Thursday 8 March 2018

Duration losses on banks, political push backs and the EUs coming existential crisis.

Governments have been the big borrowers in this cycle, effectively reinflating the pre-08 credit bubble as opposed to dealing with the structural problems. 

Has anyone seen research on how big the duration losses would be if US rates go through 3% and flat to positive term structure? I haven't seen much if any.

The banks, if they are holding duration as a carry trade, will have negative NIMs/ carry plus mark to market losses. 

For example, European banks bought >$600bn of Treasuries since 2012. For now, I think most of the US curve near-term sell-off has happened, in fact, we could even have a counter-trend position clear out/ rally, but into year end perhaps we see another sell-off. 

In the interview below Yannis Varoufakis talks about the mark to market triggers in Europe. European banks are currently relying on EUR760bn in ECB LTRO funding which is collateralised and EUR800bn of TARGET2 funding which is un-collateralised at the moment. Most of that borrowing is by periphery banks. 

I have maintained that the real existential crisis in Europe will be politically triggered by a core member, Italy, France or Spain are the only real candidates, aside from Germany obviously. 

In this recent election, 57% of Italians under 44 years of age voted for M5S or Lega, both anti-EU parties. 

Mark Blythe and David Kertzer discuss Italy below:

We just have to see what happens in terms of a coalition in Italy and whether they are serious this time around (I doubt it) or whether we need to a see a few more years of Germany product dumping into the rest of the EU as the US and UK reduce imports.  Perhaps Italy has a short parliament now based on coalition and then another election in 9 to 18 months time. 

Trade wars

The US is a fairly closed economy and while their trade deficit hurts certain parts of the economy (suppressing low wage earnings and the manufacturing sector), a trade war cant really have that big a negative impact and there are positive impacts associated with the wage/inflation/ investment cycle rebalancing. 

Germany, on the other hand, is operating an intra-EU supply chain and labour arb business model and exports total over 45% of GDP. 

(Discussed here: and here:

Germany's trade balance with some of its largest trading partners:

Germany's export surplus to the top 3 alone is EUR145bn a year alone in 2016. That 4.1% of Germany's GDP just in trade surplus to 3 countries. 

If the US and UK impose tariffs/ hard Brexit tariffs what will happen?

Will, as Varoufakis suggests, the EU use the EIB to support EUR500bn of pan-EU infrastructure spending? Will the EU engage in a Belt and Road initiative in East Europe, the Middle East and Africa? 

Of course not, the private sector will immediately product dump into France, Italy and Spain. Maybe after an existential crisis, the EU's politburo will do the EIB infra plan. 

The political, business and employment consequences of Germany's private sector product dumping tens of billions of Euros in products principally into 3 EU countries will be the trigger for real EU crisis. 

So assuming nothing much happens stemming from this Italian election as whoever is in charge probably wont have enough authority to do anything serious, then we have Brexit in Q2 next year and the potential for an EU crisis going into year end or early 2020 triggered by the onsequences of German product dumping. The Fed should have raised rates into the 2.5-3% range as well by then.


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