ECB day - rearviewmirror vs windshield

*Happy ECB day to everybody!

As preannounced by the ECB, we should expect a "no change" to interestrates today. Focus will be on what Jean Claude Trichet will have to say post the rate announcement.

My guess is that he will still be chasing the inflation ghost. Yes, we will have super inflation in a few years and probably stagflation before that, but only the economies that have survived til then will be able to experience it.
Being behind the curve long enough with an outlook to eventually be ahead of it by doing "nothing" from here will not work. Especially if the rearviewmirror is the preferred tool.



*Jean, please cut the rates - look out the windshield

Being on the Euro subject, it might be worth reminding that he has all the reasons in the world to cut interestrates down to zeroish. Ill mention a big one, its the CEE area.

First of all, the banks in the CEE area are mostly foreign owned.
A vast majority of the owners are banks from the Euro area.
These banks are increasingly facing threats of government stakes and nationalisation as their creditlosses mounts.
Government ownership implies a bias towards domestic lending leading to a significant reduction of funds to subsidiary banks and branches in the CEE area.




*The CEE area is extremely sensitive to reduction or withdrawal of private capital inflow
The CEE area is the most vulnerable Emerging market area globally when it comes to dependence on foreign private capital. According to BIS, net capital inflows 2007 was about zero% of GDP for Asian and Latam Emerging markets, while it was 14% of GDP for the CEE area.

Cross border claims for BIS reporting banks on the global Emerging market area was roughly 2.5 Trn Usd in 2007, which marks an increase by roughly 1.5 Trn Usd over the past 4-5 years. Destination for this capital was Emerging Asia and the CEE area mainly. While the capital impact as a share of %GDP was 2% in Emerging Asia, it amounted to 32% of GDP in the CEE area.

The extent of this private capital inflow has explained why the CEE region as a whole have been able to run such extensive current account deficits since the inflows exceeded the deficits , leaving the CEE area to build up their currency reserves. Now, as foreign banks reduce their presence and funds are likely withdrawn or reduced, this will leave the CEE area with a substantial funding gap.

We are already seeing the signs of hard currency shortages and this will likely increase going forward, with rating agencies downgrading CEE countries further as deficits swell and creditlosses mount, unemployment etc increase. As these outflows from the CEE area intensifies we might even see CEE centralbanks having to sell part of their FX reserves in order to cover the shortages. Since they are denominated in Euro, that means selling of Euros in the market.



*Dejavu of the 1997-1998 Asian currency crisis?

As mentioned yesterday, this reminds to a large extent of the situation during the Asian crisis (apart from most of those currencies being pegged or semipegged), as private capital inflows vastly overwhelmed ditto outflows pre crisis. This created big imbalances in the process which were duly reversed during the 1997/1998 Asian crisis. The CEE area is now at risk of experiencing a similar outflow with ensuing currency weakness.

Obviously, these creditlosses will hit "western european banks" and taxpayers in these countries. This will hurt the Euro further. Fingers crossed that Jean Claude Trichet has a look through the windshield soon.



*Protectionism on the rise

Looking at the other side of the Atlantic I am concerned by the statements of the new US Secretary of the Treasury, Timothy F. Geithner.

Partly for his talk about "currency manipulation" directed at China, partly for the Democratic winds of protectionism, where "Buy American Steel" in conjunction with the TARP money has been heard.

Mr Geithner brings me a dejavu of the Clinton administration in the early nineties when trade barriers and "currency manipulation" was high on the agenda. I am concerned Mr Geithner could bring about further financial protectionism, which would only escalate it further. Re China; Dont open Pandoras box Mr Geithner. Be grateful if "they" dont devalue.

In Europe we might soon see financial protectionism even within the Eurozone as the sovereign spreads splits the Eurozone are into North vs South and makes open markets unworkable under current terms.





*Scandinavian banks will get hit hard

In the Baltics, the Scandinavian banks are sitting on all the risk themselves. They are the Baltic banking system. These countries have currency boards - in a deflationary environment.

-Now, do you, dear reader, believe the Baltics have received private capitalinflows equal to or bigger than the CEE area when measured as % of GDP ?
-Further on, would you believe the Baltic assets are under more or less pressure than the CEE ones, given that they have floating currencies?
-Do you believe the Baltics will incure bigger or smaller creditlosses, as a % of GDP, than the CEE countries?
-Last question, would you believe that the banks responsible for the Baltic banking system will make it through this without government support?

Ill leave it to you to figure out the answers.
By all means, enjoy the shortsqueezerally in certain Nordic banks stocks. Just dont believe the bull(!) story.

SEB out with their report today. It was great. Hadnt expected anything else either.
But income is not where the focus should be at this juncture. The threats come from other areas, like creditlosses. SEB had reserved 898 MLN Sek for Baltic credit losses. I would guess 9 BN Sek would be more appropriate, but it still wouldnt be enough. But with 9 BN the result wouldnt look that good, would it? The huge discrepancies between balance sheet and market valuations is an ongoing theme that will create massive holes which will become very difficult to fill in.

Finally, SEB CEO Annika Falkengren is out saying that SEB have bought a "homeinsurance" by doing the IPO, zero dividend and creditloss reservations. No Annika, you havent. A homeinsurance is a Put and although you would need one, that is not what this is. You have sold a Call on the SEB, increased the premium for current Call owners and made a tiny value increase towards mark to market valuation of your creditportfolio. Hopefully Mrs Falkengren gets better advice going forward and learns the basic products her bank is selling.





As always, good luck









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