A Tale Of Two Central Banks (Fed Vs ECB And Their Bank Stocks)

This is a tale of two Central Banks: The US Fed and the European Central Banks. And their respective commercial banks.

First, The Federal Reserve. US commercial banks recovered from the global financial crisis, although not completely.

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But for the ECB, such is not the case for European banks.

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Indeed, this a tale of two Central Banks.

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US And China Credit Impulses Are Negative (Annual Change As % Of GDP), Along With The Eurozone

The bad news? The credit impulses (annual change as a percentage of GDP) for both the USA and China are negative.

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The good news? The decline in China’s credit impulse is lessening.

If we throw the Eurozone into the Papusa, we see that the Eurozone has negative credit impuse growth, but is better than China or the USA.

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Since 2005, China’s sovereign yield curve has actually increased will Japan’s has dropped into negative territory.

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Evidence That Europe Is Slippin’ Into Darkness: 10Y German Sovereign Yields Lower Than Japan’s 10Y Sovereign Yields

Europe is slippin’ into darkness.

Evidence? 10-year German sovereign yields are lower than the major global low-yield leader, Japan.

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Of course, the European Central Bank is doubling down on its failed monetary policy.

Shilling: A Recession Is Coming, And Maybe a Bear Market, Too (Equities Normally Drop About 21% When The Economy Contract)

Shilling has an interesting Gary Shilling piece on Bloomberg on impending recessions and stock market declines. With a great photo of a bear waving!

I first suggested the U.S. economy was headed toward a recession more than a year ago, and now others are forecasting the same. I give a business downturn starting this year a two-thirds probability.

The recessionary indicators are numerous. Tighter monetary policy by the Federal Reserve that the central bank now worries it may have overdone. The near-inversion in the Treasury yield curve. The swoon in stocks at the end of last year. Weaker housing activity. Soft consumer spending. The tiny 20,000 increase in February payrolls, compared to the 223,000 monthly average gain last year. Then there are the effects of the deteriorating European economies and decelerating growth in China as well as President Donald Trump’s ongoing trade war with that country.

There is, of course, a small chance of a soft landing such as in the mid-1990s. At that time, the Fed ended its interest-rate hiking cycle and cut the federal funds rate with no ensuing recession. By my count, the other 12 times the central bank restricted credit in the post-World War II era, a recession resulted.

It’s also possible that the current economic softening is temporary, but a revival would bring more Fed restraint. Policy makers want higher rates in order to have significant room to cut in the next recession, and the current 2.25 percent to 2.50 percent range doesn’t give them much leeway. The Fed also dislikes investors’ zeal for riskier assets, from hedge funds to private equity and leveraged loans, to say nothing of that rankest of rank speculations, Bitcoin. With a resumption in economic growth, a tight credit-induced recession would be postponed until 2020.

“Recession” conjures up specters of 2007-2009, the most severe business downturn since the 1930s in which the S&P 500 Index plunged 57 percent from its peak to its trough. The Fed raised its target rate from 1 percent in June 2004 to 5.25 percent in June 2006, but the main event was the financial crisis spawned by the collapse in the vastly-inflated subprime mortgage market.

Similarly, the central bank increased its policy rate from 4.75 percent in June 1999 to 6.5 percent in May 2000. Still, the mild 2001 recession that followed was principally driven by the collapse in the late 1990s dot-com bubble that pushed the tech-laden Nasdaq Composite Index down by a whopping 78 percent.

The 1973-1975 recession, the second deepest since the 1930s, resulted from the collapse in the early 1970s inflation hedge buying of excess inventories. That deflated the S&P 500 by 48.2 percent. The federal funds rate hike from 9 percent in February 1974 to 13 percent in July of that year was a minor contributor.

The remaining eight post-World War II recessions were not the result of major financial or economic excesses, but just the normal late economic cycle business and investor overconfidence. The average drop in the S&P 500 was 21.2 percent.

At present, I don’t see any major economic or financial bubbles that are just begging to be pricked. The only possibilities are excess debt among U.S. nonfinancial corporations and the heavy borrowing in dollars by emerging-market economies in the face of a rising greenback. Housing never fully recovered from the subprime mortgage debacle. The financial sector is still deleveraging in the wake of the financial crisis. Consumer debt remains substantial but well off its 2008 peak in relation to household income.

Consequently, the recession I foresee will probably be accompanied by about an average drop in stock prices. The S&P 500 fell 19.6 percent from Oct. 3 to Dec. 24, but the recovery since has almost eliminated that loss. A normal recession-related decline of 21.2 percent – meeting the definition of a bear market – from that Oct. 3 top would take it to 2,305, down about 18 percent from Friday’s close, but not much below the Christmas Eve low of 2,351.

Now here is an interesting chart from BofAML showing global equity returns over global IG bonds and The Fed Funds rate.  For the moment, Global Equities/Global IG bond (total returns) are rising with The Fed rate increases. Interesting.

 

Exhibit-1 BofAML

BofAML’s chart does not support Shilling’s thesis. But it is because the BofAML chart focuses solely on The US Federal Reserve at a time where other major Central Banks are NOT tightening.

A grizzly bear waves at Madrid's zoo on

Deutsche Bank + Commerzbank = Ogre Zombie Bank (Nothing Plus Nothing = Nothing)

What do you get when you merge German zombie Deutsche Bank and zombie Commerzbank? An ogre zombie bank!

Or as Billy Preston almost sang, “Nothing Plus Nothing Equals Nothing.”

Both Deutsche Bank and Commerzbank are trading at under $10 or 10 Euros per share. This is down from over $100 per share for Deutsche Bank in the 2000s and Commerzbank was trading at over 200 Euros as well. How the once mighty have fallen.

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Earning per share for Deutsche Bank have plummeted despite efforts to revamp their business model.

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The same goes for Commerzbank.

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While Commerzbank hasn’t issued any contingent collateral (CoCo) bonds, Deutsche Bank has issued 4 CoCo bonds. Here is the 6% CoCo bond. The good news? Both CDS and the yield to maturity (YTM) have been declining in 2019, likely reflecting the expected merger of the two.

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The downside? Merging two large zombie banks creates an “Ogre Zombie” bank. One that the ECB and German government cannot permit to fail.

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The Mummy Returns! ECB’s Draghi Raises Their TLTRO Program From The Dead To Combat Weak Euro Area Growth

The ECB’s Mario Draghi has decided to raise the dead (as in Modern Monetary Theory) by reviving the ECB’s Targeted Longer-Term Refinancing Operations.

Mario Draghi revealed the biggest cut in the European Central Bank’s economic outlook since the advent of its quantitative-easing program as policy makers delivered a new round of stimulus to shore up growth. The ECB president said the euro-zone economy will expand just 1.1 percent this year, 0.6 percentage point less than forecast in December. 

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The central bank will revive its Targeted Longer-Term Refinancing Operations to encourage banks to provide credit to businesses and consumers, and will hold interest rates at current record-low levels at least through the end of the year, several months later than previously indicated.

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The Euro declined on Draghi’s announcement.

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And most Euro area 10 year sovereign yields are down 5 basis points or more.

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Draghi must not read from the Modern Monetary Theory (MMT) book!

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