In a sad case of deja vu all over again, the over-reliance on 'shaky' collateral and concentration of risk is building once more - this time in the $648 trillion derivatives market. New Clearing House rules (a la Dodd-Frank) mean derivatives counterparties are required to pledge high quality collateral with the clearing houses (or exchanges) in a more formalized manner to cover potential losses. However, the safety bid combined with Central Banks monetization of every sovereign risk asset onto their balance sheet has reduced the amount of quality collateral available; this scarcity of quality collateral creates liquidity problems. The dealers, ever willing to create fee-based business, have created a repo-like program to meet the needs of the desperate derivative counterparties - to enable them to transform lower-quality collateral into high quality collateral - which can then be posted to the clearing house or exchange. This collateral transformation, while meeting a need, runs the risk of concentrating illiquid low quality assets on bank balance sheets. In essence the next blow up risk is the eureka moment when all banks are forced to look at the cross-posted collateral. Last time it was the 'fair-value' of housing, now it is the 'fair-value' of 'transformed' collateral that is pledged at par and is really worth nickels on the dollar - "The dealers look after their own interests, and they won’t necessarily look after the systemic risks that are associated with this."
13 months ago, in the aftermath of the debt ceiling fiasco, which we now know was a last minute compromise achieved almost entirely thanks to the market plunging to 2011 lows, S&P had the guts to downgrade the US. Moody's did not. Now, it is Moody's turn to fire up the threat cannon with a release in which it says that should the inevitable come to pass, i.e. should congressional negotiations not "lead to specific policies that produce a stabilization and then downward trend in the ratio of federal debt to GDP over the medium term" then "Moody's would expect to lower the rating, probably to Aa1" or a one notch cut. Moody's also warns that should a repeat of last year's debt ceiling fiasco occur, it will also most likely cut the US. Of course, that the US/GDP has risen by about 8% since the last August fiasco has now been apparently forgotten by both S&P and Moodys. Sadly, continued deterioration in the US credit profile is inevitable, as every single aspect of modern day lives that is "better than its was 4 years ago" has been borrowed from the future. More importantly, with the S&P at multi year highs courtesy of Bernanke using monetary policy to replace the need for fiscal policy, Congress will see no need to act, and Moody's warning will be completely ignored. This will continue until it no longer can.
America's July trade deficit came in slightly better than expected, printing at $42 billion, compared to expectations of $44.4 billion, on exports of $183.3 billion and imports of $225.3 billion, which was to be expected in light of the ongoing drop in Chinese net trade surplus. After all global trade is a zero sum game. The better than expected number was an increase from the revised July deficit of -$41.9 billion, revised lower from $42.9 billion in June. And while GDP beancounter calculations will generate slightly higher Q3 GDP forecasts as a result of the number and revision, the reason for the "improvement" is an ongoing contraction in global trade, which is anything but favorable for the world's economies for which any diversion from a status quo M.O. means longer-term pain.
By now everyone knows about the collapse in Chinese iron ore consumption, electricity production and luxury good demand (see Burberry), as well as the record copper stockpiling, all of which point to the arrival of the long-deferred Chinese hard landing. Rumors, subsequential denials notwithstanding, that Chinese Hu Jintao successor Xi Jinping may or may not be missing, are not helping. Below we present yet another data point which had, for the longest time managed to diverge from the underlying Chinese economic reality, only for it too now to recouple with gravity with a bang: Chinese crude imports. Coming in at 18.4 million barrels, this was a 16% plunge from July's total imported energy needs, and is the lowest print since mid-2010 swoon, first crossed to the upside back in early 2009. Which likely is where the general Chinese economy is as well, at least in terms of actual demand. Only this time instead of going from the lower left to the upper right, to quote Dennis Gartman, it is doing the inverse.
