Three Events That Will Set the Tone for 2015

January 19 2015

January could very well turn into a highly memorable month. Later this month, the ECB and the Federal Reserve will indicate their intended policies for 2015 on January 22nd, and January 27th/28th respectively. The Greek elections are just around the corner and many companies will publish their financial statements while analysts expect the decline in corporate profits in a long time. 

Three Events That Will Set the Tone for 2015

January could very well turn into a highly memorable month. Later this month, the ECB and the Federal Reserve will indicate their intended policies for 2015 on January 22nd, and January 27th/28th respectively. The Greek elections are just around the corner and many companies will publish their financial statements while analysts expect the decline in corporate profits in a long time. Today, the EUR/USD dropped to its lowest level since 2003, the oil price crashed in an unprecedented way, the Dow Jones dropped for five consecutive trading days and the Swiss Franc rose by 20% on a single day after the Swiss Central Bank gave up its Euro peg. Continue reading if you want to know what is about to happen within the next two weeks.

Swiss Euro Peg Was Unsustainable

Last week, we compared the balance sheets of the three major central banks. We concluded that total assets of the Fed amount to 28% of U.S. GDP, those of the ECB amount to 16% of Eurozone GDP, and that the balance sheet of the Bank of Japan soared to 61% of Japanese GDP.

Since 2011, when the Swiss Central Bank initiated its price ceiling on the Franc, Switzerland has allowed total central bank assets to grow to 75% of Swiss GDP.

It is stunning that the Swiss National Bank did not hold its recently acquired euro’s as currency reserves, but exchanged them for riskier assets. The Swiss Central Bank has become a gigantic hedge fund. Obviously, we are not talking about a fund that is accountable to its customers and whose asset managers are putting their own money at risk. It has injected no less than $200 billion into the financial markets. To put this in perspective, the world’s biggest hedge fund (Bridgewater Associates) has $78 billion of assets under management.

This clearly refutes the illusion that hedge funds rule the world. We live in a world dictated by central banks, not hedge funds.

This does not only refer to the Swiss Central Bank; other central banks are equally active in the financial markets.

It is even an open secret that central banks actively purchased S&P 500 futures. Other central banks are also buying billions of assets that, historically, they never bought. In the past, central banks only traded highly-liquid short-term bills of exchange; now central banks buy stocks and mortgage derivatives in quantities that would cause an instant heart attack to every economist of the past.  

We are conducting the biggest monetary experiment of all times.

With the decision by the Swiss Central Bank in mind, the focus of attention has now shifted to the ECB meeting of next Thursday. The expectations are sky high, which means that whatever asset purchasing program the ECB will announce, it can only be disappointing to the financial markets. This may have a negative impact on gold. My guess may be wrong, which would mean that the gold price could quickly rise to $1,300/oz or more.

There is No Way That Greece Will Turn out “Just Fine”

Let me picture the situation: the Greek national debt amounts to €317 billion. Three quarters of this sum is held by public institutions: the IMF, European governments (directly and indirectly, more details will follow) and the ECB.

As you may remember, the Greek sovereign debt has already been restructured before. While it was affirmed that Greece would be saved by the European powers, the losses were mainly shifted to the private sector. This explains why the private sector holds a comparatively small share of the Greek national debt.

If you were to ask your neighbor what European country paid the lowest interest rate on its bonds in 2013 ? Germany or Greece ? most would instantly choose Germany. The contrary is true, though. The average interest rate paid by Greece was 2.3%. Germany paid a little over 2.5%.

The expectation is that opposition party Syriza will win the Greek elections, which would result in a Greek threat to leave the euro in order to obtain additional debt relief.

Who will pay for the losses in that scenario?

Around €142 billion of the Greek national debt is financed through the European Financial Stability Facility (EFSF). This is an indirect financing mechanism. The Netherlands guarantees part of the sum lent by the EFSF, but does not provide (or very little) direct financing. But it also finances Greece by means of direct state aid.

The Netherlands guarantees 5.7%. Looking at both the direct state-aid and indirect state-aid through the EFSF, we see that over €11 billion is at stake for the Netherlands. This amounts to over €1,500 per employed person in the Netherlands.

Greece is on the verge of collapsing.

The debt level continues to rise, currently more than 160% of GDP. However it was the Troika (a delegation of the European Commission, the ECB and the IMF) which once suggested that a debt amounting to 120% of GDP was unsustainable.

Interest expenses can hardly be lowered any lower (after all, Greece already pays less than Germany!) while the debt level continues to rise. Full debt restructuring or “Grexit” is the only way out. We will see how many votes Syriza, the opposition party, will receive during the upcoming Greek National Elections on January, 25th.

The Federal Reserve for Dessert

The elections are followed by the FOMC’s meeting (the Fed’s interest rate setting committee) on January, 27th and 28th. We can expect a thing or two as well. Analysts hope to infer when interest rates will be increased, although the Fed may use the recent volatility as an excuse to postpone an interest rate raise for some indefinite amount of time.  

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