International Currency Swap Markets Reveals of a Developing Credit Crunch!

Big trouble for risk asset bulls. US dollar shortages have been emerging all over.

From the Bloomberg: (bold mine)

A crunch is developing in international funding markets.

The cost to convert local currency payments in the euro area, U.K. and Japan into dollars has jumped amid speculation the Federal Reserve will raise interest rates in December. With other major central banks set to hold, or even loosen, monetary policy, the projected policy divergence is supercharging the usual year-end uptick in demand for dollar funding….

The one-year cross-currency basis swap rate between euros and dollars reached negative 39 basis points Wednesday, the largest effective premium for dollar borrowing since September 2012, according to data compiled by Bloomberg. The rate was at negative 37 basis points as of 11:31 a.m. London time.

The measure, which was closely watched by investors during the financial crisis as an indicator of stresses in the banking system, reached negative 138 basis points in 2008 following the collapse of Lehman Brothers Holdings Inc. While the increase this month is driven more by monetary-policy divergence it still has implications for global banks. It also means U.S. companies, which have been borrowing in euros to take advantage of historically low interest rates, must pay more to swap those proceeds back into dollars….

This rush for dollar fundraising across the globe this month pushed up the one-year cost for Japanese banks to the highest level since 2011. Meanwhile, the cost for U.K. banks has more than doubled in November. That’s unusual because the surge was mostly focused in the euro area and Japan the last two occasions that funding costs rose, according to George Saravelos, global co-head of foreign exchange research at Deutsche Bank AG in London.

Well, this seem more than just about the FED’s lift-off, although speculations about it have been exacerbating the current conditions.(see charts above)

This seems really more about those balance sheets overstuffed by debt as evidenced by the $9.6 trillion credit in US dollars to non-bank borrowers outside the United States at the end of Q1 2015 (BIS)

This excerpt from a study from the Bank for International Settlements illuminates on the current dynamic: (Global dollar credit: links to US monetary policy and leverage, BIS, Robert N McCauley, Patrick McGuire and Vladyslav Sushko January 2015)

First, evidence from 22 countries over the past 15 years shows that offshore dollar credit grows faster where local interest rates are higher than dollar yields, and this relationship has tightened since the global financial crisis. And the wider the gap between local 10-year yields and those on US Treasury bonds, the faster the next quarter growth in outstanding US dollar bonds issued by non-US resident borrowers. This finding is consistent with the observation that, since 2009, dollar credit has flowed to an unusual extent to emerging markets and to advanced economies that were not hit by the crisis, while it has grown at a slower pace in the euro area and the United Kingdom (UK). In sum, dollar credit has grown fastest outside the US where it has been relatively cheap.

Second, before the global financial crisis, banks extended the bulk of dollar credit to borrowers outside the US. Low volatility and easy wholesale financing enabled banks to leverage up to funnel dollar credit offshore. These findings are consistent with Bruno and Shin (2014b) and Rey (2013).

Third, since the crisis, non-bank investors have extended an unusual share of dollar credit to borrowers outside the US. Firms and governments outside the US have issued dollar bonds, and banks have stepped back as holders of such bonds. The compression of bond term premia associated with the Federal Reserve’s bond buying has induced investors to bid for bonds of borrowers outside the US, many rated BBB and thus offering a welcome spread over low-yielding US Treasury bonds. We also find that inflows into bond mutual funds offering a spread over US Treasuries played a significant role in spurring offshore dollar bond issuance. We interpret this as evidence of the portfolio rebalancing channel of the Federal Reserve’s large-scale asset purchases.

A key observation is that, following a brief spike in spreads in Q4 2008, spreads declined in the subsequent quarters even as the stock of offshore dollar bonds grew rapidly. Thus, while we cannot reject the “spare tire” argument of Erel et al (2012) and Adrian et al (2013) at the height of the crisis (ie firms substituting from supply-constrained bank financing to bonds, despite widening spreads), any such effect seems to have been short-lived. Instead, heavy bond issuance amid falling yields and narrowing spreads points to the importance of a largely policy-induced favourable supply of funds from bond investors beginning in early 2009.

We end with a discussion of the implications for policy. First, dollar debt outside the US serves to transmit US monetary easing into immediately easier financial conditions for borrowers around the world. Second, while policy in economies outside the US can raise the cost of dollar debt at home, the effect of such policy is limited by multinational firms’ ability to borrow dollars abroad through offshore affiliates. Third, the recent prominence of bond markets in supplying dollar credit introduces new risks to financial stability, and thus changes the way that we need to think about the policy challenges posed by offshore dollar credit growth.

Now a progressing feedback mechanism between onerous cross border debt levels AND a downshift in global economic performance has been increasing strains in the supply of US dollar. Combine these with Fed’s potential rate hike (policy asymmetry between US and the world), hence the brewing credit crunch storm.

