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Macroeconomic signals - associates debate

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Bristow and McDowell havin a chat in public (very nice), Bristow first ,,,,,













I think there can be little doubt about commodity prices, a Strong probability of oil being back over $100 USD a barrel during 2011 given the OPEC output reductions to leverage pricing after the hiatus at 140 USD and the fall back to current levels, and a considerable probability of corn, meat and other food staples rising in cost given the rises in animal food costs and possible shortages of key arable crops. Market volatility will certainly increase driven predominantly by manipulations of the bond markets leveraging the current sovereign default situations, the perilous nature of certain economies in terms of deficit and debt ratios, proposed direct tax rises which will impact GDP and the already depressed credit markets with high PD risk and reserves, the increased capital requirements of B3 Tier 1 capital provisions and of course the range of necessary austerity measures being introduced. The US QE measures have been a temporary patch fix however there is little demand in credit markets which must depress consumer markets and of course the budget deficit which is very costly to maintain at 440 bn USD interest payments annually are unsustainable and this means inevitable austerity measures as this debt cannot continue to spiral given the state of the property market with the securitisation of lending and the addition of market volatility to credit risk and this is before we consider the balance of trade deficit and rising unemployment costs with its double fiscal whammy now at 10%.

One of the major risks is of course not only in the CDS market and the correspondent default risks which does affect hedging, but one must consider that whilst 80% of derivatives relate to interest and FX hedging, there remains a further 130 trillion USD circulating of the total 650 trillion derivatives market which relate to other forms of derivative, many high risk and relating to securitised credit risk in one form or another added to the various forms of SWAPS, forwards and options. The OTC market may be come more rigidly controlled and managed but it should not be forgotten the sheer volume of these “weapons of mass destruction” that are still present within the system. From electronic trading to dark pools to questionable ratings, to inaccurate valuations there is still a great deal of submerged risk to both liquidity and in some cases solvency which has not yet sent he light of day. The balance sheet asset write downs in Europe of 550 billion euros at the end of 2009 was said to be an interim payment and one of the large consultors estimated at the time that exposure was potentially triple this sum and that was before the sovereign debt crisis. Trading volumes are down around 30%, there is tremendous volatility in bond markets and of course the transition to electronic trading and arbitrage hungry cyber bots as John Angus calls them do create significant volatility at lightening speed with large volumes chasing small arbitrage margins in a snowball effect. Having reached the point where MIT describe 4 milliseconds as an eternity, the old days of the bear pits and screaming traders have given way to ultra fast e systems which JAM and I are writing another paper about currently. Circuit breakers which shut down e trading after 5 minutes of an exchange varying by 10% is of little comfort in a world in which it takes 4 second to move a 1000 million euros according to Jerome Kerviel, and core legacy systems take 1 to 3 days to produce a t-1 partial risk analysis on a Tier 1 portfolio. Even given he fact that Tier 1 capital proposals under B3 are calling for an average 7% safety margin of regulatory reserve capital plus a 2.5% counter cyclical buffer of little use is this information when risk adjusted valuations take 1 – 3 days to model, stress and calculate and if Irish bonds are to be subject to a 20% haircut at junior levels of little use would a 7% capital buffer be to a fund which was structured of this type of asset.
So yes; there is more pain to come on balance sheets, many are over valued and not properly adjusted for risk in terms of the asset risk profile and market risk exposure, there is an elevated provision for PD on credit risk in property and other credit markets, market speed and volatility is increasing, the stress tests which excluded sovereign debt convinced nobody and Ireland has shown why this was the case at 85 billion euros, 35 billion of which is destined to bank recapitalisation and 50 billion of which is for government recapitalisation, and the volatility of the bond markets when coupled to sovereign default risk, peripheral lending risk, and gdp to deficit and debt ratios being at critical levels in Europe where they have typically doubled over the last decade all combine to create a highly volatile scenario. The fact that the sovereign default risk and potential bond market manipulation represents significant volatility and thus profit opportunities also explains the fervour in propaganda in order to pressurise and therefore manipulate market confidence and pricing to produce the crises of confidence which leads to the profit opportunities. Some concerns are genuine and the numbers are self evident and then add in a very large dash of hype and periodic arbitrary opinions from unaccountable rating agencies destabilising matters further to fuel the blaze with petrol.

by David R Bristow

Response by Robert McDowell

I am much more comfortable with Government debt and deficits including debt interest (much of which in most countries involves a quarter to half paid merely from one arm of government to another). The debt and deficits data overlooks financial assets acquired in the same time as gross debt and deficits rise - I don't consider the net positions to be alarming and therefore perceive the sovereign debt crisis as much exaggerated and to be political and market-brokers' and macro-speculators engendered.  Ireland and Greece etc. are highly dependent economies and not truly sovereign that have been giving a good kicking that while not undeserved by the banks and some others is also to make the bigger culprits look good only by relative comparison.

I agree about markets remaining volatile and the massive issues concerning OTC, hidden and fragmented markets. I would want all of these at least statistically reported and as far as possible brought "on-exchange". FX, MM and Bonds trading is almost all off-exchange and that is absurdly risky.  Derivatives are both on and off exchange and should all be on-exchange and processed in clearing houses.

The main calamities, or what will appear to be such, coming soon, are China falling off a cliff and along with much of the rest of Asia (Australia is already falling over the edge) and a recession phase for the Euro Zone and C.Europe generally - it's normal recession now due given that the Credit Crunch recession was only a transmitted shock effect from USA/UK etc.  Hence much of the under-recording of credit losses in C.Europe will now be properly exposed by a more prolonged dose of 'normal' recession. Emerging market economies will also have a  negative shock when their current commodity boom ends - and as many times in the past there will be a flight to $/£ markets including property.

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