Monday November 28

Stocks fell to start the week, with the Opec meeting and the Italy referendum as two risk events on the horizon. The S&P 500 fell 0.5% to 2,201 and the Dow Jones fell 0.3% to 19,097. The KBW Bank index today fell 1.8% while Utilities rose 1.8%, indicating that recent post-election trends lost some of their momentum. Both are binomial outcomes that will drive risk for the foreseeable future in their respective markets. It is hard to predict either outcome given the nature of the Opec discussions and the fact that political polls have not been very credible this year. A “No” vote in Italy would have the most adverse affect on Italian banking stocks since eight banks are in distressed territory and the current prime minister has been an advocate for coming up with a solution. US equities are still near record highs. The two year Treasury yield fell 1bp to 1.11%. the ten year Treasury yield fell 5bp to 2.31%. 2yr vs 10yr bull flattened to 1.21%. In FX markets the US dollar was weaker for the most part against peers with the exception of the pound. USD fell 0.2% against EUR to $1.0609. USD fell 1% against JPY to Y112.07. USD rose 0.5% against GBP to $1.2411. Oil prices rose in spite of bearish headlines over the weekend. WTI rose 1.8% to $46.89. Brent rose 1.6% to $48.01.

Banks are hoping that financial deregulation will also bring back the Volcker rule. Volcker rule prevents banks from taking principal risk on their balance sheets and in their trading books. This inhibits private equity investments and proprietary trading. In order for Volcker rule to be formally eliminated it would have to go through Congress, making it a difficult process. However some analysts believe that an alternative would be for regulators and compliance managers to simply not enforce the rule as strictly as they did before. The rule as it currently exists is very subjective, and trade criteria that is outlined as impermissible in the Volcker Rule is highly subject to interpretation. It wouldn’t be difficult for regulators to take a more lenient interpretation of the rule under the new administration. However any informal response would have to garner support from a variety of different agencies. The OCC regulates trading done on behalf of national banks, the SEC regulates broker-dealers, and the CFTC handles swaps trades. The largest banks have each of these, and each would be affected by a more lenient Volcker Rule interpretation. The largest banks lobbied heavily against the rule, and it has drawn criticism from Jamie Dimon in the past.

Hopes for an Opec deal are once again being reined in amid tension between both Opec and non-Opec members. In September Opec members agreed to a modest production cut, however the key details regarding which countries the cut will come from will be ironed out on a meeting this Wednesday. On Saturday Iran said it would seek an exemption from production cuts. Nigeria and Libya are also expected to get exemptions because of supply disruptions in those respective countries. However Saudi Arabia most likely will be less willing to cut production if Iran is seeking production. Iraq has also expressed reluctance in joining the plan since it needs funding to finance its conflict with Isis. Additionally over the weekend Saudi Arabia’s oil minister suggested it might be better to let prices rebalance on their own. Saudi Arabia and Iran have been at odds for a long time, as Saudi Arabia is Sunni and Iran Shiite. Even if Saudi Arabia is able to find non-Opec countries to cut production as well, it still wants Iran to bear some of the burden as well. Russia has expressed a willingness to participate, however Saudi Arabia said it would not negotiate with Russia until an agreement within Opec is reached. Iran is coming off of sanctions and thus is not very willing to cut production at current levels. Iran’s economy is more diversified away from oil relative to other Opec countries. Just 25% of its budget comes from receipts from oil exports, compared to 70% for Saudi Arabia. Iran said it wants to be at its pre-sanction production levels before considering output cuts, which is estimated to be around 4mm barrels a day. Currently it is believed to be pumping between 3.7 and 3.9mm barrels a day. Analysts expect that if no deal is reached oil prices may fall back into the $30s.

Even as financials have been among the biggest beneficiaries of Trump’s election victory, Italian bank shares have struggled as a result of NPLs and political risk. Year to date Italian banks have underperformed European peers by around 40%. While US banks have risen around 15% year to date, Italian banks are down more than 50%. Today alone UniCredit is down 4%. Eight of the largest and oldest banks in Italy are in different stages of distress and the current administration has been somewhat willing to recapitalize the sector. While the Referendum on Sunday does not directly touch the financial sector, if the No vote prevails and Renzi steps down the group that rises in popularity may not support the current administration’s efforts to recapitalize the banking sector. Banks have been issuing equity to raise cash on the hopes that the government will assist in the recapitalization. The stock price declines so far this year are investors pricing in these political risks. Italian banks have more than 10x as many NPLs as American banks do, and as a result the government has set up a rescue fund that buys equity in struggling banks as well as distressed loans from their balance sheets. Investors are now starting to look at this situation the same way they see Brexit and Trump in hindsight. As such analysts expect that the “No” outcome is priced in and that it would not be a huge shock at this point. If Renzi resigns investors would be far less likely to support and take risk in Italian banks, and would increase political risk.

Monday November 28

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