Yesterday's downgrade of BAC was potentially problematic for credit markets. I am less concerned about the holding company downgrade. Downgrading the bank to A2 from Aa3 could become problematic. That is the entity most derivative counterparties will face. A2 is still fine, but I suspect many counterparties will be having meetings over the next few days to discuss how comfortable they are facing BAC as a derivative counterparty. It might be wrong, and unnecessary, but it is something that will be occurring. BAC should be doing everything in their power to address this potential risk immediately. The risk of ratings downgrades to a bank is twofold. On a basic level, it may reduce the flows they see as counterparties prefer to trade with higher rated entities for their derivative trades. That is manageable. The bigger, and far more problematic issue, will be if firms cut their lines to that bank. This would cause banks to unwind or assign existing trades, or to buy protection on the downgraded banks to "hedge their hedge". Protection buying would drive their spread higher (if this was all exchange traded, it wouldn't be an issue). Unwinds could force the bank to raise some cash. Most hedge funds will have one way collateral agreements with banks, so that on any positive mark to market, they are posting collateral to the bank, which the bank can typically use "rehypothecate". Hedge funds will unwind or assign profitable trades, which will force the bank to return collateral to the hedge fund. It is a subtle, but painful, way for a bank to experience a run. It happened with Bear and with Lehman.
Initial Claims Miss Consensus, Prior Bad Data Amplified, 103,000 Unemployed Fall Off Extended BenefitsSubmitted by Tyler Durden on 09/22/2011 - 08:46
Another day, another chance for the BLS to fudge jobs data by revising last week's claims miss to an even worse number: sure enough last week's -428K drop was just revised to -432K. Which means that this week's consensus miss, which was at 420K, is irrelevant, with the weekly number coming at 423K because all headlines will blare than claims actually declined by 9K. The game has become so old (and we mean old: the BLS has been doing this very same fudge for 2 years in a row now) we are stunned anyone falls for it. And one thing that will also most certainly be ignored is that the 423K number is really 427K because as the BLS reported, a -3,776 drop in claims in Texas was due to "Fewer layoffs due to holiday" - well the holiday is over. Lastly, and most troubling for the economy is that another massive 103,000 people dropped off extended benefit claims in one week. Just as troubling is that 1.7 million people have dropped off the government's dole in the past year as can be seen in the chart below: these are people that haven't gotten a job, they have just stopped being counted by the govt.
While nobody will actually care about today's set of high frequency economic updates, seeing how the world's implosion has now been validated and it is all up to the global central banks to bail us out (which they will fail at miserably), as has been anticipated on this blog for months, here is what the algos, who are the only ones trading US economic headlines now, have to look forward to.
- The FOMC decided to implement “Operation Twist”, however provided a downbeat assessment of the US economy yesterday, and warned of “significant” downside risks to the economic outlook
- Manufacturing PMI reports from China and the Eurozone came out worse than expected
- According to an article in the FT, BNP Paribas is in talks with Qatar to secure investment. However, the report was later denied by co.’s CEO
- The USD-Index traded higher amid risk-averse trade, which in turn weighed upon EUR/USD, GBP/USD and commodity-linked currencies
If you think this morning has a September 12, 2008 smell and feel to it... You are right. Complete and total CDS bloodbath in sovereigns and fins means a global bailout may not be imminent, but the market sure demands it as contagion has been upgraded to gangrene. Bernanke has now officially blown it with the twist and Mr. Market demands a $1 trillion+ LSAP, or else...
While the bulk of the re-recessionary fears this morning came out of China where economic contraction is now fully raging, Europe is not helping after both Manufacturing and Services Flash PMIs came in worse than expected, and far worse than previous, and more notably with the Services PMI printing below 50, or contracting for the first time in 2 years. In a nutshell, Manufacturing came in at 48.4, Services at 49.1, both missing consensus of 48.5 and 51.0, and far lower than prior 49.0 and 51.5 respectively. As Reuters notes, "None of the 37 economists polled by Reuters had predicted that services activity would contract and this is the first time the index has been below the 50 mark that divides growth from contraction since August 2009....It was a similar picture in the manufacturing sector, which had driven a large part of the bloc's recovery. The factory index dropped to its lowest level in two years at 48.4, slightly below expectations of a fall to 48.5. "The numbers are still consistent with some GDP growth, so it does not signal recession just yet," said Martin Enlund at Handelsbanken. "That said, we are seeing a slow-motion train crash in the euro area, where credit contraction risks leading to a new recession by Christmas unless governments face up to the task swiftly and forcefully." In other words, on one hand I) the perpetual shining beacon in Europe: economic growth against all odds courtesy of Germany, has now been dimmed, and on the other, II) the liquidity run on Europe's banks is raging even harder, especially with II being reinforced by I, and immediately sending BNP 3M USD Libor from 0.385% to a year+ high of 0.39% as the average Li(e)bor has risen for nearly the 50th consecutive day from 0.356% to 0.358%.
