Mish's Global Economic Trend Analysis

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Mortgage Refis Plunge Following 76 Basis Point Rise in 30-Year Rate; Treasury Yield Reaches 14-Month High; What About Convexity Hedging? Posted: 11 Jun 2013 12:47 PM PDT Curve Watchers Anonymous has been watching the rise in interest rates across much of the yield curve. Yield Curve as of 2013-06-11 click on chart for sharper image As one should suspect, mortgage rates have been rising in conjunction with the rise in treasury rates. Here is a chart from Steen Jakobsen, Chief economist at Saxo Bank in Denmark. Note the annotation "30 Yr mortgages rate is up 76 basis points on the year with no growth increase". the phrase "no growth" pertains to lack of growth in the overall US economy. BankRate notes the following 3-month trends. 30-Year Mortgage Rate 15-Year Mortgage Rate 5/1 ARM Mortgage Rate As one might suspect this rapid rise in mortgage rates will wreak havoc on mortgage refinancing. And it did. I called a couple of my industry contacts and they state refinancings have plunged by 50% or more. One contact says there has been spillover into new home applications, another has not seen that "yet". Word About Convexity As rates rise, three things happen. Refinancings plunge Losses mount Hedging increases Bloomberg discusses convexity hedging in its report Treasury Yield Reaches 14-Month High. Convexity Hedging "Some people are probably concerned that Treasury yields are approaching a level that would trigger convexity hedging, which will push yields even higher," said Soeren Moerch, head of fixed-income trading at Danske Bank S/A in Copenhagen. "That adds pressure to the market." As rates increase, the potential for refinancing mortgage bonds and loan-servicing drops, extending the average lives of the securities and leaving holders more vulnerable to losses. Investors then may seek to pare the duration risk or rebalance existing hedges by selling longer-dated Treasuries, mortgage bonds or transacting in interest-rate swaps or options on those contracts, sending yields higher and spreads wider. Dealers from Deutsche Bank AG to Barclays Plc said the risk of that happening was reduced by the fact the Fed currently has $1.2 trillion of mortgage-backed securities in its stockpile, making it the biggest holder of the securities. No Repeat "The actual convexity hedging flows will be less when rates rise this time than it was in the past," said Dominic Konstam, global head of interest-rates research at Deutsche Bank. The hedging "was massive in 2003, and we won't see a repeat of that. With the Fed holding so much of the mortgage paper, it really knocks down the amount of mortgage hedging needed when yields rise." Convexity hedging "may not" kick in, "as much" but the Fed is buying massive amounts of treasuries,  yet treasury yields soared, with mortgage rates up a very significant 76 basis points in little over a month. Mike "Mish" Shedlock http://globaleconomicanalysis.blogspot.com  Mike "Mish" Shedlock is a registered investment advisor representative for SitkaPacific Capital Management. Sitka Pacific is an asset management firm whose goal is strong performance and low volatility, regardless of market direction. Visit http://www.sitkapacific.com/account_management.html to learn more about wealth management and capital preservation strategies of Sitka Pacific.

