A month ago, when stock markets around the globe were hitting all time highs, we wrote "The Bronze Swan Arrives: Is The End Of Copper Financing China's "Lehman Event"?" which as so often happens, many read, but few appreciated for what it truly was - the end of a major shadow leverage conduit (one involving unlimited rehypothecation at that),and the collapse of a core source of shadow liquidity. One month later, China's "Lehman event" is on the verge of appearing, and with Overnight repo rates hitting 25% last night, coupled with rumors of bank bailouts rampant, it very well already may have but don't expect the secretive Chinese politburo and PBOC to disclose it any time soon. So now that the market has finally once again caught up with reality, for the benefit of all those who missed it the first time, here is, once again, a look at the arrival of China's Bronze Swan.
If anyone thought Bill Gross would take what is likely the worst P&L day in PIMCO history without a fight, they would be wrong.
Gross: To paraphrase #Bernanke 2002: “Regarding the Great (Re)pression. You’re right Milton, we did it. Sorry. We won’t do it again.” ???
— PIMCO (@PIMCO) June 20, 2013
So did Bernanke just do it again?
Where's the buy-the-dip mentality? Yesterday's collapse triggered yet another Hindenburg Omen - the 7th in the last month) and it appears it is the equity market's turn for some pain as Treasuries (which initially weak) have stabilized 2-3bps higher in yield. The Dow has lost 15,000 and is down over 200 points today; the S&P 500 is testing back to its 1,600 level; but homebuilders are being battered (as clearly good is now officially bad). The S&P 500 is now the furthest below its 50DMA in 2013 - this is key as it has been critical support all the way up. Gold and Silver have been crushed (and copper and oil are following) this week so far and the USD is up 1.75% so far. Credit markets are being destroyed - investment grade spreads are 10bps wider to 90bps from FOMC.
Moments ago, Caterpillar released its May 2013 dealer statistics breaking down the 3-month rolling average for machine retail sales. Curiously, unlike in previous months when Asia/Pac was the worst performing region on a year-over-year basis, in May it was the US that showed the worst results. Just how bad: retail sales in the US clocked at a -16% clip, just barely above the -18% drop in April, and only the second lowest print in the past 3 years. And just to put the CAT dump in perspective, the chart below correlates CAT North American retail data with a 3 month delay in Durable Goods Orders ex Transportation: has CAT become the best leading proxy for corporate CapEx, and if so, just how much more negative does it have to get before the recession-watchers join the bond vigilantes in waking from hibernation?
If the June Empire Fed index was a humiliating embarrassment to whoever collates the data, with only the headline number rising even as all index components plunged, and was merely released to baffle with BS some more before the FOMC meeting, today's Philly Fed release will surely shock anyone who believes the markets and the economy are still correlated. Printing at 12.5, this was a surge from May's -5.2, far above the -2.5 expected, the highest print since April 2011, and the biggest beat of expectations since October 2011. When "Baffle with BS" fails, just baffle with BS some more. Of course, keep in mind that while in previous months the plunging Philly Fed led to a bad news is good news outcome, today's big beat will merely reinforce the hawkish Ben view, and encourage yet another Taper Tantrum.
The initial knee-jerk reaction to QE3 and the extension into unlimited free money forever last September sent mortgage spreads dramatically lower and sparked a super-excited flood of cash into cheap-to-finance REO-to-rent housing markets. This created the faux-prosperity that even Bernanke is banking on in our housing markets now. However, that mortgage spread (the difference between 30Y mortgage rates and 10Y Treasury yields) compression slid wider from its initial move but had stabilized. Until, that is, Bernanke mentioned the 'Taper' word - at which point the mortgage market moved well beyond its pre-QE3 levels and things began to escalate. While Bernanke has done his best to convince us that the Fed will be here, the mortgage market seems to be a non-believer and even at $85 billion a month (across MBS and Treasuries) he has lost control of the mortgage market. As Bloomberg notes, the tone of Bernanke’s comments were "very assuring and soothing, but that’s like a mother telling her baby that she will be leaving in a very gentle voice," said one mortgage trader, adding "the baby will still have a fit."
In a world in which every commercial and investment bank has become a FDIC-backed hedge fund with no risk and unlimited leverage/return, it means that what used to be a November 30 fiscal year end for the financial industry has been rebased to a December 31 FYE. Except one bank still valiantly clinging to the title "largest independent investment bank" (and blasts CNBC with commercials claiming the same): the high-yield underwriting and trading midcap - Jefferies. And courtesy of its May 31 quarter end, Jefferies always provides an early glimpse into bond trading dynamics for the quarter. Said volumes (and thus revenues), represented by both total principal transactions, as well as just pure Fixed Income Sales and Trading, are shown on the chart below and are self-explanatory.
