The T Report: Central Bank Policy Remains Key

The JPM situation continues to seem to settle down. In spite of wild rumors of massive losses, there is little indication that the losses have changed dramatically, and the available for sale portfolio that everyone seems to want to ignore seems in good shape and is there to be harvested. Whatever Mr. Dimon’s “tax related concerns” about selling that portfolio, it has to be sold. They need the money and they need the CIO office’s portfolio to be closed down. Whatever JPM’s final loss (or gain) comes in at in the CIO office, the market is becoming comfortable that no one else had the same trade, and if anything, some banks had the other side and are profiting. This isn’t a systematic risk trade and bank stocks look cheap based on that.

In Europe it comes down to ECB and Greece. The ECB is the biggest lender to Greece. That remains the biggest problem, with the IMF and EU’s own exposure as another big hurdle. How this is handled is absolutely crucial to the success or failure of the exit. Right now, the ECB in particular, but also the IMF seem to be ignoring the losses they face on this and the potential losses from other exits.

For the first time in the crisis, the ECB and IMF need plans to protect themselves as well as the countries and banks involved. I don’t think they yet understand the potential risk in other countries once currency devaluation is a real option.

The hope of Eurobonds is just foolish. Eurobonds won’t happen. They simply can’t while each country maintains completely independent policies. If the goal is to get cheaper financing to the countries in trouble, the first thing that the ECB could do is extend maturities and reduce coupon on the bonds they own in SMP. That could happen. Eurobonds cannot.

Euro “project” bonds or something issued by the EIB to fund infrastructure bonds can and will happen. These won’t be true Eurobonds but will likely be spun as such.

The markets, while still oversold, are a little more balanced than at the start of the week. Without intervention and some aggressive new policies, they will likely resume the slide. On the other hand, it seems obvious to everyone that the market and economy is once again very fragile, and I find it hard to believe that the ECB or Fed will take the risk of letting the tailspin accelerate without trying some new form of QE.

Fixed income, and high yield in particular remains very nervous and unidirectional. It is either “buy buy buy” or “sell sell sell”. It doesn’t seem like anyone believes the fundamentals have changed. It looks like there is still money available to be put to work as buyers creep back in whenever the global situation seems remotely stable. HYG had a small increase in shares outstanding and is not trading at a discount anymore, both of which are positives. On the other hand, last year’s sell-off is still a concern and weakness brings out sellers trying to protect their P&L. Look for the volatility to remain, though in a market where the underlying bonds are being quoted with 1 point bid/offer spreads, eyeing every ¼% move in the HY18 index of HYG is a good way to wind up doing something you will regret.