Tuesday, February 28, 2012

Never a dull moment ...

On the eve of the European Central Bank's second LTRO (long term repo operation) the street is all over the map on the size of the liquidity operation and its effects.  The consensus is looking for total borrowing between 400 and 600 billion Euros.  If the amount comes in around that range it will be generally positive for stocks but nothing that will move the market substantially.  What we don't want to see is a number that's too high or too low.  If the ECB loans out closer to a trillion this will be negative for the Euro and because the Dollar moves inversely to the Euro, such a result would initially spark a Dollar rally initially and force a correction in stocks.  However, once the smoke clears and everyone realizes that European banks are even more insulated from a possible sovereign default I believe risk assets will renew their rally.  In any case, unless the borrowing is less than 300 billion Euros, Gold and Silver will continue their rise.

But now there's another event overshadowing the LTRO.  A news blurb out of Reuters this afternoon stated that the International Swaps and Derivatives Association (ISDA) is going to meet on Thursday morning to decide whether the terms  of the "voluntary" debt restructuring negotiated with private debt holders of Greek debt should trigger credit default swaps these investors purchased as protection for what exactly is occurring at this time.  This could be a real market mover.  On the face of it, the outstanding exposure on Greek sovereign debt is a net 3 billion.  However, the CDS market is unregulated so there's no clearing house to identify counterparties to trades.  And in the vast over the counter market there's no way to tell how many of these swaps were used as collateral in other leveraged trades.  When Lehman went down in 2008 and these instruments were triggered many owners of these swaps called their counterparties to call in their protection and no one answered the phone!  Consternation over this meeting could possibly spur a correction in stocks.

So now it's not just the LTRO we have to watch but the ISDA meeting on Thursday.  Never a dull moment ...