Unintended consequences

February 12, 2016

Yesterday’s session once again opened up the divisive world of currencies. With Fed rate hikes off the table, then that dynamic is no longer applicable for the market. It’s become a lot more about risk, but more specifically the inability of central banks to counter-act the instability and uncertainty we are seeing, whether through words, actions or deeds. Indeed, the question is to what extent they have contributed to the current round of volatility and uncertainty through policies of negative interest rates, which we’ve seen in Switzerland, Sweden, Japan and the Eurozone in various forms. As is often the case, there are negative and unintended consequences when you turn the world of finance upside down, as happens when you ask depositors to pay for the privilege for depositing funds with you.

The other issues in markets this week has been the further fall in banks stocks, together with the sell-off in CDS and also CoCo bonds. The irony is that such bonds were designed to act as a buffer between banks and governments, taking the strain through cancelled interest payment or, in extremis, conversion into equity, to avoid governments taking the pain and bond-holders sitting pretty (as happened in the global financial crisis). The irony is that the lack of liquidity in many markets (in part owing to banks pulling back from taking risk) has contributed to the cure becoming the thing that is killing the banks. Another example of the law of unintended consequences.

There has been little respite overnight, with the Nikkei down nearly 5%, although European equity markets are seeing some stability in early trade. The yen’s move below the 112.00 level has yet to be sustained. There is some scattered talk in the market of possible intervention on the yen from the BoJ, but this is just speculation, given the extent of the move seen and the likely internal disappointment and frustration that the move to negative rates last month proved to be so ineffective on the currency.

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