09 February 2016 at 11:00 GMT
- Banks' shares are now in focus of the equity selloff
- With its share tumbling and CDS spreads spiking, watch Deutsche
- Eurozone periphery government bond yields rose
- Gold is up again
By Walter Kurtz*
What started as a crude oil driven selloff in the equity markets has quickly evolved into fears around the global banking sector. Why? Here are some trends that help explain the situation. 1. Bank jitters started with Portugal’s bank called Novo Banco which was restructured forcing haircuts on senior bondholders (including Blackrock and Pimco). As analysts had suspected for some time, European senior bank bonds are not really "senior" and are in fact subordinated to depositors. The Novo Banco event brought this issue to light. Moreover not all senior bonds were treated the same. Only bonds carrying a minimum denomination of €100,000 (institutionally held) were hit. After such an event, why would any institution ever buy a senior European bank bond? 2. Bad loan balances at some European banks continued to rise. Italian banks looked especially shaky and starting in 2016 Italian bank selloff accelerated.
3. Sovereign wealth funds
of many oil producers hold significant amounts of financials shares. With fiscal situations strained, dumping public shares is a quick way to release some of those petrodollars. This is one of the links back to oil.
4. As bank shares sold off, some became concerned about capitalization. The focus shifted to the so-called CoCos (contingent convertibles) which became a popular way in Europe to raise tier-1 capital. The securities are treated like bonds and therefore don't dilute existing shareholders. In an adverse event a regulator can force CoCos to be converted to equity - providing additional capital cushion. Now that some have raised questions about capitalization, investors became concerned about CoCos shutting off coupons in order to preserve capital. In such a situation investors are effectively short a put on the bank but are not collecting any premium (coupon). So they headed for the exists.
By the way, here are the top CoCo issuers.
Note that Pimco even created a fund to buy CoCos and similar securities.
5. The market especially focused on Deutsche Bank
which had its first year of losses since the financial crisis. Many investors have been calling for a major restructuring at the bank for some time. With the CoCos getting hit and shares selling off to new lows investors became concerned about DBs stability. DB CDS spreads spiked. Moreover, the CDS spreads on subordinated debt hit new records.
What's particularly troubling is that DB's CDS spread is approaching that of UniCredit, a major Italian bank.
This uncertainty has spilled over into the broader financial sector.
One concern about this renewed pressure on banks is that it could reignite the Eurozone stability fears. For example, Greek shares fell to the lowest level since 1990 as bank shares lost almost a quarter of the value in one day.
periphery government bond yields rose in response to these new concerns, with spreads to Bunds jumping (Eurozone core and other major economies saw their government bond yields moving sharply lower and for the first time in history, the Japanese 10-year government bond yield moved into negative territory.). Here is the situation with Portugal.
Continuing with Japan
, the yen had a sharp rally, regaining its status as a "safe haven" currency (for a while the euro had that status). USDJPY
is now back to 2014 levels, reversing a great deal of work the BoJ did to weaken the yen. A much stronger yen, combined with the pressure on Japan's banks, sent the Nikkei sharply lower.
With all the negative rates around the world (discussed above), the option-implied probability of negative rates in the US is on the rise.
The market-implied probability of a March Fed
rate hike fell to zero. Looking at the market-implied probabilities of Fed rate hikes in 2016, now there is an over 70% chance of "one and done". This is likely to damage the Fed's credibility.
1. For the first time in months gold
2. Wholesale gasoline
futures are trading below 96 cents per gallon.
3. Related to the above, the average US diesel price dropped to $2.008 a gallon, the lowest in nearly 11 years.
Finally, after all the scary trends above, let's end on a positive note. Ireland's
consumer confidence hit a multi-year high. Impressive.
Turning to Food for Thought, we have 3 items this morning:
1. 23% of Americans watch the Super Bowl for the commercials. Amazing.
2. Based on consumer surveys, the tech industry could be facing tough times ahead.
3. VCs continue to plow money into tech.
— Edited by Clemens Bomsdorf* Walter Kurtz is an alias
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