Central bank demand internationally continues and demand for gold in the increasingly volatile Middle East remains robust as seen in data from the Istanbul Gold Exchange. It showed that Turkey’s gold imports were 11.3 metric tons last month alone. Silver imports were 6.7 tons, the data show. Much of these imports may be destined for Iran where imports have surged an astonishing 2,700% in just one year – from $21 million to $6.2 billion. In the first seven months of this year, Turkey's exports to Iran have also skyrocketed to $8 billion, up from $2 billion in the same period last year. And it is widely believed that the major portion of the increase, which is $6 billion, stems from the export of gold. There is speculation that the Iranian central bank is buying gold and that they may be accepting gold in payment for oil and gas in order to bypass western sanctions. Turkey is paying for the oil and natural gas it is importing from Iran in gold, Turkish opposition deputies have claimed, drawing attention to the enormous increase in Turkey's gold exports to Iran in 2012. “Gold is being used as an instrument for payment. Under the guise of exportation, gold is being sent to Iran in exchange for oil,” Sinan Aygün, a deputy from the Republican People's Party (CHP), has told Turkish daily Today's Zaman.
Equities traded lower in Europe today as market participants continued to book profits after a rally to 13-month highs on growing concerns that even though the Constitutional Court in Germany will dismiss the injunction, it may enforce certain conditions. In addition to that, yesterday’s comments from Spain’s Rajoy who said that the new ECB backstop makes a bailout for his country less urgent. As a result, there is a risk that markets may scale back their expectations of an imminent full-scale bailout and in turn lead to another speculative attack on Spanish bonds. This, together with touted profit taking, saw the short-end in Spain and Italy come under pressure (2y Spanish yield up 8bps and 2y Italian yield up 7bps). In turn, this supported duration assets throughout the session. Looking elsewhere, the looming elections failed to deter investors from the latest DSL tap, which drew a record low yield. Going forward, the second half of the session will see the release of the latest Trade Balance data from the US, as well as the weekly API report. In addition to that, the US Treasury will sell USD 32bln in 3y notes.
- Germany says U.S. debt levels "much too high" (Reuters)
- Netanyahu ramps up Iran attack threat (Reuters)
- Burberry plummets by most ever, slashes guidance, rattles Luxury-Goods Industry as Revenue Growth (Bloomberg)
- FoxConn Again Faces Labor Issue on iPhones (NYT)
- Southern whites troubled by Romney's wealth, religion (Reuters)
- China's Xi not seen in public because of ailment (Reuters)
- Another California muni default: Oakdale, Calif., Restructuring Debt, Planning Rate Raise After Default (Bond Buyer)
- Spain's PM expects "reasonable" terms for any new aid (Reuters)
- Bernanke Proves Like No Other Fed Chairman on Joblessness (Bloomberg) - Ineffective like no other?
- John Lennon’s Island Goes on Sale as Irish Unpick Property Boom (Bloomberg)
The key event overnight was the German constitutional court's announcement shortly after 8 am CET in which the Krimson Kardinals announced that, as largely expected by everyone except the EURUSD trading algos, there would be no delay in the September 12, 10 am CET injunction decision, as a result of the last minute bid by Peter Gauweiler. As Bloomberg reported, “It’s no surprise the court won’t change its plan,” said Christoph Ohler, a professor of European law at Jena University. “You cannot directly sue over the acts of European institutions in a German court, so it’s difficult to introduce these arguments in this case." The decision to press ahead with the ruling will probably bolster the German government’s faith that the bailout facility will get the court’s backing. German Finance Minister Wolfgang Schaeuble told students last week he was confident the ESM would be approved. “Europe won’t collapse on Sept. 12,” Franz Mayer, a law professor at Bielefeld University, said in an interview last week. “In the end, the court will allow Germany to ratify the ESM, but there will probably be some strings attached. The bigger issue than the actual ruling is what extra language the court will add to the reasoning on where the limits are in the future,” said Mayer. “The markets seem to be quite afraid the judges may spoil certain options for the future, like collectivization of debt within the euro zone." Which leads us to the quote of the morning when even Schauble it appears is channeling Clinton after he said that interpretations on the word "unlimited" can vary. No they can't, and this is precisely the issue that the judges will take offense with, if anything.
