Hello Everybody. We are witnessing today uprisings in the Middle East region after successful dethroning of their ruling regimes. This Geopolitical event is adding seasoning to existing laundry list of issues. Today I will discuss current events around the world from my perspective and will add my analysis on US interest rates, swaptions.
This Week, Uprisings in Middle East, Finding next ECB leader in rudder less political Europe, Berlusconi and Ruby the heart breaker scandal in Italy, Inflation genie in Emerging markets, QE2 and Federal Reserve, Republican and democrats political drama in Wisconsin have peppered this week’s flow of economic events.
Uprisings triggered in Egypt following toppling Ben Ali’s regime in Tunisia. This has initially created flash point for Oil price rises. But somehow Mubarak’s regime lost its power to hold onto its position in front of popular uprising. Consequently Oil flashed sub 90. Today we are seeing further uprisings in Libya and Bahrain. This drove oil to 98. On the Eve of 2011 no one expected this event to come to play into existing global issues. As always Life is full of surprises and we are witnessing it live now. This kind of flux in Middle East adds uncertainty to Oil price. Global investors are discussing can this happen in Saudi Arabia. This all depends upon the dissatisfaction and unrest level in the Saudi youth. I will leave it to future but would definitely advise to hold on to some Oil calls. I think after Middle East if we focus at EU and see what’s going on there, it looks very ironic. At one end, ECB is struggling to find a new successor & Angela Merkel German premier is fighting her domestic elections and on other end Italian Premier is struggling in sex scandal. One thing common is every one is muddling through their problem. This brings into memory one of the great stories of the Nero playing Violin when Rome is burning. Today when recession is making it difficult for ordinary people to bring food to their dinner table, their leaders are finding ways to fight their issues instead of focusing on people. Currently inflation genie is slowly coming out of the bottle as measured by statistical reports. This brings me next to look at Emerging markets in latin America and Asia. Brazil, India and china are already flashing amber with regards to food price inflation. China is already tightening its monetary policy to arrest this inflation monster. Only course of time will tell who has won the battle. From Emerging markets to US to see how measures taken by Federal Reserve is affecting asset markets, Fiscal restraint drama enacted by republican governors. Ben Bernanke has slashed the interest rates to its lowest level, he successfully completed Quantitative easing first phase and started second phase. These measures appear to have stabilized stock markets, lowered Treasury rates and looks deflation is no more a problem. Now new problem we are seeing is inflation. Next at the political level we are seeing governors Wisconsin and couple of other states are targeting Public school funding reductions. In my opinion real cuts should come through clear cut reforming of Health care sector and slashing the burden on the entitlements. This can be done by creating a tiered health care structure. In this Basic health care will be free and additional health care services needs to be purchased at some insured costs. Any way this problem is more political and will be solved by the force of economics.
Interest rates and Options
This morning I read Analysis from Richard Koo (from Nomura) discussing US is following the path of Japan. Agreed his analysis has good graphs comparing the state of housing sector rise and fall in Japan and overlaid with US Housing sector. I am also seeing in local housing markets, prices are not rising. But one strange thing is sellers are still holding onto their price levels. I believe most of these sellers are doing what Issac Newton did during the south Sea bubble by holding on to his positions.
Rates have been decreasing since last week despite seeing higher CPI prints. 10y swap rates are at 3.69 and market consensus is expecting them to go as high as 4 this year. In my view this is a possibility. Skews have not changed much compared to January month end. Short dated skew for 5y tails is now moving away from super lognormal to lognormal. This means, payer skew is cheapening. Long dated skew is also becoming slowing more closer to Normal compared to what it was a month ago.
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