Most things in here don’t react well to bullets.

Mint – Blain’s Morning Porridge  - March 7 2014

Ryan, be careful what you shoot at. Most things in here don’t react well to bullets.

The world’s TV screens remained glued to the Ukraine. It’s becoming a classic gabfest/stand-off - an opportunity seized by disunited European politicos to say meaningless things and demand Russia does what they ask.

I am sure President Putin is very aware of the adage “there are no monuments to committees”. Surprisingly, Europe as a cacophony of national self-interests isn’t having the desired effect of disciplining the bear. (US readers – mild and obvious sarcasm alert.)

Unfortunately, as events 100 years ago showed, mittle-Europe unpleasantness has a disturbing habit of occasionally developing an unexpected non-positive momentum. At some point an ill-considered remark, ultimatum or demand might just backfire. As one wag commented on Facebook a few days ago: Please keep your Archdukes indoors this weekend.

Markets have such a situation in the rear view mirror, watching for potential/likely headline shocks. Otherwise, it’s how to play the long game, and business as usual.  

The long game is global growth – concerted policy driving growth creation through domestic strategies, global trade and solid politics – as the key factor. Central banks are unlikely to shock the hopes of growth through ill-considered rate hikes. We can probably apply “pretend and extend” to global rates far longer than the “nervous nellies” believe (editor's note: from the start, based on my experience of writing about the Latin America debt crises in the 1980s, I've said that we need near zero official rates for a decade, combined with 5-7% annual inflation, debt restructuring/extension and debt forgiveness: the other BB).

Today all eyes are on the US employment report, and how skewed it will be by the recent chilly US weather. I’m reliably informed by people who count such things that “weather” was mentioned 119 times in yesterday’s Fed Beige Book. It’s the weather stupid.. which I suppose means a weak number is a strong one.. Which begs the question.. why are we watching it.. but we will…

In credit markets, bonds continue to ratchet tighter. There is an interesting dynamic driving corporate demand. As is well known, Solvency 2 ALM matching provides a pretty solid incentive for pension/insurance funds to duration match assets and liabilities, thus putting large swathes of cash into bond markets. (We’ve wondered often enough how dangerous it is when our pensions have been regulatory stuffed with govie bonds.. it’s somewhat analogous to geese being force-fed corn – it may be tasty, but doesn’t end well for the bird.)

Corporate pension plans are generally back up, solvent and fully funded on the back of stock gains. The result is corporate CFOs have the opportunity to switch their corporate pension schemes into bonds to match liabilities. So they take advantage of cheap interest rates to raise cheap long-term funding to buy bonds issued by other corporates to put into pension plans to meet future liabilities.

That’s kinda circular… But rest assured. It’s happening.

Meanwhile, the demand for AT1 bonds – or 81s as we are now calling them here (think about it.. we are such wags aren’t we..) – seems inexhaustible. (81s are a wider epithet than CoCos.) Most of the names that have come to the CoCo/81s market thus far are generally acceptable names – decent bank names with sound capital cushions to cover any shocks.

What will set the 81s market reeling will be a shock trigger event happening, or a regulator enforcing a coupon stop – creating our old favourite: the zero-coupon perpetual bond. It’s likely to happen to a weaker name first… and contagion across the whole 81 sector will be immediate. So be concerned when you see weaker peripheral banks start to come to the 81 market in more regular style.  

For instance, this morning I read the four largest Greek banks require some €6bn in additional capital – one signal to start selling 81s will be when Greek banks issue.

Excellent comment from the credit analyst at a French bank pointed out that spreads on 81s are getting unattractively tight. As new deals are immediately trading tighter on the break, its only a matter of time before we see sub-6% coupons.. If you want un update on the market and don’t see our runs or recent commentary – give me a shout.

Full marks to Lloyds btw – their exchange offer to ECN holders into new 81s was fair and logical. Lloyds would now be perfectly within its moral rights to do a clean-up call at 100 on them.

So as another weary week wends to a close, I gaze out of our new eyrie on the 20th Floor here in The Wharf of Canaries… and look forward to what promises to be a sunny weekend. Have a great one..

Bill Blain

0207 786 3877

[email protected]

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