The chart below shows 2050 years of relative global GDP, during which there was a surprisingly flat distribution of the major economic powers: China, India, and the "West", at least until the mid-1800s, when the "Western" Golden Age began primarily courtesy of the industrial revolution, followed by the arrival of the Fed and virtually endless leverage (i.e., borrowing from the future until such time as no more debt capacity remains at either the public or private sectors), only to end in the late 1900s when the marginal balance of power shifted back to Asia, which became the next nexus of debt accumulation (see our earlier post on The Great Recoupling for some additional perspectives). And while the chart, from Deutsche Bank and PWC, attempts to predict the next 40 years of relative GDP distribution by eventually regressing back to the the long-term trendline, we feel that this is quite an optimistic assumption for a world in which virtually every "developed" country is insolvent, begs for China to ease whenever western inflation sends gas prices soaring making reelection of the incumbent impossible, and is reliant on the indefinite continuation of the USD's reserve status to preserve the last traces of western superiority (not to mention cheap funding of $-trillion deficits as far as the eye can see).
While the official number from the FMS is not out yet, according to an advance look by the CBO, the August deficit soared from a modest $70 billion to a whopping $192 billion, the highest August deficit in history, and coming at a time when traditionally the US Treasury does not generate substantial deficits. It also means that "that" $59 billion budget surplus in April, coming after 42 straight months of deficits, and which surprised so many, was just as we suspected, nothing but a play on the temporal mismatch between treasury receipts and outlays. Most importantly, with one month left in the fiscal year, a month which, too, will likely come well above last year's $63 billion, the US has now spent $1.165 trillion more than it has received via various taxes. Finally so much for the year over year improvement: at $1.23 trillion deficit in the LTM period, this is only 3.2% less than the August 2011 LTM deficit which was $1.27 trillion, despite nearly 2 million more workers employed (at least according to the BLS) and generating tax revenue. Expect the US to end Fiscal 2012 with a total deficit of well over $1.2 trillion, which in turn means that the average burn rate of $100 billion in new debt issuance each month, will continue into the indefinite future.
Since The Dreme (Draghi Scheme) began shortly after the EU Summit, the P/E multiple on the S&P 500 has risen by a faith-defining 2x. This is the largest three-month rise in this indicator-of-indifference-to-reality since the initial burst rally off the March 2009 lows. Meanwhile, the actual earnings consensus is being marked down further, heading for an earnings recession as we pointed out last week. It seems investors are too afraid not to believe in P/E miracles or perhaps it is just faith that central banks have it all under control and their 'promises' are as good-as-gold.
Bill Gross may be credited with inventing the term 'the New Normal', although his recommendation to purchase gold above all other asset classes, something which only fringe blogs such as this one have been saying is the best trade (in terms of return, Sharpe Ratio, and the ability to sleep soundly) for the past three and a half years, he is sure to be increasingly ostracized by the establishment, and told to take all his newfangled idioms with him in his exile to less than serious people land. Which takes us to David Rosenberg, who today revisits his own definition of the New Normal. And it, too, is just as applicable as that of the Pimco boss: "The new normal is that the economy doesn't drive markets any more." Short and sweet, although it also is up for debate whether the economy ever drove the markets in the first place. But that would open up a whole new conspiratorial can of worms, and is a discussion best saved for after Ben Bernanke decides to save the "housing market" by buying more hundreds of billions in MBS and lowering mortgage yields further, even though mortgage rates already are at record lows (something that mortgage applications apparently couldn't care less about as we showed last week), while "avoiding" to do everything in his power to boost the S&P, which recently was at 5 year highs, and certainly "avoiding" to listen to Chuck Schumer telling him to do his CTRL+P job, and "get to work" guaranteeing Schumer's donors have another whopper of a bonus season.