Yesterday, Goldman's Jan Hatzius, piggybacking on what has now become a prevalent belief among Wall Street economists following a "leak" from the WSJ's Jon Hilsenrath, predicted that the FOMC minutes would hint at more easing, in the form of "sterilized" interventions, or in other words, an extension of Operation Twist. There is, however, one problem with this analysis. It is total BS, for a simple reason that for every bond on the long end that the Fed buys (and it has bought a whopping 91% of the 20-30 year gross Treasury issuance), it has to sell one in the 3 Month - 3 Year maturity interval. And therein lies the rub. As Bank of America shows below, at the end of Twist in June there will be just 2 months worth of Treasurys available for sale. What could fix this? Well, instead of ZIRP until 2014, Bernanke could say the Fed would keep rates at zero until 2016 or even 2018, and proceed to sell all Fed holdings in the 3 month - 5 year or 3 month - 7 year intervals. This however, would make the entire bond curve an epic farce, shifting the belly to beyond the 10 year point, and in the process blowing up the MBS market due to total collapse of traditional convexity heding strategies. Which we don't think is likely unless the world is coming to an end. In other words, anyone hoping that Twist will be extended, is wrong, and in turn it means that any real option for the Fed's NEW QE will be the outright monetization (aka LSAP) of either USTs or MBS, ala QE1 and QE2.
We have been warning of the uncomfortable current similarities to last year's (and for that matter cycle after cycle) high-yield credit underperformance / lagging behavior 'canary-in-the-coalmine' relative to the exuberant equity market for a month now. Now, Bank of America provides - in two succinct charts - the fundamental underpinning of this grave concern as across the high-yield credit universe revenues are not catching up with costs - creating significant margin pressures - and at the end of the day, a market that cares more for cash flow sustainability than the latest headline or quarter EPS upgrade from some sell-side pen-pusher is waving a red-flag as margins are the lowest they have been since March 2009 and is falling at a much faster clip than in the fall of 2008 as the reality of money-printing comes home to roost. And just to add salt to this fundamental wound, technicals are starting to hurt as supply picks up and 'opportunistic' issuance turns notably heavy - perhaps helping to explain how the ongoing inflows have been unable to push prices further up in the US. Lastly European high yield is trading tick-for-tick with sovereign risk still - as it has since the middle of last year and so as LTRO-funded carry fades, we would expect it to underperform - especially as austerity slows growth.
In the past we have jokingly discussed the creation of a Death Star as the way the world can save itself by printing an almost infinite amount of money to support growth. As almost everyone, especially the MMT crowd it seems, can plainly see, if printing some money is good (well it must be, markets are up) then printing more money must be better, right? Well, no (as we discussed in detail here). There are unintended consequences and as we pointed out recently, we are already seeing less and less effervescence in the real economy from QE's impact and the spectre of the inflationary pressures that implicitly limit the 'benefit' of this action is nowhere more painful than in energy prices (and in fact the price of anything in relative limited supply as opposed to cash which is printed daily). Professor Antony Davies, of Duquesne, takes this subtle concept to task in this exceptionally straightforward 206-second video on money as an IOU and its solution to the caveman's ills providing the background for why money's inherent value is relinquished once it becomes printed en masse. Printing more money doesn't make more goods and services appear, simply spreads the value of the existing goods and services among a larger number of dollars - this is inflation. Our wealth comes not from money but from the goods and services that money buys. Q.E.D.
As so often happens, every time there is a ramp in the stock market, especially one which is not accompanied by retail buying, those who are buying, are forced to do so on increasingly more margin, as there is only so much cash in the market without booking actual profits. Sure enough, as of the end of February, margin debt was $289 billion, the highest since July 2011, while Net Free Credit (Free Credit Cash plus Credit balances in margin accounts less Margin Debt) of negative $33 billion (meaning investors have negative net worth) was the lowest also since July. What does this mean? Simply said, that if the cross asset rout continues, which means bonds yesterday, and stocks and commodities today, the margin calls will once again resume, as they used to in the fall of 2011, leading to a toxic liquidation spiral, pushing prices even lower. So in keeping with the times, and sticking heads in the sand, watch out for that 3pm call from your repo desk. Best idea would be to just let it go through to voicemail.
Today’s Spanish auction results were, in a word, awful. Not just higher yields, but a terrible bid-to-cover and perhaps even worse; all of the funding could not be accomplished. The effects of the LTRO are rapidly diminishing as the money has now generally been utilized and the national banks of a nation can no longer support the funding needs of the countries in the periphery. We have reached the turn here and I predict much higher yields to come now for the troubled nations in Europe including Italy. What could be accomplished by liquidity has been accomplished but solvency problems cannot be cured by liquidity alone and that lesson is about to be re-learned again.
Unlike yesterday's modest manufacturing ISM beat, today's follow up March Services ISM is out at 56.0, reverting back to the Schrodinger theme so prevalent these days, missing the consensus of 56.8, and down from 57.3 in February, posting the first sequential decline since September 2011, and the first miss to expectations in 4 months. The core New Orders indicator was down from 61.2 to 58.8, still above 50 for 32 consecutive months. The backlog of new orders also dropped from 54.5 to 52.5 Amusingly, despite every energy commodity surging, the Prices index in March somehow posted a miraculous drop from 68.4 to 33.9. The only series that was contracting, and unchanged at 49.5, was supplier deliveries, even as inventories increased once again, from 53.4 to 54.0. And if the ADP report was enough to give traders a headache whether or not more QE is coming, today's final economic data point, refutes the latest jobs strength ahead of the NFP, once again leaving everyone into the dark as to the Chairman's true intentions.
