back. Being an editor of a daily, comprehensive publication like The John Lothian Newsletter is a lot harder than it seems – particularly in a slow news week like this one! I am even more an admirer of yours (as well as your great team – thanks, gang!) after sitting in your seat for these past four days! I hope I have been a good apprentice! Carry on Obi-Wan!

Quote of the Day

Looking ahead, the banking system is likely to need access to a wider range of funding sources.

A joint ECB/Bank of England paper just released, as quoted in the WSJ story “ECB, Bank of England Outline Options to Boost Asset-Backed Securities Market”

Lead Stories

ECB, Bank of England Outline Options to Boost Asset-Backed Securities Market
Brian Blackstone – WSJ
The European Central Bank and Bank of England on Friday outlined options to reinvigorate the market for bundled bank loans, which was “tarnished” by the global financial crisis, saying a better-functioning market for asset-backed securities can help boost lending to the private sector, particularly small businesses.

***DA: Cautious investors? Perish the thought!

Big investors replace banks in $4.2tn repo market
Tracy Alloway in New York – Financial Times
Big investors, including hedge funds, mutual funds and real estate trusts, are replacing banks as the biggest users of the overnight funding market that played a key role in the financial crisis.

***DA: How long before they get put under the “systemically important” umbrella? Some already have been.

You’re All Whales in Bond Market Now With Trading Volume Slump
Lisa Abramowicz – Bloomberg
It’s getting easier for a smaller group of bulls in the U.S. Treasury market to create angst for the bears.
That’s because government-debt trading volumes have slumped to 18 percent below the decade-long average, Federal Reserve data show. As Brean Capital LLC’s Peter Tchir wrote this week: “There is no liquidity even in the mighty Treasury market.”

Pimco may be turning corner on money outflows – CEO
The world’s biggest bond fund, Pimco, may be about to end a net outflow of client funds that reached 22 billion euros ($30 billion) in the first quarter, its Chief Executive Douglas Hodge told a German newspaper.

Europe’s Bond Traders Face Overhaul Seen Stricter Than U.S.
John Glover – Bloomberg
The biggest transformation in the history of Europe’s $11.4 trillion corporate bond market has kicked off with dealers and investors asked to adopt changes even stricter than those that prompted upheaval on Wall Street more than a decade ago.
In its efforts to prevent a repeat of the financial crisis, the European Union is seeking to make the credit market more transparent by publicly disclosing bond-trading prices. Dealers are concerned they will suffer the fate of their U.S. counterparts after the introduction of the Trace bond-price reporting system in 2002, when a study found $1 billion in commissions were wiped out in the first year alone.

Shorts Squeezed as Treasuries Defy Forecasts: Chart of the Day
Liz Capo McCormick – Bloomberg
Betting on higher U.S. Treasury yields has proven to be a painful for bond traders.
The CHART OF THE DAY shows that hedge funds and other large speculators reduced net short positions by about half on the benchmark 10-year note since the end of last year, according to Commodity Futures Trading Commission data. Traders bailed out of bets that note prices would fall as yields tumbled even as the Federal Reserve was scaling back its bond-buying program.

Tranquil markets are enjoying too much of a good thing
Gillian Tett – Financial Times
Something peculiar is happening in western capital markets. This month almost every measure of volatility has tumbled to unusually low levels. If you look at the degree of actual (or “realised”) price swings – and projected (or “implied”) future movements – investors are behaving as if the world is utterly boring.

***DA: No interest, in more ways than one.

Second Verse, Same as the First
The Reformed Broker
To recap – Volatility is nowhere to be found – not in currencies, in fixed income or in equities. Complacency rules the day as investors and institutions gradually add more risk, using leverage and increasingly exotic vehicles to reach for diminishing returns in an aging bull market. This as economic growth – led by housing and consumer spending – stalls out and the Fed removes stimulus that never really worked in the first place.

***DA: If Herman’s Hermits’ Henry VIII is stuck in my brain I will have Joshua to blame.

Don’t assume newest Fed policymaker is a look-alike hawk
Jonathan Spicer – Reuters
The newest Federal Reserve policymaker is probably not as hawkish as her background suggests, and Loretta Mester’s expertise in financial markets and inflation could make a splash as the U.S. central bank reverses its most accommodative policy experiment ever.

***DA: Reverses? I think he means “takes a pause.”

Have bond investors become too big?
Louise Bowman – Euromoney Magazine
The biggest bond funds now dominate the market for good or ill. Just how much muscle they now wield in the primary market is, however, a matter of some dispute.

Super-Size Me: China’s ‘Mini’ Stimulus Starts Expanding
China’s so-called mini-stimulus is beginning to morph into something larger.
Nomura Holdings Inc. economists said measures including central bank loans for low-income housing are “starting to amount to something quite significant” as they scrapped their forecast for a second-quarter cut in banks’ reserve requirements. UBS AG said the government has gradually strengthened its mini-stimulus over the past couple of months and the central bank “has quietly eased liquidity conditions.”

Piketty Issues 4,400-Word Defense of His Book on Inequality
Rich Miller – Bloomberg
French economist Thomas Piketty published a detailed 4,400-word defense of his best-selling book on income inequality against allegations that he relied on faulty data.

