Risk aversion lowest in two years ( what me worry , what could go wrong market ) ....... the key takeaway is that there is no thing as fundamental valuation now - for equities or even bonds. That is dead , get over it ......

http://soberlook.com/2012/09/risk-aversion-lowest-on-over-two-years.html?utm_source=BP_recent

MONDAY, SEPTEMBER 17, 2012

Risk aversion the lowest in over two years

Given the recent demand for "risk-on" assets, it is worth taking another look at the risk indicators to see how much risk appetite is currently in the markets vs. for example in March - after the second 3-y LTRO. The first two indicators to consider are the CS Risk Appetite Index and the Fisher-Gartman Risk-On Index.

Both show a recent "risk-on" spike. However, while the CS index is materially below its March-April peak, the Fisher-Gartman index is at the highest level since the index was launched.

CS Risk Appetite Index (CS)

Fisher-Gartman Risk-On Index (CNBC)

As discussed earlier (see this post), the CS index is sensitive to the global equity and credit markets, while commodities, currencies, as well as equities drive the Fisher-Gartman calculation. The main difference this time however came from emerging market equities, a larger component of the CS indicator than the Fisher-Gartman index. Emerging markets have underperformed the overall global equities index.

MSCI World and MSCI EM total return (Bloomberg)

Given these subtleties in the risk indicators related to emerging markets equities, let's take a look at a third measure, the Citi Macro Risk Index, to "break the tie". Here is the definition:

The Citi Macro Risk Index measures risk aversion in global financial markets. It is an equally weighted index of emerging market sovereign spreads, US credit spreads, US swap spreads and implied FX, equity and swap rate volatility. The index is expressed in a rolling historical percentile and ranges between 0 (low risk aversion) and 1 (high risk aversion).

This measure is based on credit spreads and implied volatility indicators. Note that the index is inverted relative to the two above, indicating the perceived level of risk in the markets rather than the risk appetite.

Citi Macro Risk Index (Bloomberg)

Based on this third risk measure, the perception of risk in the system is now the lowest since early 2010, before the Greek sovereign debt issue first moved the markets in a material way.

Other than the underperformance of emerging markets equities, the overall risk aversion seems to be declining toward multi-year lows. Welcome to the new "new normal", where central banks set the level of risk appetite - and right now they simply want risk to be ignored (see discussion).

and why would one consider risk , not with all the good news from Cyprus this weekend.....

http://globaleconomicanalysis.blogspot.com/2012/09/battle-between-germany-and-france-over.html

Monday, September 17, 2012 11:55 AM

Battle Between Germany and France Over Spain Bailout Application; Numerous EU Ministers At Odds Over Banking Union

France has encouraged Spain to apply for aid as soon as possible. In Germany, Wolfgang Schäuble wants anything but a timely application.

Note that unless a country requests a bailout, and agrees to terms set by the IMF (something Spain does not want to do), the entire OMT plan of Draghi is useless.

On September 12, José Manuel Barroso, European Commission president unveiled his European banking union proposal with a goal of having it approved by December.

All 27 EU member states have a veto on Barroso's plan, not just the eurozone countries.

Numerous EU Ministers At Odds Over Banking Union

The odds of approval by December are zero percent given battles between eurozone and non-eurozone countries erupted over the banking union erupted in Cyprus at an EU meeting on Saturday.

 Germany, Sweden, Poland and the Netherlands called for a more “realistic” negotiating timetable to resolve the problems, suggesting talks will run into 2013. Anders Borg, Sweden’s finance minister, said it was “undecidable and not acceptable” to aim for a deal by the end of the year.

Germany is in favour of the ECB having some responsibility for monitoring big financial institutions, but is resisting the broad scope and high degree of centralisation proposed by the European Commission.

Germany also objects to what it says is hasty implementation, with the ECB taking over supervision for all banks by 2014.

After the meeting Wolfgang Schäuble, the German finance ministers, threw out a further complication by demanding a pan-eurozone stress test for banks before supervision is passed to the ECB.

