U.S. Fed: Why replacement of “operation twist” with outright bond purchases makes a difference

December 17, 2012

JP Morgan’s Nikolaos Panigirtzoglou presented a nice reasoning, why the December 12 2012 U.S. Fed decision to replace its maturity extension program with outright bond purchases of the same size will put in place an important additional influence on long-term treasury yields. This influence is an intensified “liquidity affect” over and above the previous “demand effect” on government bonds.

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Why is volatility so low while uncertainty is still so high?

December 15, 2012

This note from Claudio Irigoyen and others supports the notion that implied volatilities naturally return to long-term trend even if economic uncertainty does not. While implied volatility is very sensitive to deteriorating conditions, actual and implied volatility under poor but stable conditions may be compressed by investor adaptation (defensive repositioning, risk management changes, easing risk aversion, etc.) and policymakers’ direct market intervention (liquidity supply, policy puts, etc.). Technically speaking, the first derivative of economic uncertainty indicators may condition the mean reversion of implied volatility.

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BIS re-interpretation of TARGET2 (im-)balances

December 10, 2012

In an easily readable working paper Stephen Cecchetti and colleagues explain the connection between euro area break-up concerns, Target2 balances, and financial conditions. This research would support the idea that commitment to 100% euro zone stability, via OMT and other measures, is the most effective form of monetary easing in the euro area.

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On collateral chains

December 8, 2012

A new IMF paper investigates the role of shadow banks in securitization and collateral intermediation. One important forward-looking concern is the potential vulnerability of collateral chains, i.e. the use of a single security for multiple secured loan transactions.

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Functions and risks of shadow banking

December 1, 2012

Shadow banking encompasses credit intermediation outside the regulated banking system, mostly through investment funds, money market funds, structured finance vehicles, broker-dealers, and finance companies. In parallel to the classical deposit-based funding of bank intermediation, the shadow banking system establishes secured transactions-based wholesale funding of non-bank intermediation. Thereby, the role of asset managers and off-balance vehicles of banks in intermediation has greatly increased, as has the importance of asset managers as source for “collateral mining. Regulators fear that shadow banking has been conducive to excessive leverage in the economy and contributed to systemic pressure through sudden stops and asset fire sales.

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A review of euro area bank deleveraging

October 27, 2012

Since 2008, Bank delevering has been on of the key drivers of the euro areas poor economic performance and its vulnerability to recurrent financial crises. Barclays Cross Asset Research nicely summarized and discussed its main drivers, whose impact is widely seen as most intense in 2012 and maybe 2013. ECB and IMF research suggests that the deleveraging is ongoing and could eventually reach an equivalent of 10-30% of euro area GDP.

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History of public debt reduction

October 27, 2012

In its October 2012 World Economic Outlook the IMF presented a 135-year study on public debt reduction strategies. It points out that debt stocks of over 100%  of GDP have not been uncommon and do not normally lead to restructuring. Indeed, in the developed world out of 26 episodes only 3 ended in default (Germany and Greece). Successful debt-reduction strategies typically use growth-enhancing and easy monetary policies.

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Consequences of euro area break-up fears

September 29, 2012

A very interesting Banca d’Italia study shows how euro area break-up expectations are becoming self-reinforcing, i.e. precipitating a divergence of sovereign yields and financial conditions beyond what is consistent with sovereign credit fundamentals.

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Chinese wealth management products

June 2, 2012

Chinese wealth management Products (WMPs) are a form of asset backed shadow banking deposit, paying above the rates of regulated banks. The WMPs have been soaring to become the second biggest segment of the financial system. The incur large maturity mismatches and hence are subject to serious liquidity risks.

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The basics of financial repression

May 9, 2012

A subtle type of sovereign debt restructuring is “financial repression.” Financial repression denotes a compound of measures to channel cheap funding to governments, accompanied by a steady dose of inflation. It was practised in the developed world during Bretton Woods era.

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