Prophetic or what

Money Markets

Looks like I managed to call the fall in Yen about right – it hasn’t collapsed, but has still managed to give up 3 or 4 percent in a couple of weeks. Add in the usual FX leverage and you could have been looking at 30 or 40 percent returns. It’s funny how you always remember the good trades.

What about the dollar overall you may ask, well there seems a pretty well defined correlation between positive stock markets, accompanying increase in risk appetite and a fall in the dollar’s value. This might work for a while, but what if the news continues to buoy markets? Surely this should translate into a stronger dollar? A quicker recovery should be good for the economy, attracting investment and fuelling an increase in the need for the dollar (once all the massive holdings of dollars reserves have been exhausted). Couple of caveats, that someone has money to invest from another country/currency and that the stockpile of sidelined cash isn’t so stupendously huge that it could fund a 2,000 point rally on its own.

Conversely if the investment outlook takes a turn for the worse expect the dollar to keep appreciating.

Evolving Central Banks are at the forefront of new policy; quantative easing has been used a few times in the press when describing the Fed’s response to near zero rates. As one commentator put it you would have assumed that with (US) rates near zero the Fed could pack up and have a nice time off, instead they are forging new responses to the generally accepted methodology of cutting rates to stimulate an economy and raising them to slow things down.

A simple description of quantative easing is the creation of money (from nothing by the central bank) which is then leant back to the market. The market (banks) can then leverage this cash for new investments (loans). In theory $100 million of new money could generate $1billion in new customer loans and thereby unblock the credit dam. In reality there will be only a few banks who will feel confident enough to embark on a new round of lending to the potentially insolvent (read “currently employed”). 

The Fed recently announced plans to ‘create’ another 1.1 trillion dollars, that’s 1 and twelve zeros after it – in case you are starting to lose track of how much that is. It used to be millions and billions, now it’s billions and trillions, an easy 1 thousand fold increase.

Without exception the world’s banks have been trying to get their capital to a higher level. A simple explanation of capital is how much the bank (and its investors) has put up of their own money, (retained earnings and share capital plus preference shares). The Bank for International Settlements (BIS) set the parameters of how to measure investments against that capital, cash and coins are weighted at 0%, risky loans might be 100% weighted. At the moment, the goal is to achieve a Tier 1 ratio of capital to investments (as specified by each regulator) as high as possible and has spawned a mini arms race to see who can ‘show’ they are best placed. However it comes at a price.

Typically in the US, UK, Canada and Europe this ratio must be a minimum of 4%, in Cayman that ratio is set by CIMA and is a multiple of that. In short, Cayman banks are required to have much higher reserves. This partly explains why the banks here are all better placed than their onshore counterparts to weather the financial storm.

Be careful though when looking at a bank’s capital; if it’s being bolstered by expensive capital it may look good on paper today but will hamper a bank in the long run to make money. Those preference shares will slowly bleed a bank dry if they are issued with too high a coupon. Much better to get a Government guarantee to ensure you are only paying slightly over Sovereign risk rather than capital market prices.

Being in the business of assessing risk constantly it can come as a surprise when you see irrational behaviour in the face of risk. Everything in life has a risk. Most of it is accepted and ignored – think crossing the road, simple, measured and yet still has a life changing potential. The key to risk is understanding it and responding accordingly, if you don’t understand the risk, educate yourself. Alternatively never cross the road. How dull.

Disclaimer: The views expressed are the opinions of the writer and whilst believed reliable may differ from the views of Butterfield Bank (Cayman) Limited. The Bank accepts no liability for errors or actions taken on the basis of this information.

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