Archive - Nov 2010

In an interview with Dow Jones, William White, who previously was an economic adviser to the Bank of International Settlements, and prior to that spent 22 years at the Bank of Canada, warned that the "massive infusion of credit" accompanying the sudden and dramatic ramp up in the printing of new money as a policy response to all problems, both within the developed and developing worlds, is now "manifesting itself in the sharp rise of asset prices in large developing economies, which could potentially become another bubble that will burst with disastrous consequences for the global economy." He added that the global economy is in a 'particularly dangerous' position that can only be corrected if the currencies of developing countries strengthen relative  to those of developed countries, according to William White, one of the few policy makers to correctly predict the onset of the financial crisis. Of course for that to happen, the much fabled decoupling needs to finally manifest itself, and for Jim O'Neill to be finally proven right. Of course, that won't happen. Which is why we ask, the next time there is a systemic wipe out, in addition to naturally eliminating the Fed, can the terms BRIC, N-11, and all other such ridiculous acronyms, please be banned from usage in perpetuity?

As we pointed out earlier, the Irish 10 Year just hit an all time high of 503 and has continued leaking higher. The main catalyst according to several trading desks is the following RIA Novosti report which says that Russia, demonstrating far more prudence than a recently insane China, has stated that it is excluding Ireland and Spain from possible sovereign wealth fund investments: "Russia has excluded debt-saddled Ireland and Spain from the list of
countries whose securities can be used as investment targets for
Russia's sovereign wealth funds, the Finance Ministry said on Wednesday. The Finance Ministry, which posted the respective orders on its website
on Wednesday, said it had shortened the list of sovereign wealth fund
investment "to reduce risks in the process of the funds' management." It appears Russia is gearing for the inevitable jettisoning of a peripheral Eurozone country now that Europe will be forced to take drastic measures to lower the euro following today's QE2, something China appears to not be able to grasp just yet. And while the Irish cash treasury curve is getting increasingly flat, it is still upward sloping. Which is more than one can say for the CDS curve, which just like Greece, went inverted, and the 10 Year is now trading 40 bps inside the 3 Year. Which brings us to our trade recommendation of the day: just like in Greece cash was slow to catch up to synthetic, the expectation is that both curves will eventually overlay. However, as Greece taught us playing cash/CDS basis trades can result in some very dramatic liquidity induced flame-outs, we suggest sticking to either product on both sides of the hedge: namely - establish a cash flattener (sell 10 Year at 7.462%, buy the 3 Year at 5.330% for a pick of 210 bps), hedged with CDS steepener (sell 3 Year at 559 bps, buy 10 Year at 515 bps, for a net of 45 bps), both on a duration neutral basis . Assuming both curves pancake, one would stand to make about 165 bps. Of course, a simpler trade is just to put a flattener on for 3s10s cash.

As part of today's refunding announcement, the US Treasury provided a link to much needed monthly detail of the curve maturity profile. Below we present the two key charts. In a nutshell: in an ironic twist, the Fed has once again found itself in a catch 22: the second the curve stops flattening, especially in the 3M-5/7Y sector, whether due to the end of QE2-XXX, or due to actual, legitimate economic improvement (and you would see it here first, nowhere else), the interest paid on US debt will surge, and the Fed will have no choice but to roll all expirations into bills, creating a Frankenstein of a monster in which the entire US economy will live bill auction to bill auction, until even the rate on Bills become unsustainable.

RANsquawk US Afternoon Briefing - Stocks, Bonds, FX etc. – 03/11/10

The Irish-Bund spreads has just hit a lifetime high of over 500 bps, pushing above 502.75 last. Elsewhere, the EURUSD continues to trade over 1.40 despite the now inversely parabolic drubbing in gold. Then again, what can one expect when Cramer recommend buying it with both hands.

Treasury issued its QE2 cheat sheet this morning. Also learn how Basel 3 will turn banks, traditionally known for taking deposits and lending, into hedge funds for sovereign and IG corporate debt. Loan sharks to presumably pick up the lending slack.

One of the most fanfared decisions earlier in 2010 was the Treasury's announcement that it would gradually begin to taper off the sizes of upcoming treasury auctions. Too bad that that announcement assumed that the economy would gradually stand to normalize, tax revenues would pick up, and the Fed would never be forced to perform QE on itself again. Alas, the recent issuance projection demonstrates, and as today's refunding statement confirmed, this reduction is now over. In fact, auction sizes may once again have to increase to accommodate the $100 billion a month incremental demand interest due to QE2. The statement provided by Assistant Treasury Secretary Mary Miller, who until recently was a fixed income manager at T. Rowe Price, and even more recently stated that the Fed's buying plans won't affect UST issuance (oops), provides some insight into what the Treasury's more detailed refunding expectations are.

The Tea Parties have returned the 10th amendment and constitutional governance to the discussion, and clearly impacted elections. What they don't seem to talk about much is the weak dollar's role in our malaise. Absent changes in dollar policy, the Tea Party movement could be discredited too.