 

Headline of the Day: Chronic Addiction to Central Banking Narcotics

From Barrons

Domestic Media’s Reports on Philippine Banks: Did You Two Visit the Same Country?

In a fact finding mission on South Vietnam, two diametric reports from his underlings prompted the late US President John F, Kennedy President to sardonically ask: The two of you did visit the same country, didn't you?

We apply this to the today’s divergent headlines and reports on Philippine banks:

Excerpted from the Inquirer

Now headlines and summary reports from the Businessworld…

On Metrobank

 

On BPI

 

Updated to add: It may be technically true that indeed banks made profits as of September, but the intent of this post has been to show of the stark difference in the framing of the said reports. The Inquirer report was wildly optimistic to basically omit the negative aspects while Businessworld report took on a more balance stance.

Quote of the Day: The Economics of the Dull Cookbook Memorizer

At the Cafe Hayek, Professor Don Boudreaux splendidly differentiates 'Knowing about economics' from 'Knowing economics'. (bold mine)

There are people who know a fair amount, or even a great deal, about economics. To know a lot about economics, however, is not to know economics; it’s not to know how to think like an economist.

Someone who knows a lot about economics has learned a lot of economic jargon (e.g., “marginal cost”) and all of the textbook definitions (e.g., “Marginal cost is the addition to the producer’s total cost of producing one additional unit of output”). This person also has memorized the often-intricate rules for how to bend and shift various ‘curves’ such as supply, demand, cost, and IS-LM. And, today, this person is often also skilled at finding quantitative data and processing them in the various data-processing machines that are called econometric techniques.

Knowing how to think productively like an economist is typically assisted by knowledge of such things, but it involves far more than knowing the above. Indeed, knowing the above isn’t as essential as the typical economist today supposes it is to being a genuinely good economist. Too often, mastery of superficial stuff such as the above convinces those who have mastered these superficialities that they understand economics. The sorry result is that such people never bother to master the skills of actually doing economic analysis properly.

Imagine someone who memorizes a world-class cookbook. This person learns all the culinary jargon; all the formulae for all the soups and sauces; all the best combinations of spices; all the recommended oven temperatures for all the different baked dishes. All the recipes and information printed in the cookbook. But what this person really ‘learns’ from the cookbook is that preparing meals is an engineering feat: faithfully follow the recipes of the ‘best’ cookbooks and you can be a superb cook. Voila! Cooking is easy if one masters the recipes!

What this cookbook student never learns, though, is that being a superb cook ultimately requires individual judgment, wisdom, and creativity in knowing when to stick with a recipe and when sticking with a recipe will produce a meal unfit for tonight’s dinner guests. What this cookbook student never learns is how to create delicious meals for which there is no already-printed recipe. This cookbook student, in short, masters, at best, only that which a skilled chef can explicitly commit to paper; this cookbook student – being in fact quite dull – never masters the creative art of cooking.

Lots of economists, in my view, are like this dull cookbook memorizer. They sling the jargon freely; they know, and can recite flawlessly, all the latest recipes (that is, models). They can name those recipes’ creators (that is, today’s in-vogue economic theorists). They know a lot about economics.

But when they actually attempt to do economics, it quickly becomes clear that they don’t know what they’re doing. They’re not really economists. They consistently fail to ask that most important of all questions that economists ask: “As compared to what?” They forget that monetary costs and monetary benefits are only a subset (and sometimes a small subset) of full costs and benefits: They mistakenly suppose that monetary costs and benefits are all of the relevant costs and benefits. They, in the most wooden of ways, take the recipes they know literally: Any observed real-world variations from the cookbook (that is, textbook) recipes are, for such economists, solid evidence that the real-world is flawed.

The fact that reality is far richer in details – the fact that competition operates on many more margins than are included in economists’ formal models – the fact that people, as consumers and as producers, are indescribably more creative and clever and intrepid and diverse than are the ‘agents’ who populate economic models – the fact that maximizing the collective monetary incomes of some arbitrarily defined group of people (for example, “low-skilled workers” or “blue-eyed people whose last names start with the letter Z”) is likely to be both positively meaningless and normatively dubious – these facts are invisible to too many modern economists. This blindness to the most important features of economic reality is promoted by the failure of modern economic training to teach young economists to ask, always to ask, why.

Oh, this wisdom is ever so relevant today particularly when applied to domestic mainstream economics--where economics has been mistaken as about shouting economic terminologies or jargon and their numbers or selectively picking data--ironically, without really understanding its economic essence.  

And that's the reason why I learned economics: to protect myself from "economists" (of the cookbook memorizers or the Sadako type variants)