26 September to 2 October: Back to the Future

In a throwback to the GFC, global markets closely tracked the Deutsche Bank share price last week. Long considered to be under-capitalised, DB navigated the post-crisis period “Italian style”, failing to properly address its balance sheet and protected by its national champion status. However, this year the share price has unravelled after the IMF judged the bank “the most important net contributor to systemic risks” and its US unit was one of only two to fail FED stress tests. The latest moves were prompted by a 16th September fine by US authorities for mis-selling mortgage securities amounting to USD 14bn. Given a price-to-book ratio of 0.25, this led to client’s questioning the bank’s solvency (some funds withdrew “excess cash and positions held at the lender”) and the share price hitting a 33-year low of EUR 9.90. However, reports that a USD 5.4bn settlement with the Department of Justice is close, saw a Friday recovery – by the end of US trading the company’s ADRs were 14% higher on the day.

Rumours of a reduced Deutsche fine are yet to be confirmed, but it is very unlikely that the bank will have to pay anything close to the original number. This is both because it is not in the interests of the regulator to create a systemic bank failure and because the fine appears outsize relative to peers. In terms of broader solvency, the current valuation makes it difficult to raise equity and for clients to have faith in the institution. Moreover, the question of political support is complex. However, the current central bank toolkit is far evolved from 2008, with a vast range of liquidity “escape-valves”.

In a second blast from the past, OPEC agreed on Wednesday to cut production at a meeting in Algiers. Whilst the ultimate price impact will depend on final agreements (likely at the 30th November meeting), as well as the participation of non-OPEC members, the group indicated it will reduce production to 32.5 million barrels per day (the first cut since 2008 and a reduction of around 2.2%).

The OPEC agreement has helped support the oil price, but remains lacking in detail (such as individual member commitments). Oil producers are playing weak hands, for example Saudi Arabia has seen a 12% budget surplus in 2012 slip to a 16% deficit, and Iran, Iraq, Libya and Nigeria are all seeking to increase production. Last week, the number of rigs drilling for oil in the US increased for the 13th week in 14 and on Sunday Russian oil output posted a new all-time high, up 4% in September vs. August.

This week should have a greater data focus with Global PMIs and US employment data.

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