Investors leave safe-havens for risk

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Suddenly it looks a little less rosy for the safe havens. The gold price came under sustained assault once again for a while yesterday, falling to a low of $1,704, a decline of nearly 11% from the record high just two days earlier. The extraordinary sell-off only returned the gold price back to where it was trading on the 9th of this month, so hardly a calamity. As stocks lost traction yesterday afternoon, gold came roaring back, and this morning is back up at $1,772.

Not for the faint-hearted. For the year-to-date, the gold price is still $350 higher. Interestingly, another safe-haven, namely the Swiss franc, is also looking less assured recently. Yesterday’s ZEW index of Swiss investor confidence for the month of August plummeted to a two-year low of -71.4, down from -58.9 in the previous month. Clearly the export sector is traumatised by the incredible strength of the currency. The Swissie briefly threatened to break through the 0.80 level yesterday – just two weeks ago it was poised to go through 0.70. EUR/CHF was above 1.15 for a time yesterday after coming close to reaching parity earlier this month. Bonds, another recent safe-haven, have run into profit-taking – for example, the 10yr gilt yield is up 25bp from last week’s multi-decade low of 2.25%.

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Commentary

QE3 expectations cool ahead of Jackson Hole. As the week has progressed and Fed Chairman Bernanke’s Jackson Hole address on the US economic outlook later today has loomed larger on the horizon, expectations of an announcement on additional quantitative easing have diminished. Steadier markets have facilitated some of this cooling; had equity markets continued to convulse this week like they have done through the rest of this month, then the demands for more QE from the Fed would no doubt have been louder. For those who are not yet convinced of the need for more stimulus of this kind, the arguments include the fact that the inflation rate is much higher this time around, and that the US central bank is unsure whether the economy is experiencing anything more than a soft patch. Even if Bernanke were minded to pursue more QE at this time, he would need to endure the scepticism of at least three members of the FOMC, who publicly criticised the recent decision to commit to unchanged rates for the next two years. More likely is that the Fed Chairman will acknowledge the weaker period of growth that the economy is currently struggling through, alongside a discussion of the potential policy options the Fed still has at its disposal. One of those policy options, an explicit commitment to a lengthy period of low official rates, has now been used. He may well allude to the use of another tool – lengthening the maturities of the securities held on the Fed’s balance sheet – as a way of (hopefully) further reducing long-term interest rates and aiding borrowers. Bernanke may just keep the nuclear option of QE3 up his sleeve.

A more benign perspective on European bank funding. It is most certainly the case that some European banks have experienced difficulties obtaining funding recently, but the furore whipped up around the issue appears to have been excessive. Those who argue that the situation is increasingly troublesome point to the significant widening in the 3mth Euribor/OIS spread recently (out to 66bp today, from just 20bp at the end of June) and the increasing reluctance of US money market funds to lend to European banks. As a general observation, European banks are much more reliant on short-term dollar funding from the wholesale market than their US counterparts. However, a perfectly reasonable case can be made for suggesting that the European bank-funding situation is, for the most part, quite benign. Firstly, at 66bp the blowout in the 3mth Euribor/OIS spread is well below post-Lehman levels which regularly reached 200bp. Secondly, the reason that this spread has widened at all recently is because of a significant increase in excess reserves at the ECB. As a result, the benchmark Eonia (the Effective Euro Overnight index average for unsecured lending transactions in the interbank market) has fallen to just 0.89%, well below the benchmark refi rate of 1.5%. In short, Europe’s best banks are benefitting from a marked cheapening in funding costs. Also, it turns out that the number of banks actually accessing the ECB’s one-week liquidity-providing operations this past week was the lowest for almost a year.

It is also worth emphasising that Europe’s banks are much better capitalised these days compared with the situation around the time of Lehman’s demise. According to calculations undertaken by a major investment bank in London, eurozone banks have raised nearly EUR 300bln in capital over the past 18 months. The average core tier-one capital ratio of the 25 largest banks in Europe is now well above 10%, compared with less than 7% pre-Lehman. Finally, if there really was such a dollar funding crisis amongst Europe’s banks, how is it that there has been essentially no usage of the ECB’s emergency facility in recent weeks (apart from one small exception last week)? As Bundesbank board member Dombret suggested yesterday, dollar funding for Europe’s banks is: “…a non-negligible but small part of European banks’ short-term liabilities”, and that it is easily covered by existing central bank facilities. Ergo, what funding crisis? For those who are concerned, it appears that some of the smaller banks in southern Europe, and possibly some French banks, are experiencing funding restrictions on some fronts. And, the EFSF will soon be in the position where it can directly re-capitalise some of these troubled banks.  But to claim that it is a generalised funding crisis afflicting European banking more broadly seems to be an exaggeration at this stage.

No respite for the depressed UK consumer. UK consumers remain thoroughly downcast about the economy and their personal finances. According to the latest CBI survey of UK retailers, the net balance for the volume of sales plunged to -14 this month, down from -5 in July and the worst reading since the middle of last year. Forward orders look terrible and retailers reflect that sales for this time of year are dreadful. Separately, the Nationwide Building Society’s measure of consumer confidence fell to just 49 last month, not that far from the low of 42 seen at the beginning of 2009. This latest confirmation of the dire mood amongst UK households failed to elicit much response from the currency yesterday, in large part because the situation is already widely known. After almost reaching 1.66 again a couple of days ago, cable has fallen back to 1.63 as the dollar benefits from the pummelling in the gold price. One piece of good news for the currency however is the announcement that the UK and Swiss authorities have reached an agreement on tax evasion by British nationals that could generate some respectable revenue for HMRC over coming years. Despite the pervasive pessimism amongst UK consumers and the tremendous squeeze on living standards, it is not as though the predicament is any different in a lot of other advanced economies. As such, the fact that the UK economy is flirting with recession once again is not a sufficient reason to be negative on the currency.

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