Simply confirming once again that reality itself has now become a farce...
ES (the e-mini S&P 500 futures contract) closed the day session almost perfectly at its VWAP (volume-weighted average price) as the last 45 minutes of the day saw a relatively 'cheap' equity market (compared to CONTEXT broad risk assets) rally out of its tight post-Europe's-close range. There was heavy volume as we got close to VWAP (although Composite volume was the lowest since Thanksgiving Friday) and little ability to push through it and the fact that the major financials (stocks or CDS) did not really participate in the XLF's modest pull higher at the same time also suggests it was not performance chasing as higher beta was not outperforming that much. Stocks and credit stayed much more in sync than in recent days but we note that the seemingly increasingly important HYG did not sell off as much in the middle of the day and markets pulled back to it into the close. The weakness in TSYs and steepening of the curve post Europe, as well as some recovery in commodities helped support equities as EURUSD did not lose much more ground in the afternoon (even though SEK did). After outperforming all day, Silver rallied back in line with Copper and Gold's 2.5-3% down day while Oil clung desperately to the safety of strengthening USD -1.3% vs DXY's +1.2%.
Recently, we presented and discussed one of the biggest issues for European banks: the urgent need to delever substantially (to the tune of over €2.5 trillion) by selling assets, in order to placate various regulatory entities that banks are solvent, and, far more importantly, the market, which has so far proceeded not to short banks into oblivion only due to the ongoing short selling ban, and to the explicit backstop from the ECB (and, indirectly, the Fed). However, since deleveraging into an deflationary environment will certainly require bank bailouts due to collapsing asset prices, the question is what the impact of bailouts on banks will be. And here Bloomberg's Yalman Onaran explains all too vividly how not even in ponzinomic finance is there ever a free lunch... even if bought with free money. "If the Southern governments put money in their banks, their sovereign debt will go up, exacerbating their problems,” said Karel Lannoo, chief executive officer of the Centre for European Policy Studies in Brussels. “Then the banks’ losses will rise because they hold the government debt. That’s a vicious cycle. It’s hard to know which one to stabilize first, the sovereign bonds or the banks.” And therein lies the rub, and the problem at the core of it all: when one is dealing with a continent and its insolvent financial system whose banks have underwater assets that amount to the size of the host nation's GDP, "It’s hard to know which one to stabilize first, the sovereign bonds or the banks." Recall that killing both birds with one silver bullet is what the failure that is the EFSF was supposed to do, by allowing sovereign debt rolls and fund bank nationalizations at the same time. Now that that hope is gone, all we have is the inevitable "death spiral."
In his book “More money than God”, Sebastian Mallaby describes how George Soros received a signal from Helmut Schlesinger (president of Bundesbank at that time), to go ahead and speculate on a devaluation of the Italian Lira and the British Pound. Germany had enjoyed a boost from the integration of Eastern Germany, which, partially due to a generous 1:1 exchange offer for the Eastern German Mark, led to unacceptably high inflation. Despite numerous warnings from the Bundesbank, fiscal policies did nothing to reign into the growing threat to price stability. Seeing its advice ignored, the Bundesbank fought back and raised its discount rate all the way to 8.75%. This caused problems for other European countries, who were forced to follow the Bundesbank unless they wanted to risk a weakening of their currencies. They had to apply a restrictive monetary policy despite their own economies just recovering from the recession of the early 90?s. According to Mallaby, British finance minister Lamont had insulted Schlesinger at a meeting, trying to extract a promise to cut German interest rates. Despite Schlesinger’s refusal, Lamont led the press to believe Schlesinger had made concessions.The “payback” didn’t wait for long; Schlesinger publicly denied any intention of cutting rates. He also expressed low confidence in the fixed relationships among European currencies, particularly the “unsoundness” of the Italian Lira.
