First Impressions

Accentuate the Negative
by Doug Ashburn, John Lothian News

This morning the ECB fulfilled what was arguably the worst kept secret in the central banking world – a move to cut its deposit rate below zero. Yes; it is official – if a bank wishes to leave money with the ECB, it must now pay for the privilege, an annualized rate of -0.1 percent.

Why do I say “worst kept secret?” First, because I knew of it ahead of time. And if the information made it all the way to my inbox, it is hardly proprietary. Second, and more importantly, the market has known for weeks, which is why EUR/USD responded the way it has this morning (chart compliments of CME Group and powered by TradingView):

EUR/USD broke a full big figure on the announcement but quickly snapped back and has been trading higher all morning – a total head-fake. Of course, the four-penny break came last month when the rumors began swirling that negative rates were coming. Buy dollars on the rumor, sell them on the fact.

Why has there been no mass exodus from the euro on the news? Will this new rate spur lending and move the economy forward?

My answer is the same for both questions. Deflation is coming to the eurozone. With deflation on the way, perhaps paying a tenth of a percent on deposits is a cost of doing business, or a cost of capital preservation. A tenth of a percent is a rounding error, not statistically different from zero. Of course, for leveraged institutions, a certain amount must be held in cash as a buffer, and this is true whether the rate is -0.1 percent or -10 percent. The only other choice is to leverage up.

We know where that strategy has led.

Quote of the Day

“Draghi’s gone all-in today. Don’t think of this as a bazooka. This is more like a fleet of killer drones to target deflation from all angles. It’s a quantitative-easing style response without the risk-free asset rally, so the periphery grinds in in spread terms.”

Owen Callan, an analyst at Danske Bank A/S in the story, “Euro-Area Bonds Surge as Draghi Unveils New Stimulus”.

Lead Stories

Draghi Takes ECB Deposit Rate Negative in Historic Move
Stefan Riecher and Jeff Black – Bloomberg
The European Central Bank cut its deposit rate below zero and said it would announce further measures later today as policy makers try to counter the prospect of deflation in the world’s second-largest economy.

***DA: Word of the day: bazooka

The ECB Will Need More Than Negative Rates To Get Lending Going
Alen Mattich – MoneyBeat – WSJ
The European Central Bank is likely to set a negative deposit rate following today’s policy meeting. Most analysts think so anyway.

***DA: Further evidence of what I was saying in today’s commentary. Look at Denmark and its experience with negative rates.

Euro-Area Bonds Surge as Draghi Unveils New Stimulus
Lucy Meakin and David Goodman – Bloomberg
The bonds of the euro area’s higher-yielding nations surged as European Central Bank President Mario Draghi lowered interest rates and unveiled an unprecedented round of stimulus measures to boost the region’s economy.

Stocks at a record, but bonds look to break bad first
U.S. stock and bond markets have risen in tandem all year as investors in each found reasons to support their views: stocks are up on signs the economy is improving, and bonds have gained on expectations for low inflation and relatively slow growth.

***DA: Sounds mutually exclusive to me. Buy stocks and buy bonds as a hedge? I would rather leave my money at the ECB and take the -0.1 percent hit.

Volatility Increases From Currencies to Bonds Before ECB
Kevin Buckland and Eshe Nelson – Bloomberg
Euro volatility surged to the highest in a year and price swings in Treasuries rose to a two-month high as investors speculated on the extent to which the European Central Bank will ease monetary policy today.

***DA: I think we can put this story to rest now. The vol spike did not extend past the 1-week date, and everything else is still several points lower than the long-term average. Since the initial announcement, vols have been getting crushed across the board. Have a nice summer; see you in September.

Bank of England Keeps Interest Rates Unchanged
NY Times
The Bank of England on Thursday decided to leave its benchmark interest rate unchanged at a record low, even as Britain’s economy continues to gather strength.

***DA: Speaking of lower volatility.

Enigma of Junk Explained in Pension Fund’s Return Hurdle
Caroline Chen – Bloomberg
To understand why investors are willingly accepting the lowest yields ever on the riskiest corporate securities, look to Japan.
As central banks around the world keep interest rates near zero and investors struggle to find ways to boost returns, managers of Japan’s $1.25 trillion Government Pension Investment Fund said in minutes of a March meeting released in May that they’re considering loosening their practice of only buying investment-grade debt and venturing into junk bonds.

Kenya launches $2bn debut bond roadshow
Katrina Manson in Nairobi and Javier Blas in Maputo – Financial Times
Kenya launches its much-delayed attempt to raise a $2bn debut sovereign bond today with a 10-day campaign starting in the US.

