PrefBlog

The Europeans have been distracted from the G-20:

Finance ministers from Germany, France and the U.K. met in Seoul to discuss Ireland’s debt crisis after bond yields soared on concern the European Union will need to step in with a bailout.

Ministers are monitoring developments and will probably issue a joint statement later today, said Steffen Seibert, a spokesman for German Chancellor Angela Merkel.

The premium investors charge to hold Irish debt over German bunds climbed to a record yesterday and the euro fell to the lowest level against the dollar since September. Yields on 10- year Irish bonds added 31 basis points to 9.07 percent. Bailing out Ireland’s financial system could cost as much as 50 billion euros ($68 billion) under a “stress case” scenario compiled by the finance ministry and central bank.

Germany is the biggest contributor to this year’s 860 billion euros in loans and pledges to stem Europe’s debt crisis. Bonds of the euro area’s so-called peripheral nations have tumbled since EU leaders on Oct. 29 backed Merkel’s demand to set up a permanent rescue system by 2013 that makes bondholders foot part of the cost of any future debt crisis.

Wow! Higher chance of default has brought with it higher yield demands! Who woulda thunk it? It must be those nasty hedge funds and short sellers at the bottom of this.

Charges have been laid in a tipping scandal. What I find most interesting is that the alpha-tipper (ground-zero tipper? primary tipper?), Mitchell Finkelstein, got his information in three of the four transactions by simply poking around in the Davies Ward Phillips Vineberg LLP document management system – I would have thought that material of this nature would be password protected with access logs maintained and reviewed. Who knows? It might have been; the OSC Statement of Allegations doesn’t go into much detail about it, but it’s an interesting question.

The Canadian preferred share market took a loss today on average volume, with PerpetualDiscounts down 18bp and FixedResets losing 2bp.

France has joined Germany in urging easy sovereign defaults:

French Finance Minister Christine Lagarde said investors must share the cost of sovereign debt restructurings, backing a German call that helped send yields on Irish and Portuguese bonds to record highs.

“All stakeholders must participate in the gains and losses of any particular situation,” Lagarde said during an interview yesterday in Paris for Bloomberg Television’s “On the Move” with Francine Lacqua. “There are many, many ways to address this point of principle.”
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Lagarde’s comments mark France’s most explicit backing of German proposals to make bondholders contribute in bailouts, which deepened the slump in bonds of the so-called euro peripherals. Risk premiums that investors demand to buy their debt have risen since an Oct. 29 European Union summit when German Chancellor Angela Merkel sparred with European Central Bank President Jean-Claude Trichet over her demand “to see that it’s not just taxpayers who are on the hook, but also private investors.”

Merkel’s views on sovereign default were reported on November 2.

The EU stands vigilant with a policy of quantitative wheezing:

The European Union said Thursday it is prepared to financially help Ireland as investors continued dumping bonds issued by the Irish government and other fiscally weak countries in the euro zone.

“We have all the necessary instruments,” European Commission President Jose Manuel Barroso told reporters in South Korea, where he was attending the summit of the Group of 20 industrialized and emerging nations. “The EU is ready to support Ireland.” He declined to speculate on whether the EU’s new €440 billion sovereign rescue fund would be needed.
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“With three countries in the euro area now having virtually lost access to capital markets, the implications for the region as a whole could easily become systemic again,” market analysts at the Royal Bank of Scotland said in a note.

RBS said the ECB’s government bond-purchasing program will “be scaled up meaningfully” by another €100 billion by early next year. “The more it waits the bigger the purchase program will have to be,” it said.

Econbrowser‘s Jim Hamilton highlights a paper by Ke Tang and Wei Xiong titled Index Investment and Financialization of Commodities:

This paper finds that concurrent with the rapid growing index investment in commodities markets since early 2000s, futures prices of different commodities in the US became increasingly correlated with each other and this trend was significantly more pronounced for commodities in the two popular GSCI and DJUBS commodity indices. This finding reflects a financialization process of commodities markets and helps explain the synchronized price boom and bust of a broad set of seemingly unrelated commodities in the US in 2006-2008. In contrast, such commodity price comovements were absent in China, which refutes growing commodity demands from emerging economies as the driver.

In his post Commodity inflation, Prof. Hamilton highlights the correlations against the USD.

My view has been that the Fed needs to prevent a repeat of Japan’s deflationary experience of the 1990s, but that it also needs to watch commodity prices as an early indicator that it’s gone far enough in that objective. In terms of concrete advice, I would worry about the potential for the policy to do more harm than good if it results in the price of oil moving above $90 a barrel.

And we’re uncomfortably close to that point already.

It was a restful, slightly negative day for the Canadian preferred share market, as PerpetualDiscounts were down 2bp on the day, while FixedResets lost 6bp. Volume was relatively low.