While not new to our thoughts, Richard Koo, Nomura's Balance Sheet Recession guru, has penned a lengthy but complete treatise on why governments need to borrow and spend now or the world faces a deflationary spiral. The Real-World Economics Review posting makes it clear how his balance sheet recessionary perspective of the deleveraging and ZIRP trap we now live in means bigger and more Keynesian efforts are needed to pull ourselves out of the hole. While we agree wholeheartedly with his diagnosis of the problem, his belief in the solution...at such times only, the government must borrow and spend the private sector’s excess savings,...is flawed in so much as the size and scale of additional government borrowing at this time of smaller and more risk averse balance sheets leaves the governments (of currency issuers and users alike) more anxious of bond vigilantes than ever before. Furthermore, the impact of a much-bigger-than-previously-believed shadow banking system deleveraging and de-hypothecating and the historical precedents now engraved in manager's minds leaves them thinking 'fool me once...'. His thoughts on the political difficulties of such a borrow-and-spend solution and the 'when to exit this solution phase' is noteworthy in its timing (and cyclical perspective) with the belief that there will be plenty of time to pay down the accumulated public debt because the next balance sheet recession of this magnitude is likely to be generations away, given that those who learned a bitter lesson in the present episode will not make the same mistake again. The next bubble and balance sheet recession of this magnitude will happen only after we are no longer here to remember them. Finally, he warns that perceptions of the recovery from the Lehman shock is NOT recovery from the balance sheet recession and has an interestingly xenophobic approach to solving Europe's problems. Its important to note that at all times, in our view, a deflationary shock will be met with an increasingly more powerful currency devaluation, no matter how many Japanese economists scream, after all its never been easier just to add a few zeros.
A few days ago, Citigroup announced it would lay off 4500 bankers around the world, although with nothing more definitive, the bank's employees likely thought that "out of sight means out of mind", especially with the holiday season days away. To their chagrin, our latest favorite website, the Department of Labor's "WARN" site, which usually well ahead of various HR offices will advise New York bank employees how many and which office are going to lay people off. Sure enough, here is Citigroup, with just disclosed plans to fire 413 people, with full breakdown by which offices are to be affected. If you are one of the several hundred to be laid off from the 388/390 Greenwich location, our condolences: fear not - the economy is getting better; after all last week initial claims for unemployment benefits literally tumbled meaning the re-depression is now over. You will be back working in the comfortable confines of infinitely rehypothecated fractional reserve banking in no time.
Earlier today, Fox Business' Charlie Gasparino broke the news (which was really surprising only for anyone who had not seen the JEF stock slide in the past several months) that the firm has fired a substantial number of people just after the bank's fiscal year end: "People inside the firm say the cuts are occurring most heavily in Jefferies' equities division, and according to traders inside the firm, they could total as much as 11% of the entire firm when the job cutting is complete". We now have some additional, and more disturbing information: the actual number of people is roughly 65 or so, but the worst news is that Rich Handler will demand a 1 year clawback from the departees, in the form of bonus refunds for both cash and stuck. While this has been isolated to Jefferies for the time being (which has other liquidity concerns of its own, most of which are quite well known), we are certain that now that this practice has a "case study" other banks, especially of the B-grade variety, will implement comparable clawback strategies. This approach, once adopted broadly, will likely cause a substantial dent in banker spending patterns, as rarely if ever before have termination without cause been accompanied by demand for money back. In effect, this activity will force even greater spending retrenchment, and could cause a flight of the ultra high net worth retail customer who will suddenly be forced to think twice about spending not the upcoming bonus, but even the previous one, heretofore considered safe and sound, in some Cayman bank account.
Unlike some of the more noteworthy fund managers who appear on our TV screens all too often, Hugh Hendry seems to have been head-down hard at work. The appropriately named Eclectica fund that he manages has had a stupendous year as The FT reports his 'China Short' fund is up over 52% for the year. We discussed his already-solid performance back in September, when he was up a mere 40% YTD following an exceptional month in September. Given the difficulties of shorting Chinese firms directly, the deeply contrarian manager who makes no apologies for his view of a 1920's Japan-like crash in China is clearly doing something right. His positions in Japanese entities with large Chinese exposures makes great sense and the fact that he has kept outperforming this quarter even as Japanese credit has rallied back quite impressively, from spike wides in September and October, seems testament to our TV-Appearance-to-Performance anti-correlation thesis.