This step-by-step approach is at odds with France, which is pressing for the eurozone to move rapidly towards a centralised system for supervising all 6,000 lenders in the single currency area.

Sweden, Poland and the UK are concerned about the legal anomaly of the European Banking Authority being unable to impose binding decisions on the ECB, while it could force sovereign states to comply when it adjudicates in a dispute. The commission argues that, in the rare event of the ECB failing to comply voluntarily, banks would be bound to comply with EBA decisions.

Battle Brews Between Germany and France Over Spain

Eurointelligence reports Germany now actively discourages Spanish EFSF application.

 Among the many narratives from the informal Ecofin over the weekend, the one that struck us the most has been the active discouragement by Wolfgang Schäuble of a Spanish aid application, while France has been reported to be pressuring Spain to make an application. Last week, on his visit to Madrid Jyrki Katainen made the same point. Germany appears to be siding with Finland and other small countries, according to Bloomberg, which writes that France exerts pressure in the opposite direction.

(We think this is quite remarkable, and a certain way to end the current phase of optimism. Schauble does not want a Spanish EFSF/ESM vote in the Bundestag, but by encouraging a delay, or worse an attempt to forego an application indefinitely, the entire OMT programme by the ECB will soon be exposed to be fraud, as it is premised on the idea of an aid application.)

The other big theme from Cyprus is the sharpening dispute over a banking union.

The FT quotes Anders Borg of Sweden as saying it was “undecidable and not acceptable” to aim for a deal by the end of the year. Cinco Dias quotes Borg as saying "we cannot accept banking supervision centered on an ECB we cannot belong to without joining the Euro". El Confidencial arrives at the logical conclusion that Spain is failing to secure its objective to extract a commitment to bank recapitalization on the timetable agreed in June.

As reported by EUObserver last Tuesday, the 10 EU countries outside the Euro have strong misgivings about the banking union and might withhold the necessary unanimity, though not only over being forced to submit to ECB supervision but for instance out of concern that being backed by the ESM would give Eurozone banks a competitive advantage over non-Euro banks in the eyes of depositors.

The Wall Street Journal [in Slow Path to Policing Europ Banks] writes that Jörg Asmussen presented the ECB's proposals for a banking union to the Ecofin, which he said must include common supervision, resolution regime, and deposit insurance. Wolfgang Schäuble is opposing joint supervision of all banks, advocating instead ECB supervision of "systemic" institutions. The German savings bank association is said to oppose plans for joint resolution and deposit insurance on the grounds that this would "raid Germany's financial safety net to bail out shaky foreign banks". The Sparkassen and Volksbanken have, in fact run ads in the German press last week in the form of an open letter to Angela Merkel, as reported by Handelsblatt on Thursday.

Non-euro countries raise concerns on banking union

Let's take a closer look at the EU Observer article Non-euro countries raise concerns on banking union, mentioned above by Eurointelligence.

 EU ambassadors from Bulgaria, the Czech Republic, Denmark, Hungary, Latvia, Lithuania, Poland, Romania, Sweden and the UK met on Monday evening (10 September) in Brussels to share concerns regarding the European Commission's banking union plans to be unveiled on Wednesday.

The 10 'euro-outs' each have a veto over the banking union plans, as they will require unanimity in the EU Council of ministers to pass.

A level playing field between banks inside and outside the eurozone is the main sticking point.

For central and eastern European states - where 65 percent of the banking sector is in the hands of Austrian, German, French and Italian banks - the worry is the move will create unfair competition of big banks versus local ones.

"If the choice is between an Austrian and a Romanian bank, where would your grandmother put her money? Clearly having the might of the ESM and Germany behind it creates a competitive disadvantage for the local ones," one EU diplomat said.

Another issue is that non-euro countries can opt into the banking union, but would have no say in the governing council of the ECB which is made up of eurozone members only.

The debate about having a parliament - or a special committee within the European Parliament - just for the eurozone is being followed with deep concern among the 'outs,' as it would cement a two-speed Europe already taking shape.