***DA: I have yet to meet the economist who, when his or her data or conclusions are challenged, says “oops, my bad!”

Mom and Pop Investors Return to Municipal Bonds
Aaron Kuriloff – WSJ
Municipal-bond prices have come roaring back, reversing last year’s rout despite enduring financial challenges facing U.S. cities and states. The resurgence in the $3.7 trillion market comes as bond buyers attempt to find higher investment returns amid a tumble in U.S. interest rates.

***DA: Was the recent seloff wrong or just early?

Ah, I see we are firmly in the “what if QE fails” stage of the debate…
David Keohane – Financial Times
… and back on the “buy foreign bonds” option. Never mind the former might never happen, let alone happen when the ECB meets next week and does its best not to disappoint.

IFC bond aims to breathe life into Rwandan local debt market
Kanika Saigal – Euromoney Magazine
The Rwanda debt market has been given a boost after the successful issue of the International Finance Corporation’s first bond in Rwandan francs, but regulators face an uphill battle to nurture the fledgling bond market.

Central Banks

Fed’s George wants rate hikes soon, and not too gradual
Ann Saphir – Reuters
Kansas City Federal Reserve Bank President Esther George said Thursday she is open to leaving the U.S. central bank’s balance sheet big even as it withdraws accommodation, a comment that reveals the extent of uncertainty at the Fed over future policy.

***DA: Wouldn’t that force the Fed to take a loss on its portfolio?

US Fed seen sticking to range when hiking interest rates
Jonathan Spicer and Richard Leong – Reuters
Don’t count on the U.S. Federal Reserve to go back to a numerical bulls-eye to aim at when it finally decides to raise interest rates. A target range for the federal funds rate may well be here to stay, at least for the foreseeable future.

***DA: For some, the foreseeable future does not extend past next week.

RBI aims to manage redemption pressure with 14-year bond issue
For the first time this year, the Reserve Bank of India has introduced a new 14-year security in its weekly government bond sale due on Friday as it tries to reduce future redemption pressure after sizeable issues.

Mr. Draghi–Your Public Awaits
Tommy Stubbington – MoneyBeat – WSJ
Ever since the European Central Bank president said last month that officials would be “comfortable” easing policy, investors have been figuring out how to respond to new efforts the central bank might deliver to head off dangerously sluggish inflation.

Unfair Shares – Speech By Andy Haldane, Bank Of England Executive Director, Financial Stability And Member Of The Financial Policy Committee


Currency Algorithms Set for ‘Huge Growth,’ Molten Markets Says
John Detrixhe – Bloomberg
Algorithms used in foreign-exchange transactions are poised for growth as traders shy away from telephone deals amid heightened scrutiny, according to the chief executive of currency-trading platform Molten Markets Inc.
“We’re on the edge of a huge growth in algorithms,” Simon Wilson-Taylor of Rowayton, Connecticut-based Molten Markets, said yesterday at the Profit & Loss Forex Network New York conference.

For Bitcoin, a Tasty Dish
Paul Vigna – MoneyBeat – WSJ
Dish Network, the big U.S. satellite TV company, announced this morning that it will add bitcoin as a payment option for its subscribers, beginning in July, becoming what appears to be the biggest company yet to signal its adoption of the cryptocurrency.

Indexes & Index Products

The ‘Hotel California’ Flap: ETF Investors Should Take It Easy
Eric Balchunas – Bloomberg
A recent article by Tracy Alloway in the Financial Times turned heads when it compared exchange-traded funds to the Eagles song “Hotel California,” in that investors can get in anytime they like but they can never leave. While using rock lyrics to explain the world of finance is fun to do, saying you can “never leave” an ETF is a stretch akin to Michael Lewis saying the entire stock market is “rigged.”

NASDAQ OMX Lists PowerShares Multi-Strategy Alternative Portfolio ETF
NASDAQ OMX today announced that PowerShares launched a new exchange traded fund, PowerShares Multi-Strategy Alternative Portfolio ETF, which is listed on The NASDAQ Stock Market.

MarketAxess and BlackRock Partner to Provide iShares Fixed Income ETF Information and Electronic Basket Trading Technology
The consolidated iShares content on the MarketAxess trading system enables ETF market makers to trade baskets of iShares ETF constituent bonds using MarketAxess’ patented list trading functionality. Bid and Offer Wanted lists can also be sent via Market Lists, MarketAxess’ Open Trading protocol, to access the liquidity pool of over 1,000 institutional investor and broker-dealer firms.

ASEAN Exchanges Introduces Three New Tradable ASEAN Indices


Gold Set for Monthly Drop as U.S. to Ukraine Curbs Haven Demand
Glenys Sim and Nicholas Larkin – Bloomberg
Gold traded near a 16-week low and headed for a monthly loss as signs of an improving U.S. economy and easing of tension in Ukraine curbed demand for a haven. Palladium was set for a fourth monthly advance.

CME, LME compete to provide alternative to London silver ‘fix’
Clara Denina – Reuters
Major metal exchanges emerged as contenders in developing an alternative to the London silver price benchmark, or “fix”, after the century-old system for setting the globally recognised price is disbanded in August.

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