German Constitutional Court to Rule Whether ECB Actions Violate German Law; Irrelevant Arguments and Outright Lies; Dangerous Games Posted: 11 Jun 2013 10:11 AM PDT The German Constitutional Court in Karlsruhe, heard arguments on Tuesday on whether ECB measures to contain the eurozone crisis violate German law. The court does not have the power to block the ECB, but it does have the power to restrict German participation in various funding schemes. The New York Times dramatically states German Court Debates Fate of Euro. Karl Albrecht Schachtschneider, a retired law professor and well-known euro opponent, told the court he hoped that "the euro adventure will be brought to an end for the good of Germany and the good of Europe." On the opposite side, Wolfgang Schäuble, the German finance minister, warned that the cost to Germany would be incalculable if the country left the currency union. And he pointed out that under the European Central Bank, inflation has been lower than it was with the deutsche mark. "The E.C.B. is acting within its mandate," he told the court. Mr. Schäuble said the central bank could be put into an impossible position if it were faced with conflicting rulings by courts in different euro zone countries. The hearing, in a fenced-off court and police complex in a wooded area outside Karlsruhe, a city in southwest Germany near the border with France, drew an eclectic group of Germans on both the left and right who deride the euro as a travesty and long to bring back the deutsche mark. Outside a security checkpoint, several dozen anti-euro protesters chanted and waved signs. One sign called for Jörg Asmussen, a German arguing on behalf of the E.C.B. in the hearings, to be thrown in jail, an indication of the emotion that some Germans attach to the issue. Mr. Asmussen, a member of the E.C.B.'s Executive Board, and Jens Weidmann, president of the Bundesbank, were expected to argue opposite sides of the question later in the hearings, which continue through Wednesday. Mr. Weidmann is expected to repeat his counterposition, often expressed in speeches and interviews, that buying such bonds would violate a prohibition against using the euro zone's central bank to finance governments. The objections raised by the opponents of European Central Bank action tended to follow a similar set of themes. The central bank's policies, they said, will evolve into a means to transfer German wealth to Greece, Italy and other European Union countries against the will of the German people. E.C.B. policies will save banks at the expense of ordinary citizens, complainants argued. Irrelevant Arguments and Outright Lies Schäuble said "the central bank could be put into an impossible position if it were faced with conflicting rulings by courts in different euro zone countries." So what? That is not the problem of the court. Schäuble said inflation was lower under ECB mandate. Once again that has nothing to do with the legality of the issues at hand. Schäuble warned that the cost to Germany would be incalculable if the country left the currency union. That comment is disingenuous at best. It ignores the huge potential costs to Germany if Germany stays in the eurozone. Regardless, the argument about costs of a breakup are irrelevant. There is only one issue in this case that is relevant: Do any ECB actions or proposals violate a German constitutional prohibition against using the euro zone's central bank to finance governments? I am certain they do. Whether the court pushes the line one more time is the only issue in doubt. I suspect they will, again, with still more wishy-washy language regarding where the line in the sand is. You can see a strong hint of that possibility as the Times points out "questions [by the judges] suggest the court might rule on narrow grounds, arguing that at least some aspects of the complaints were premature". Dangerous Game Spiegel Online Guest Commentary by Peter Bofinger says ECB Case at High Court: The Bundesbank Is Playing a Dangerous Game With its opposition to the ECB's bond-buying policy, the German central bank is pursuing a risky strategy that may stem in part from a desire to enhance its own power. The Bundesbank concedes that the purchase of bonds by central banks is a common practice, but notes that in the case of the United States, Japan or the United Kingdom, central banks only buy bonds of high creditworthiness. The ECB, by contrast, plans to buy bonds of "poorly rated member states" in order to reduce their high-risk premiums, writes the Bundesbank. In doing so, Bundesbank officials are deliberately ignoring the fact that the budget deficits and debt levels of the aforementioned three countries are in some cases considerably higher than in the crisis-hit nations of the euro zone. The "high creditworthiness" doesn't reflect budgetary discipline there. Rather, it stems purely from the fact that the central banks in question opted for large-scale bond buying to give a clear signal to market participants: the US, Japan and the UK will never suffer a liquidity problem in the bond markets. Mud Slinging All the euro proponents can do is throw mud and hope some of it sticks. It's quite a stretch of the imagination to propose the Bundesbank purpose is to "enhance its own power". Regardless, "why" Jens Weidmann, president of the Bundesbank, has pursued this action is of course irrelevant. The only question at hand is whether or not ECB actions violate the German constitution. Two-Faced Presentation Finally, I would like to point out the blatant two-faced nature of euro proponent arguments. On one hand they want the court to believe ECB actions will be limited, and on the other hand they want the ECB to do anything and everything (including buying outright junk) in a "whatever it takes" approach, regardless of the risks to German taxpayers, and regardless of constitutional issues. The end clearly justifies the means for euro proponents. And here's the irony: The true "dangerous game" comes when populists seek to ignore constitutional issues for the sake of convenience. Nothing good ever comes from such actions. Mike "Mish" Shedlock http://globaleconomicanalysis.blogspot.com Mike "Mish" Shedlock is a registered investment advisor representative for SitkaPacific Capital Management. Sitka Pacific is an asset management firm whose goal is strong performance and low volatility, regardless of market direction. Visit http://www.sitkapacific.com/account_management.html to learn more about wealth management and capital preservation strategies of Sitka Pacific.

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