For Britain, having a more powerful and united eurozone is also problematic when it comes to banking regulation or the balance of powers within the European Banking Authority, the London-based body pooling all 27 national banking supervisors.

Estonia - a eurozone member - is a special case, as its whole banking sector is in Swedish hands. But Sweden is outside the eurozone, so Estonia will be in the banking union, but its banks will remain under national supervision from Sweden.

List of Countries Having Problems With Banking Union Proposal

• Germany
• Netherlands
• UK
• Sweden
• Poland
• Bulgaria
• Czech Republic
• Denmark
• Hungary
• Latvia
• Lithuania

As I have stated before, the UK ought to decide to leave the EU entirely. To place itself at risk of having to comply with EU banking regulations and restrictions in London, financial transaction taxes, and eurozone bailout funding, on top of numerous silly trade agreements and absurd farm policy agreements is pure insanity.

Since any one country can sink this thing, it sure cannot pass as is, nor can all of this possibly be ironed out by December.

Mike "Mish" Shedlock



And digesting what the Fed has done......


SUNDAY, SEPTEMBER 16, 2012

Draining duration from the markets

As part of Operation Twist, the Fed was taking tremendous amounts of duration out of the market. In effect the average duration of outstanding fixed income products in the market was lowered by their action. The idea was to create a shortage of high duration product, thus lowering long-term rates.

By converting bond purchases and sales into 10-year equivalents (duration adjusted) one can measure how much "effective" 10-year notes have been taken out of the system. With Twist continuing on and agency purchases commencing shortly, this process is going to accelerate. 

Source: JPMorgan
Some are asking - so what? Who cares if the market's overall duration is shortened? The answer is that ultimately it is the institutional investors such as corporate and state pensions who will get hurt the most by this process. These investors have long-term liabilities and will now be increasingly struggling with the so-called "duration mismatch". They also have a return hurdle. That allows corporations (even highly leveraged ones) to issue longer dated paper and force institutions to accept ridiculously low yields for the credit risk taken (see discussion). And pensions' portfolios stuffed with higher risk paper should be everyone's concern.

SUNDAY, SEPTEMBER 16, 2012

Agency MBS spreads collapse, durations shorten, swap spreads follow, and fundamental valuations go out the window

Fannie Mae and other agency MBS spread to treasuries declined sharply in the last couple of days - to the lowest levels in years in fact - all in reaction to the news from the Fed (see post). With spreads this low, the Fed will be buying paper at some of the richest valuations in recent history. The chart below shows the spread between current coupon FNMA 30y yield and the 10y treasury.

Current coupon FNMA 30y yield minus the 10y treasury (Bloomberg)

Markets are still digesting this massive move.

Bloomberg: - A measure of relative yields on mortgage securities dropped tothe lowest on record after the Federal Reserve said it will expand its purchases...

“A typical fundamental-value framework really isn’t applicable here” because the Fed’s goals differ from those of normal investors, said Todd Abraham, co-head of the government and mortgage-backed fixed-income group at Federated Investors Inc. “It makes it pretty challenging to determine at what point you need to change your allocations. It’s almost more of a case of needing to try to anticipate what others are going to do.”

Adjusted for the prepayment option, the spread on these bonds (OAS) is close to zero - basically pricing no credit risk associated with agency debt (see discussion).

With mortgage rates expected to decline further, the market is anticipating accelerating prepayments, shortening the effective duration of many MBS bonds. Part of the unprecedented decline in spread against the 10y treasuries (above) was driven by these falling durations, as the "on-the-run" agency paper started trading to shorter dated treasuries, which have lower yield.

Those who hedged MBS with 10-year rate swaps (a traditional instrument to hedge fixed rate mortgage paper) were caught off guard. Many were forced to unwind these hedges because the durations of the MBS and the hedge became mismatched. That unwind sent the 10y swap spread crashing to recent lows.

10y swap spread (Bloomberg)

It may take some time for fixed income markets to adjust to this new regime. And as Todd Abraham correctly pointed out (above), it's no longer about "fundamental-value framework".