Following the auction of the latest $32 billion in 3 year bonds, the market is expected to relax as based on the optic the auction was a stunning success, with a High Yield of 0.352%, higher than just the 0.334% hit in September when the market was collapsing. Yet the Bid To Cover of 3.624 was the highest ever in the series of the bond. Now the bad news: Primary Dealers once again accounted for well over 53.9% of the auction: or about $17 billion, which will be promptly repo'ed back to the Fed with the proceeds used for various other purposes. In other words, the clear demand for $15 billion came in the form of Indirects taking down 39.1% and Directs with 7.0%. Nonetheless, with the When Issued trading at 0.36%, there is no doubt that the auction was a smashing success, under the parameters of the US bond issuance regime. In the meantime, we await to see what happens to German Bund auctions in the next few days if the yield once again collapses, and there is just not enough demand at auction.
On Friday, following the announcement from Goldman that the firm's had just turned more bullish on European financials raising banks from Underweight to Neutral, we said: "Goldman has just started selling European bank stocks to its clients, whom it is telling to buy European bank stocks. Said otherwise, the Stolpering of clients gullible enough to do what Goldman says and not does, has recommenced. Our advice, as always, do what Goldman's flow desk is doing as it begins to unload inventory of bank stocks. Translation: run from European bank exposure." Sure enough: European banks (as per BEBANKS) are now down 3.84% today alone, or -1.5% from the Thursday close, while the general MSCI Euro Fin sector, EUFN, is down 6% today. While not quite a slam dunk trade as a Stolper FX anti-reco, nobody has ever filed for bankruptcy by making money. Thank you Goldman.
First Moody's and now Fitch are coming out with negative comments about the summit. That provides mores more air cover for S&P to downgrade France 1 notch. The EU and EIB may also get notched in that case, further hurting the reputation of the EU and their plans. Political pressure may stay the hand of S&P but if not, this should spark a steep decline in risk asset prices. It may even make it more difficult for the ECB to print as one of its strongest members stumbles.
It’s no secret that housing and employment are correlated, and the causation is intuitive. If more people have jobs, then more people have incomes that support the purchase of a home. In the other direction, the more houses that are built to meet rising demand, the more jobs will be created in construction and real estate. We can see the correlation in this chart from the St. Louis Federal Reserve displaying one measure of employment for workers age 45-54 and the index of home prices. As employment of those in their peak earning years rose, so did home prices. This is partly a function of basic supply and demand: Rising demand pushes prices higher. As employment fell, demand declined, and so did home prices. The Federal Reserve famously has a dual mandate: to maintain stable inflation and employment. The Fed attempts to pursue these goals with monetary tools such as setting interest rate targets, while the Federal government supports housing by subsidizing mortgage interest via tax policy and guaranteeing mortgages via the housing-lending agencies of Fannie Mae, Freddie Mac, and the Federal Housing Administration (FHA). The Fed’s primary tool for stimulating demand for housing has been to lower mortgage interest rates, by buying the US Treasuries that set the baseline cost of long-term debt and also mortgage securities. Indeed, the Fed’s first quantitative easing (QE) program was to buy about $1 trillion in distressed mortgage debt outright. This removed the impaired debt from banks’ balance sheets and also served to lower mortgage rates.
But fear not: the arrested are not the firm's "god's work-ing" employees; more of the OWS persuasion. From PressTV: "US police have arrested 17 members of the Occupy movement in New York as the nationwide crackdown on the anti-corporatism protesters continues." When we get additional confirmation of this arrest from US sources, and not-Iranian media, we will update. Luckily, since none of the protesters can close a Goldman (which is still a Bank Holding Company) checking account, we are confident the story will end here.
Just because credit agency downgrade risk uncertainty is not enough, FAZ now advises there is electoral risk to add to the mix. Because if Sarkozy were to lose the presidential election, his competitor, the socialist-backed Francois Hollande has said that he would not accept the decisions of the Euro-summit, and will try to renegotiate the outcome, in effect unwinding any "progress" made so far in stabilizing the European currency. "Should he win the presidential elections, France would not ratify the treaty. "If I am elected President of the Republic, I will negotiating a new agreement," Hollande announced on the radio station RTL." Why is this concerning? Because as a recent poll indicates Hollande has a commanding lead over Sarkozy as of mid-November. "The proportion of French voters who have confidence in Sarkozy to deal effectively with the country’s problems expanded to 40 percent, according to the poll published in the French newspaper today. While Socialist Francois Hollande topped popularity ratings in the poll, he lost 5 points in the period. About 51 percent of voters said they had a “positive image” of Hollande." In other words, it is likely to quite likely that Sarko will not be reelected. Which also means that suddenly all bets are off for Europe.