People sometimes pretend that mutual fund MERs are too high. But that’s what people want:

Value of Canadian mutual fund assets: $720-billion

Value of Canadian-listed exchange-traded funds: $36.2-billion

Value of segregated fund assets in Canada: $83.3-billion

Value of hedge fund assets in Canada: $45.7-billion

Value of closed-end funds: $24.1-billion

The Financial Post reports that a real newspaper reports that RBC is too big to fail on a global basis:

Royal Bank of Canada has appeared on a list of banks that have been deemed by global authorities as being too big to fail, according to the Financial Times.
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The G20 will put off a decision on whether to impose an international capital surcharge for the world’s most vital banks, which would force them to maintain additional capital buffers to help them withstand market shocks, the Financial Times report said.

While it may not be explicitly settled at this week’s G20 meeting, it is understood that the banks that are deemed too big to fail will need to raise even more capital than their peers as extra insurance against their sizable reach and influence over the world’s economy.

There are signs the US fiscal deficit is intractable:

The co-chairmen of President Barack Obama’s debt-reduction commission will propose cuts to Social Security and Medicare, as well as reductions in income tax rates in exchange for curbing tax breaks, according to a Republican aide who attended the meeting.

The chairmen’s plan is already causing some Democrats and Republicans on the 18-member commission to balk. The plan will be announced at 1 p.m. Washington time today, said commission spokesman Fred Baldassaro.

Fearless forecast: the problem will remain intractable until the President gets a call from the Treasury saying they’re having big problems selling a bond issue and can he please start working the ‘phones. Then whichever party’s in power will start showing some sense.

The 30-year Treasury auction was disappointing:

Treasury 30-year bonds declined for a sixth day as the U.S. sold $16 billion of the securities amid concern yields will continue to climb as the Federal Reserve focuses its purchases on shorter-maturity debt.

The bonds drew a yield of 4.32 percent, compared with the average forecast of 4.288 percent in a Bloomberg News survey of eight of the Fed’s 18 primary dealers. The bid-to-cover ratio, which gauges demand by comparing total bids with the amount of securities offered, was 2.31, the lowest since November 2009.

In a primer titled A Survival Guide to Bonds, by Rob Carrick of the Globe and Mail, there is a most interesting quote:

“For most of the time in the past 13 years or so, bonds have been negatively correlated to stocks,” explains Michael Herring, managing director and investment strategist at BMO Nesbitt Burns. “When stocks are down, bonds are up. So they provide a nice diversification effect, a counterbalance that dampens the volatility of the overall portfolio.”

That’s not what the Kansas City Fed thinks! In the construction of their Financial Stress Index, they indicate that the “Negative value of correlation between stock and Treasury returns” is an indicator of “Flight to Quality” and therefore a stress indicator. They cite other studies showing that this holds true for other government bond returns; specifically, the measure used is computed over rolling three month periods using the S&P500 and a 2-year Treasury bond index.

MSCI-BARRA published an interesting piece on stock-bond correlation in 2009.

The Canadian preferred share market showed little direction today – for a change! – although volume continued to be high. PerpetualDiscounts lost 3bp, while FixedResets gained 6bp, taking the median weighted average Yield to Worst on the latter index down to 2.84% – yet another new low.

PerpetualDiscounts now yield 5.28%, equivalent to 7.39% interest at the standard equivalency factor of 1.4x. Long Corporates now yiel about 5.3%, so the pre-tax interest-equivalent spread is now about 210bp, a sharp tightening from the 230bp reported on November 3.

Here’s another exhibit regarding the reluctance of asset management firms to promote star managers:

Roger Guy and Guillaume Rambourg, Gartmore Group Ltd.’s two star managers, won European fund of the year at a black-tie gala at London’s Grosvenor House Hotel on Jan. 21. Ten months later, both have quit and the company is considering putting itself up for sale.
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Rambourg and Guy together managed about a third of the company’s assets after its IPO. Three other managers have departed, prompting the company to hire Goldman Sachs Group Inc. to help find a buyer after investors including Skandia Investment Management Ltd. pulled or planned to pull 3.3 billion pounds ($5.3 billion), or about 14 percent of its assets under management, since Rambourg was suspended in March. The performance of their funds has lagged behind competitors this year, according to data compiled by Bloomberg.

… and here’s one about the usual effect of politicized regulation:

U.S. airlines canceled 4,754 flights in September, a 62 percent jump from the same month a year ago, as the government requires carriers to let passengers off stuck flights within three hours.
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Carriers are seeking to avoid fines as high as $27,500 per customer stuck on a plane during a lengthy delay under the rule by Transportation Secretary Ray LaHood. Airlines said the requirement would lead to cancellations, and as of September an additional 5,000 flights were scrapped, an 18 percent rise, since the rule took effect.
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“Cancellations are a much worse result for passengers” than long delays, said David Stempler, president of the Air Travelers Association, an advocacy group in Chevy Chase, Maryland. “The time it takes them to get to their destinations may last up to days” after a flight is scrubbed, he said.

