Every Friday after the close, we eagerly look forward to the weekly post-mortem summary by one of our favorite credit analysts, Deutsche Bank’s Dominic Konstam who better than most on Wall Street, cuts through the noise. However, things get awkward when the primary “signal” in any given week is emitted by his employer, Deutsche Bank: how does a strategist discuss global financial markets and events when the biggest variable is the source of your own paycheck: just what does one say without sounding conflicted or hypocritical?
In Konstam’s case, the answer to “how do you describe global markets in a few paragraphs when your employer is the primary source of market volatility” is the following
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Well we could talk about the current European financial bank stress.
There are some very obvious issues, many not new and it is clear that there is a very bleak potential outcome that would warrant much lower market rates and a significant decline in risk assets.
Equally though there are many alternative scenarios that involve some combination of moral suasion, policy intervention and regulatory “relief” that would avoid a major risk off event and allow markets to focus on the fundamentals of growth and current central bank monetary policies.
Of course this is what policy is supposed to do – to cut through negative externalities and there is no particular reason why the current situation is any different. Investors are eager to draw comparisons with the 2007/2008 financial crisis. Apart from the usual platitudes that the financial sector is much better capitalized now than then the real differences are even more important.
1. The problem in 2007/2008 was an asset problem. The assets themselves were never worth what banks thought they were fundamentally because of rising defaults. For sure mark to market losses exacerbated the capital shortfalls but HELOCS at par and as one CIO at a large bank was infamously heard to say “American prime borrowers do not default on their mortgages”, were the ingredients for a proper crisis.
2. It took the crisis to force central banks to enact completely new tools to address the ensuing bank run. Far from saying that interest rates are too low now and therefore central banks have fewer options, the point is the principle of effectively unlimited liquidity provision, if necessary, is now entrenched. This is true more so in Europe because of the separation of taxpayer from stakeholder. Banks won’t fail their depositors and there is no need for forced asset liquidations. Taxpayers won’t be on the hook but woe to the stakeholders.
So for what it’s worth however the ECB decides to navigate their latest challenge we are less inclined to embrace the classic financial sector meltdown led risk off trade that forces core rates significantly lower. Or at least it would need a spectacular display of policy incompetence first. (On second thoughts..?!)
Good luck, Dominic, and we can certainly appreciate why you are “less inclined to embrace the classic financial sector meltdown led risk off trade”, although we wonder how many similarities one could trade between the text above, and what Bear and Lehman strategists were writing about the state of financial markets in March and September of 2008, respectively…