SIX Swiss Exchange: Bond Party 2014
The annual SIX Swiss Exchange Bond Party took place on 27 May 2014. Some 115 traders and representatives from the bond segment made their way to “restaurant g27” in Zurich Binz. Ueli Goldener, Head Fixed Income Product Management, welcomed the guests, among whom numbered client traders, market makers and investors, and thanked them for the successful cooperation in the past and current year.

Raters’ sovereign bias, a new rebuke
Dan McCrum – Financial Times
Another salvo arrives in the intellectual spat over whether or not credit rating agency opinions have been subject to country bias, possibly influencing Europe’s debt crisis. After we featured a strongly worded piece by the Unicredit economist team in March, IPE magazine asked them to turn it into an article.

Chinese debt — going external
David Keohane – Financial Times
We’ve said that this might be a dolorous year for the dollarless in China. In which case, it’s nice of the State Administration of Foreign Exchange to loosen the rules under which Chinese companies can borrow abroad then — effective from June 1. Of course, as with all reform in China, attempts at liberalisation carry their own internal risks. In this case, the rise of external debt.

Routinous, rouinous
Cardiff Garcia – Financial Times
The chart comes via this recent note from the Dallas Fed, and the theme will be familiar to those who have read the earlier work of Frank Levy, Richard Murname, and David Autor.

***DA: Like the motivational poster said, “If a pretty poster and a cute saying are all it takes to motivate you, you probably have a very easy job, the kind robots will be doing soon.”

Yet Another Reason Why Thomas Piketty Is Wrong
Tim Worstall – Forbes
Wrong about the effects of what he predicts that is.

Central Banks

As ECB Frets Over Deflation, Real Culprit Is Japan
Michael J. Casey – MoneyBeat – WSJ
As the European Central Bank’s governing council prepares for new policy measures to combat the threat of deflation, its members might look jealously at their counterparts from the Bank of Japan.

***DA: I, for one, would not be jealous of the situation in Japan.

ECB Making Steady Progress in Review of Major Euro-Zone Banks
The European Central Bank is making steady progress in its review of the health of major euro-zone banks, a key step on the path to a closer banking union for the currency bloc bruised by a financial crisis, Daniele Nouy, the head of the new pan-euro area banking supervision authority, said Thursday.


Egypt’s currency black market under threat as confidence rises
Egypt’s currency black market is under threat from two directions, as aid from wealthy Gulf states promises to ease a dollar shortage and an increasingly confident central bank engineers a gradual depreciation of the Egyptian pound.

Hedge funds bet on euro decline
Miles Johnson and Ralph Atkins in London – Financial Times
Hedge funds that specialise in anticipating central bank policy have ramped up their bets that the euro will fall as markets price in aggressive action from the European Central Bank to weaken the single currency.

***DA: A day late and a euro short.

Euromoney FX survey 2014 results revealed
Euromoney Magazine

Indexes & Index Products

Investors Chart New Course as Index Stars Graduate
Javier Espinoza – MoneyBeat – WSJ
This week, the UAE and Qatar, which until the end of May together made up more than one-third of the MSCI Frontier Markets Index, officially graduated to the MSCI’s Emerging Market Index. As members of the emerging markets index, the two countries will be minnows alongside whales such as China and Brazil. Together, they represent just over 1% of the value of the EM index.

ETF execs push smart beta at industry event
Mike Foster – Financial News
The promotion of smart beta exchange-traded funds has gone into overdrive at this year’s annual ETFs Inside Europe conference in Amsterdam, with one delegate claiming they could even be used to replicate the investment style of legendary investor Warren Buffett.


North Korea Gold Taints U.S. Firms
As companies scrambled to meet a deadline to report whether their suppliers used minerals from mines controlled by armed groups in the Congo region, they stumbled on something even more troubling: Many of their products may contain North Korean gold.

Gold Bores Investors as Volatility Drops to 14-Month Low
Debarati Roy – Bloomberg
Investors are too busy pushing stock prices to all-time highs to bother with gold, sending bullion’s price fluctuations to the lowest in almost 14 months.
The metal’s 60-day historical volatility dropped to 12.2 today, the lowest since April 2013, according to data compiled by Bloomberg. Bullion futures traded in a range of about $11 this week, compared with about $51 last week.

***DA: Gold and other sources of value storage are supposed to be boring.

ETF Securities enters race to provide silver price benchmark
Xan Rice – Financial Times
One of the biggest providers of exchange traded funds has entered the race to develop a new global silver price benchmark when the 117-year-old London silver fix is disbanded in August.

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