10/21/2016 - The Roundtable Insight: Yra Harris on Deutsche Bank, Systemic Risk and the U.S. Elections

FRA is joined by Yra Harris in discussing the impact of the potentially failing Deutsche Bank on the global economy, along with the state of US markets as election day draws closer.

Yra Harris is a recognized Trader with over 32 years of experience in all areas of commodity trading, with broad expertise in cash currency markets. He has a proven track record of successful trading through combination of technical work and fundamental analysis of global trends; historically based analysis on global hot money flows. He is recognized by peers as an authority on foreign currency. In addition to this he has Specific measurable achievements as a member of the Board of the Chicago Mercantile Exchange (CME). Yra Harris is a Registered Commodity Trading Advisor, Registered Floor Broker and a Registered Pool Operator.

He is a regular guest analysis on Currency & Global Interest Markets on Bloomberg and CNBC. He has been interviewed for various articles in Der Spiegel, Japanese television and print media, and is a frequent commentator on Canadian Financial Network, ROB TV.

DEUTSCHE BANK

We don’t know if Deutsche Bank is a buy-in opportunity. It’s based on the fact that the EU and Germany will not allow Deutsche to fail. This extensive systemic risk because of the fact that Deutsche Bank is one of the world’s largest notional derivative books – of about $46T at the end of last year – represents a lot of risk in terms of derivatives meltdown between counterparties. While the ECB balance sheet has grown from €2T to €3.4T in just 18 months, there’s only about €7.5T outstanding Eurozone sovereign debt. It represents a challenge going forward in a very quick period of time, in terms of the overall systemic risk to the European banking system.

Its risk profile is based on Deutsche’s own models, so we don’t really know what the exposure is. It ought to be a higher risk rating than they reveal.

CAN’T LET DEUTSCHE FAIL – WHAT THEN?

It would be extremely difficult to bail Deutsche out or bail it in. If you want to see financial repression, watch what the ECB is doing to the savers in Germany. They’re bearing the bailout of the entire European project. If there was a bail-in, that would cause even more political angst. If that balance sheet grows big enough, no one can escape the EU ever, and the German taxpayers will be on the hook for this forever.

The German government is boxed in. It could go in the direction of a bailout of 100M to potentially a bail-in, as part of financial repression where there’s a wealth confiscation of assets that take place at the capital structure layers, anywhere from bank depositors to senior secure bond holders. It could happen either way or a combination of both. Or you could have both, or have the European Central Bank step in and monetize a lot of the bailout in terms of assistance for quantitative easing programs.

Mario Draghi would like to increase QE, but there’s no chance of that happening. He’s under a lot of pressure, and wants to build that balance sheet up bigger and bigger. Central bankers are running out of tricks and ammo.

The US equity market has now broken out of the uptrend. The equity market is fairly valued, but vulnerable to a sell-off. Wall Street would prefer Hillary, but she will certainly raise capital gains or the holding period in which you can obtain capital gains. People who have been in this market and have long term capital gains will likely sell that which they can before the end of the year, which makes this market vulnerable. Corporations have piled up so much debt that it weighs on this market dramatically. The amount of debt piled on the balance sheets around the world is just enormous.

The markets are vulnerable from the perspective of overvaluation measures and overhanging debt, but also from the potential of helicopter money for doing projects like infrastructure to provide a stimulus to the financial markets as well as the economy. The asset markets will have to go down significantly to some level to prompt fiscal authorities to bring the political will together to create fiscal stimulus. With increasing central bank buying of stocks, that will likely artificially support stock markets.

US PRESIDENTIAL RACE

Trump makes the markets nervous, because they don’t like unknowns translating into high volatility in the markets. Trump might be anti-trade, which could affect international companies, but Clinton might bring geopolitical events that could negatively affect the markets as well.

Several people have laid out the possibility that if Trump pulls out a surprise upset victory on election night, there would likely be calls to say this was Russian tampering and that election results should be put on hold until it could be determined if foreign interests undermined the election. This will likely provide a great deal of social unrest, which could translate into a lot of economic uncertainty. There’s a lot happening outside of North America that could work to propel the US markets higher with a strengthening dollar.

US DOLLAR STRENGTHENING

Last week we saw, for the first time since February, the US dollar move above 97.50 on the dollar index. It’s starting to look like the makings of an upside break-out in the dollar index. When you look at the problems around the world, it’s hard to believe the Euro is still above par. The Yen is still 20% higher on the year. The dollar ought to be higher, but it’s not. The central bankers are working to manage the stability of currencies relative to each other, but overall we’re looking at the decline of purchasing power of money regardless of currency.

This is about global assets – they’re all somewhat in trouble here.

PORTFOLIO CONSTRUCTION AND ASSET ALLOCATION

Treat everything as short term trades. If you can turn it into a profit, go ahead, and go on to the next one. It’s very difficult to say in a medium or long term sense because of the strong tug of war between inflation and deflation type forces. We have strong deflationary forces that are naturally happening in the financial system being counterbalanced by the very inflationary forces provided by central banks. It could go either way in a medium term. It would be difficult to quickly change your portfolio, but perhaps a diversified portfolio in the medium-long term with this short term trading strategy.

Another way is looking at companies with little or no debt, high discounted free cash flow with little or no leverage.

Abstract by: Annie Zhou <a2zhou@ryerson.ca>

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Disclaimer: The views or opinions expressed in this blog post may or may not be representative of the views or opinions of the Financial Repression Authority.