"Bring it on: let’s watch another wave of monetary policy history crash over us as you pull out the hammer and close your lips around another batch of coffin nails – ready to grasp the first nail to drive into the soon sealed coffin of Keynesian economics and then another in the coffin of fractional reserve banking and perhaps another into the coffin of fiat currencies. Oh, it’s all the same coffin? Fine – it will go quicker that way. Just remember to save a few nails for the millions of coffins of pensions and savings: for all of the responsible people who didn’t join in on the credit bonanza of the last few decades and spent their lives scrimping and saving. Let’s devalue their savings and nuke the US currency rather than go the quicker and more just road of default, shall we? Extend and pretend is the Fed’s motto, after all. Just watch out for those new crazies on the Hill that are starting to bang on the doors of the Eccles building. Will they break in and cart you off before you’ve finished your final magnum opus – the end of the US dollar and the US economy? Bring it on, Ben: take us that much nearer to the denouement of 100 years of US Federal Reserve. There won’t be a second hundred years. The final countdown starts now. " Saxo Bank

US ISM Non-Manufacturing comes at 54.3, a beats of consensus of 53.5, and the prior number of 53.2. A quick look at the components:

• New Orders: 56.7 vs. Prev. 54.9
• Employment: 50.9 vs. Prev. 50.2
• Prices: 68.3 vs. Prev. 60.1

As always, the respondents paint the most accurate picture: "Sales are still down compared to last year, but showing a slight increase", "Economy still slow for our industry, with very small signs of recovery. Strong downward pricing pressures from customers affecting business,", "Some positive growth in comp [comparable] sales over the past 2 to 3 months", "Business is picking up ever so slowly, but improving", "Generally stable-to-improving demand for our products."

In a word - skeptical: "There is a growing hope that the Tea Party has tapped a raw nerve and will serve as a lightning rod for change. And change is needed in a really big way when one considers the financial strains that mandatory entitlements, such as Social Security, will pose as the demographics, in terms of an ever-higher dependency ratio, ascends further. These mounting “locked in” fiscal costs have to be addressed as do the $3.5 trillion of actuarially unfunded state/local government pension plans. Social contracts will have to be re-written — perhaps with implications for contracts with bondholders. But hope is never a good strategy. Results are what matter. It took two full years for the Reagan rally to really take hold. An economy growing at a 7% clip in the aftermath of the 1980-82 malaise and an unemployment rate that came crashing down more 300 basis points from the highs certainly helped. So, while there is hope that the stage is being set for meaningful political change in 2012 (where the Republicans stand a very good chance of reclaiming BOTH the House and the Senate) the near-term outlook is muddled. Investors should not lose sight of the fact that the recovery is so listless that we are only one negative shock away from tilting the economy back into contraction mode." David Rosenberg

The Treasury has announced $72 billion in coupons to hit the Primary Dealers POMO churn accounts, just as expected. The breakdown is as follows: November 8: $32 Billion in 3 Years; November 9: $24 Billion in 10 Years; November 10: $16 Billion in 30 Years. Now what is interesting is that while the rate of coupon (and bill) issuance will certainly not decline, we now know that even according to the UST, it will in fact accelerate, and hit $700 billion net over the next 5 months. And as we calculated a few days ago, this means that the US Debt ceiling of $14.3 trillion will be breached. Which puts such Tea Partiers as Rand Paul in a sensitive position. In fact, last night as MSNBC highlighted, at the next debt ceiling raise vote, Paul may be able to filibuster the vote (something MSNBC seems to disapprove of, and a vote that had no problems passing last time it was cast in late 2009) which will result in essentially what is a default of the US. Of course, it is much easier to simply do away with the debt ceiling travesty altogether as even the CBO has confirmed that the US will need to raise at least $10 trillion in debt over the next decade. So why continue pretending America no longer live Primary Dealer sticksave auction to auction?

It hurts to be wrong. Not just emotionally, but physically, especially when it’s public, like swimming headfirst into a school of very ill-tempered jellyfish…..or maybe piranha. The horror of it is almost cinematic. The more artificially pumped your ego, or the more brainwashed with academic pretension, the more terrifying that moment of realization is, that moment when all your assumptions are dashed aside like a three-year-old’s alphabet blocks. To a certain point, it is understandable why so many people live in such violent denial, however, this does not detract from the perils of that denial…

Goldman's Richard Ramsden has released another report whose only purpose is to prove that the market is wrong and that banks are angles, that putbacks already priced in by the market for the TBTFs are far greater than even the worst downside case, that business models are "robust", that Basel concerns are overrated, and more such things which, of course, are a self referential plea not to sell Goldman.... Oh yes, and despite all this he cuts the price target for WFC, PNC and, oops, Bank of America, from $19 to $16/share. If Goldman cuts Price Targets when all it sees are pots of gold and unicorns, one dreads to think what may happen if the bank was actually concerned about the fraudclosure situation that according to some rumors has brutalized the banks' October (and now November) mortgage-related cashflow.

Let us think tactically about where we are, where we want to go and how best to get there, shall we?