With the US equity markets only 2 to 3% off their highs, we thought it appropriate to look around the world at where the leveraged equity unwinds so far. There remain a select few nation's equity markets that are positive year-to-date.
It would not be the DOL if the last week's initial claims wasn't revised higher. And it was: from 334K to 336K. But more importantly, the current week's number of 354K once again broke the "improving" trend, and printed far above consensus estimates of 340K, proving that there is still a substantial amount of "disposable" slack in the economy. If the stock market continues its downward jiggle, and without the Fed that may well be the case, look for the Claims trendline to resume going from the lower left to the upper right, in seasonally adjusted terms. In short: yet another red flag for the economy, which continues to reject the Fed's attempts to restart a "virtuous cycle." Yet by the looks of things, this datapoint alone is not enough to start speculation of the untaper.
We have long held the opinion that the markets, all of them, have been buoyed by what the Fed and the other central banks have done which was to pump a massive amount of money into the system. There are various ways to count this but about $16 trillion is my estimation. The economy in America has been flat-lining while the economies in Europe have been red-lining and while China has claimed growth their numbers did not add up and could not be believed. In other words, the economic fundamentals were not supporting the lofty levels of the markets which had rested upon one thing and one thing alone which was liquidity. Yesterday was the first day of the reversal. There will be more days to come.
- Bonds Tumble With Stocks as Gold Drops in Rout on Fed (BBG)
- Bernanke Sees Beginning of End for Fed’s Record Easing (BBG)
- Gold Tumbles to 2 1/2 Year-Low After Fed as Silver Plummets (BBG)
- PBoC dashes hopes of China liquidity boost (FT)
- U.S. Icons Now Made of Chinese Steel (WSJ)
- Emerging Markets Crack as $3.9 Trillion Funds Unwind (BBG)
- Everyone joins the fun: India sets up elaborate system to tap phone calls, e-mail (Reuters)
- China Manufacturing Shrinks Faster in Threat to Europe (BBG)
- More on how Syria's Al-qaeda, and now US, supported "rebels", aka Qatar mercenaries, operate (Reuters)
- Echoes of Mao in China cash crunch (FT) - how dare a central bank not pander to every bank demand?
It was only a matter of time before at least one Chinese bank (and then many more) needing to rollover overnight/short-term funding and unable to do so in an interbank market that is now completely frozen, had to be bailed out. Sure enough, according to Hao Hong, the chief China strategist at Bank of Communications Co., who cited unidentified industry sources, the People’s Bank of China used "targeted liquidity operations" to supply 50b yuan to a bank in China. Bloomberg reports that the overnight cash supplied was at 5.1%, while the 1-week at 5.4%. Hong added that more banks are in talks with PBOC to obtain funds amid a cash squeeze, as expected. The problem is that the PBOC can't continue targeted bail outs, and will sooner or later be forced into a broad liquidity providing move, which will unleash a repeat of the 2011 in China scenario, which did not have a very happy ending.
The global liquidation wave started with Bernanke's statement yesterday, which was interpreted far more hawkishly than any of his previous public appearances, even though the Fed had been warning for months about the taper. Still, markets were shocked, shocked. Then it moved to Japan, where for the first time in months, the USDJPY and the Nikkei diverged, and despite the strong dollar, the Nikkei slumped 1.74%. Then, China was swept under, following the weakest HSBC flash manufacturing PMI print even as the PBOC continued to not help a liquidity-starved banking sector, leading to the overnight repo rate briefly touching on an unprecedented 25%, and locking up the entire interbank market, sending the Shanghai Composite down nearly 3% as China is on its way to going red for the year. Then, India got hit, with the rupee plunging to a record low against the dollar and the bond market briefly being halted limit down. Then moving to Europe, market after market opened and promptly slid deep into the red, despite a services and mfg PMI which both beat expectations modestly (48.6 vs 47.5 exp., 48.9 vs 48.1 exp) while German manufacturing weakened. This didn't matter to either stocks or bond markets, as peripheral bond yields promptly soared as the unwind of the carry trade is facing complacent bond fund managers in the face. And of course, the selling has now shifted to the US-premarket session where equity futures have seen better days. In short: a bloodbath.
It seems liquidity (or counterparty mistrust) is beginning to reach extreme levels in China as the nation's banking system is now quoting overnight repo transactions at 25%. The explosion in funding costs echoes the collapse in trust (and surge in TED spread) among US banks in the run-up to the Lehman bankruptcy. MSCI Asia-Pac stocks are down over 3% with China's Shanghai Composite -2.5% at seven-month lows.
- China’s 1-day Repo Rate Climbs to Highest Since at Least 2006
- MNI - CHINA OVERNIGHT REPO FIXING AT RECORD HIGH