Something odd is happening. Germans are leaving the ECB. First Weber, then Stark. Why would senior German officials withdraw from the ECB just at a time when they should seek greater influence? One explanation: to avoid having a conflict of interest once Germany re-instates the Bundesbank as the leading central bank of Europe. Currently, Germany and Greece are engaged in a game of chicken; the Germans do not want the first “domino” of the Euro zone to fall, and the Greeks know that. Each time Greece nears default, Germany agrees to a last-minute stick save without offering a far-reaching solution. Their aim is to limit the funds actually flowing to Greece. This, of course, guarantees the crisis to simmer on indefinitely, preventing a recovery in Southern Europe. But, as with every game, this one will have to end one day. Especially as German and Dutch 5-year CDS approach 100 bps. France’s CDS rocket has long left the launch pad, reaching 190 bps recently.
It's possible that the problems in sovereign debt in Europe continue to get worse rather than better, because we are treating the wrong "disease". Everyone has been talking about the risk of "contagion". That makes me think of scientists working in pristine high tech labs searching for a cure, of technicians working on computer models, estimating spread patterns, and citizens walking around with face masks to stop the spread of the "disease". What we have is gangrene.
No big surprise as Europe opens to a crowd of sellers. The EUR has stabilized from its drop a little in the last hour or so but commodities and PMs continue to slide. Italian banks appear to be bearing the brunt for now with Intesa and Unicredit down 4-5%, but most of the major banks are down at least 3%. Credit markets appear worst hit overall with dramatic moves in XOver and Senior Financials. As we noted in a previous post, Asian credit was hit hard, particularly the major sovereigns and for now S&P futures are back to their overnight lows down around 1% from the US close.
China's HSBC Flash Manufacturing PMI was released earlier this evening and showed continued weakness at 49.4 (below 50 implying a majority of manufacturers saw conditions deteriorating). The continuing moderation of growth is weighing on the Shanghai Composite which is down around 2% but it is the CDS market that is really cracking. 5Y China CDS is now an additional 20bps wider than the 10bps decompression we saw during Wednesday and is back to March 2009 levels at 167bps. It seems global markets are disrupted.
UPDATE: A number of Asia-Pac Sovereigns are cracking wider this morning.
A few short weeks ago we described the transition of America from a government "on behalf of the people" to one "in control of the people" catalyzed, as Bill Buckler, put it simply, by one simple event: the confiscation of America's gold, and the ushering in of the welfare (or "promise") state, the same welfare state that now is supported by a system that no matter how hard one denies, is nothing but a ponzi scheme. Today, we follow up that article, with a very thought-provoking observations by BMO's Don Coxe, in which he describes that just like in the time of FDR, for whom the creation of a "mild" inflation was a prime prerogative to offset the depressionary deflation gripping the land, the moment for a brazen gold revaluation by none other than the US government has arrived. Unfortunately, it likely also means that any scheme in which the government opens a buy/sell gold window at a substantially higher price point, will mean that very soon, either by guile or by force, the US government will once again be the prime and sole owner of all the gold. As Coxe says, "The gold bugs have long proclaimed their own version of the Golden Rule: “He who has the gold makes the rules." By that standard, Barack Obama could become the leader of the world overnight." And while it is described in much more succinct detail below, in summary, Coxe's point is that the time for a government "LBO" of the gold market, one in which every last ounce is extracted from the skittish public, in exchange for pseudo-equivalent assets such as gold-backed bonds, has arrived. The only question is what the acquisition price of the risk-free alternative to fiat would be, and hence how much higher will investors push the price in anticipation of the inevitable 25% take out premium. Once the public realizes that this is the endgame, and that the buyer of only resort will be none other than Uncle Sam... then look out above.
After spending the last few weeks 'helping' the Fed with its agenda, Goldman Sachs' Andrew Tilton seems a little disappointed by the market's reaction - reasoning that the FX and equity-investing plebeians will take longer to comprehend the less familiar 'twist' operation that has already been wholly discounted into the TSY curve. While he did not get all he wanted from this meeting (even though the 'twist' was larger than expected), Hilton wastes no time in looking to the future and the chance of further economic weakness leading to more dramatic Fed actions. As we post 30Y is now -27bps!!
We suspect the world was placing a little more 'hope' in Bernanke's willingness to print-and-save-us-all as the IMF just announced the activation of its "New Arrangements to Borrow" for a further six months. Obviously, given the quota subscriptions and the nature of the NAB, we suspect the rest-of-the-world will get pound of flesh (or USD bailout) implicitly. This is not completely unexpected as we have been discussing the rise in borrowing arrangements/facilities at the IMF for a while - what is notable is the timing - given constant chatter out of Europe that all is 'satisfactory'.