Everyone's favorite stock pitchman, Bob Pisani, who lately apparently has the capacity to learn just one line and just regurgitate it ad nauseam, was on CNBC earlier screaming how gold is down because the US is so much better than the world, when in reality gold is once again being sold to fund early margin calls (yes, institutionals are that levered right now). As for the US decoupling story, which time after time is dragged out, only to be shelved once the impact of trillions in liquidity fades, and which is never different this time, here is none other than Bank of America explaining to the likes of Pisani why "the US economy is likely to prove a faulty engine of global growth." Read - no decoupling, despite what the market may be trying to say. And yes, the market, and especially the Russell 2000 is never the economy.
In the last week, both European and US equity markets have valiantly attempted to extend their rally into the stratosphere while the credit market has summarily dismissed this exuberance as 'oh those silly algo-driven momo monkeys'. Yesterday and today we have seen equities in both regions retrace aggressively to the much more realistic, liquidity spigot-lacking margin-compressing growth-slowing reality that credit has been pricing in.
We have previewed the phasing out of the LTRO effect previously here on several occasions. Now, courtesy of Art Cashin, everyone is aware that the eye of the European hurricane has officially passed, especially in the aftermath of this morning's horrendous Spanish bond auction, which shows that reality is back with a bang.
How the self-described 'mighty' have fallen. It was a month ago when we first heard of this mysterious British FX trader who dropped $300k in a Liverpudlian nightclub on a bottle of champagne that weighed more than the models he was 'dating' that night. The 'talented, charismatic, and likable' Alex Hope has been arrested by London's Financials Services Authority (FSA) in connection with an investigation into a suspected unauthorized FX trading scheme. As City A.M reports this morning, Hope's publicist confirms he is the 23 year old in question - though he 'obviously' denies all allegations. The schadenfreude on London's FX 'trading' desks (as opposed to bucket-shop retail-mauling FX 'brokerage' shops) is palpable from what we hear as 'it couldn't have happened to a nicer guy' echoes off the City's pub ceilings. As yet no charges have been filed - we await with baited breath for the sad truth to be outed.
The Mario Draghi press conference, in which the Goldman alum will spin tall tales of recovery, is set to begin. Watch it live here. If there are any notable changes to ECB policy, which is not expected, we will be sure to note.
- ECB'S DRAGHI SAYS ECONOMIC OUTLOOK SUBJECT TO DOWNSIDE RISKS
- DRAGHI SAYS `DOWNSIDE RISKS' PREVAIL ON REGION'S GROWTH OUTLOOK
- DRAGHI SAYS ECB SEES INFLATION UPSIDE RISKS PREVAILING IN 2012
- DRAGHI SAYS NON-STANDARD MEASURES WILL NEED TIME TO SHOW IMPACT
- DRAGHI SAYS IMPORTANT FOR BANKS TO STRENGTHEN BALANCE SHEETS
- DRAGHI SAYS BANKS SHOULD RETAIN EARNINGS TO STRENGTHEN - And nationalize losses?
And... goldilocks. The ADP report, which was expected to print at 206K came just where it was expected, at 209K, almost magically so, in what is probably the closest number to consensus in a long time. The previous number was revised to 230K, which means this was the 2nd drop in 3 months, and the first drop of the 3 month rolling average in the past 6 months: peak private jobs? And while the ADP has historically been a horrendous predictor of the NFP headline, this gives no actionable hint to those wishing to trade the payroll data, which in turn means that if Bernanke wants to undo his "New QE" skepticism, the decision will have to wait until Friday when equities are closed.
More pain in Spain has been the theme so far in the European morning as poor auction results across three lines has resulted in significant widening in the 10-yr government bond yield spreads over benchmark bunds with the Spanish 10yr yield up some 24bps on the day. In combination with this the latest Germany Factory orders also fell short of analysts’ expectations and as such the lower open in bund futures following yesterday’s less than dovish FOMC minutes has been completed retracted and we now sit above last Friday’s high at 138.58.
Today's otherwise key news event - the ECB rate announcement (which just printed at unchanged as expected) and press conference, will be trivial. As such, everyone is set to ignore the latest update from Mario Draghi, who courtesy of a $1.3 trillion liquidity injection since December has now largely wasted all his liquidity dry powder, at least until Spanish and Italian bonds are trading back at 7%, some time in the next few months. The result is that people like Citi's Steven Englander are saying to ignore the ECB, and to focus solely on the ADP (which has a horrendous predictive track record of the actual NFP print) report, to be released at 8:15 am, as it may be the only tradable hint ahead of the NFP report which as noted before is coming out on Friday, which is an equity holiday, although futures and bonds will be trading at the time of the release. More importantly, since the Fed now responds to economic data points in real time, a big miss to the consensus print of 206K will likely set the market surging as it will mean the Fed doves are back in control. Paradoxically, a meat or big beat, will be very market negative, as it will justify the withdrawal of liquidity support for at least 3-4 months, when the election fight will be in full swing, and Obama would be quite happy for another boost to the S&P in advance of November, and the repeat of the debt ceiling fiasco.
No surprise in today's ECB announcement. The Press conference in 45 minutes is also expected to be largely a non-event, although we will be delighted to hear Mario's response to the quality of Europe's collateral backing the trillions in fresh discount window borrowings spent on buying up Spanish and Italian bonds, which are gradually going underwater.