One of China’s major credit rating agencies has downgraded the US to A+:

China’s Dagong Global Credit Rating Co. reduced its credit rating for the U.S. to A+ from AA, citing a deteriorating intent and ability to repay debt obligations after the Federal Reserve announced more monetary easing.

The credit outlook for the U.S. is “negative,” as the Fed’s plan to buy government debt will erode the value of the dollar and “entirely encroaches” on the interests of creditors, analysts at Dagong, one of China’s five official ratings companies, said in a statement.
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Dagong, seeking to become an alternative to S&P, Moody’s and Fitch Ratings, ranks China’s debt higher than that of the U.S. and Japan, citing widening deficits in the developed world. Global ratings methodology is “irrational,” Dagong Chairman Guan Jianzhong said in July, and “cannot truly reflect repayment ability.”

In September, the Securities and Exchange Commission denied the application of Dagong to become a Nationally Recognized Statistical Rating Organization in the U.S.

Life will become even more fun if the EU sets up its own captive credit rater!

I ran across an interesting essay … The Impact of High Frequency Trading on the Canadian Market by members of the BMO-CM Quantitative Execution Services, dated July 2009 … it’s filled with the familiar booHooHoos about Portfolio Managers having their lunch eaten. I mean, look at this:

Liquidity has become less obvious – As predatory high frequency trading creates extra volume without creating additional real liquidity, it become increasing difficult for fund managers to discern the real achievable liquidity in a given stock. To date we have witnessed many instances where portfolio managers looking at total trading volume attempt to buy (sell) too much of a given stock resulting in additional market impact. This cost is again shouldered by the individual end clients

They hired an incompetent manager and it cost them. I’m not wringing my hands.

We have had several discussions with Canadian buy side accounts who have noted the decreasing effectiveness of their pre-trade analytic tools. Typically these tools rely on volume and a number of other market metrics (e.g. spread, volatility) to predict the impact a given order will have on the market for that issue. As ‘real’ volume becomes less discernable these tools have greater difficulty determining this number. Portfolio managers, who have become increasingly reliant on these tools over the last several years, are becoming increasingly frustrated with their performance.

Not frustrated enough, apparently, to do a damn bit of work to fix the problem.

The Bank of Canada has released a working paper by Céline Gauthier, Zhongfang He and Moez Souissi titled Understanding Systemic Risk: The Trade-Offs between Capital, Short-Term Funding and Liquid Asset Holdings:

We offer a multi-period systemic risk assessment framework with which to assess recent liquidity and capital regulatory requirement proposals in a holistic way. Following Morris and Shin (2009), we introduce funding liquidity risk as an endogenous outcome of the interaction between market liquidity risk, solvency risk, and the funding structure of banks. To assess the overall impact of different mix of capital and liquidity, we simulate the framework under a severe but plausible macro scenario for different balance-sheet structures. Of particular interest, we find that (1) capital has a decreasing marginal effect on systemic risk, (2) increasing capital alone is much less effective in reducing liquidity risk than solvency risk, (3) high liquid asset holdings reduce the marginal effect of increasing short term liability on systemic risk, and (4) changing liquid asset holdings has little effect on systemic risk when short term liability is sufficiently low.

I don’t like it much becaue it does not address the role of the Central Bank in reducing liquidity risk.

Regulators continue to run amok in the UK, once best known as the home of Magna Charta:

Traders’ mobile-telephone calls may be taped in an effort to stamp out insider trading under new rules scheduled to be published by the U.K. financial regulator as soon as this week.

The Financial Services Authority has said cell phones used for business shouldn’t be exempt from rules requiring banks and brokerages to record employees’ calls so that they can be listened to later. In March, the agency said in draft proposals that around 22,000 phones would be covered.
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The regulator in September warned companies to prevent leaks to the media as part of its effort to crack down on market abuse. The FSA started to cold-call traders to interview them under caution two years ago about possible insider trading, a strategy that fell prey to hoax calls.
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“We continue to work to keep undesirable people out of our financial services industry,” FSA enforcement chief Margaret Cole said in a speech yesterday. “We use information and intelligence from a range of sources to consider whether those who own or run financial firms, as well as people in sensitive roles within those businesses, are ‘fit and proper.’”

There’s more about the cold-calling here. For now, it’s all to the good – I know some fine immigrants from the UK who came here out of disgust with the ubiquitous camera monitors, ASBOs and so on. But this trend will eventually hurt us all.

Another strong day on the Canadian preferred share market, but this time with a big difference in inter-sector performance. PerpetualDiscounts gained 41bp, while FixedResets lost 3bp; today’s performance takes the Bozo Spread (the difference between PerpetualDiscount and FixedReset Current Yields) down to a mere 9bp. I am all agog to see if this spread goes negative … it is my theory that this spread shows the retail perception of the interest rate risk inherent in a Straight Perpetual … but who knows? Maybe it doesn’t. Volume was very heavy.