Archive - Aug 10, 2010

One word how mortgage originators and funding desks feel right now (not to mention Morgan Stanley bull steepener clients): Panic. The 2s10s is now at the flattest it has been since May 2009 and going lower. All leading indicators (such as the Conference Board's, see the musing from the FRBSF yesterday on the topic) that use the flatness of the Treasury curve as an input variable are about to have a heart attack, further indicating the deflation is coming, in turn further pushing the yield lower. Ironically, those who followed Morgan Stanley's recent deflation hedge trade recommendations (1 Year dual digital out 100bp in one year if 2y CMS is below 0.8% and 30y CMS is below 3.3% at expiry for 16.5bp; and the 1y 1s5s conditional bull flattener, for zero cost, struck at 126bp. Currently, the spot 1s5s curve is at 130bp) are well in the money.

The decoupling between bonds and stocks had many perplexed for a while, as some openly mused whether stocks may be correct over credit, in the first instance ever where credit was wrong and stocks were right. Well, things are back to normal. The bond-stock divergence has finally collapsed (as has the whole Schrodinger Cat paradox about [in|de]flation. The latter won, and all those claiming stocks are the proper indicator now, have been proven wrong. Our simple observation: signals sent from credit will always, and forever, win over equities. Always.To all those who put the convergence trade on, it is time to take your patient, and well-deserved profits.

You say PermaBear, I say Realist...

In advance of today's FOMC statement which the entire market is waiting for with bated breath, specifically focusing on just what form any incremental quantitative easing will take (if any), Barclays' Joseph Abate once again steps back to observe the forest in avoidance of the trees, and asks the critical question: just what is the objective of this round of QE: is it to force down short- or long-term interest rates. And since the economic benefit of the former is minuscule, the Fed will arguable be focused on the latter, thus forcing Abate to ask how this can be best accomplished "without causing the disruptions that cropped up in the first round of asset purchases." The Barclays strategist also wonders if the purpose of a possible MBS monthly purchases on a periodic basis, rather than en masse, is merely to prevent a problem that has recently become prevalent: namely the surge in MBS trade fails, a phenomenon that has received surprisingly little attention lately, yet which as the chart below from Mortgage News Daily shows is become quite a major problem, and one which the Fed is certainly concerned about (and if it isn't it should be). In other words, most pundits openly ignore the very likely distortions that will arise from a wholesale attempt at pushing LT rates lower. Read on for Abate's open ended question, as well as his logic as to why possible QE forms, at least as presented by the general media, are likely to be woefully insufficient.

In his weekly letter, John Mauldin provides us with more signs of stress in Chinese property markets. 

• Strength in the USD across the board today, most notable against the GBP which is off over 1% after the RICS report data.
• The UK housing market is showing signs of weakness, with the first drop in prices in a year according to the RICS report. Fears of a housing led double dip recession have been heightened.
• Over 14 million people are likely to be effected by the floods in Pakistan which many experts say will have a more devastating human cost than the Haiti earthquake and the 2004 Asian Tsunami

Yet another step in the escalation between Iran and the US came earlier today, this time in the form of some trade war shots, after the leading economic daily Doniye e-Ektesad quoted First Vice President Mohammad Reza Rahimi as saying that "We are going to remove dollar and euro from our foreign currency basket and replace them with (Iranian) rial and all other currencies of the countries which accept to cooperate with us. These currencies are filthy and we will no longer sell our oil in dollar and euro." AFP further clarifies: "He did not say when that would go into effect, or how Iran was going to implement that decision as the second largest exporter in the Organisation of Petroleum Exporting Countries (OPEC), in an energy market dominated by the dollar." This is certainly not the first time Iran has threatened to move away from the dollar: the problem, of course, is execution. "Rahimi also said that Iran would limit its purchases from the European Union, which amounted to 11.4 billion euros or 27 percent of the Iranian imports in 2009, according to official EU statistics. He said this would mainly affect Iran's food imports such as wheat and soybeans from Europe."

In another indication that the impact of the existing trillions of stimulus have now expired and the economy is once again following the path of least resistance to massive deleveraging, elsewhere known as deflation, productivity declined by an annual rate of 0.9 percent after rising at a revised 3.9 percent rate in the first quarter, the first time since the fourth quarter of 2008 that output per worker fell. This was far weaker than the consensus seeking a 0.2% increase. Labor costs, which are watched by the Fed to gauge inflation, added a double whammy, increasing at a 0.2 percent annual rate after shrinking at a revised 3.7 percent rate in the first three months this year. This was also weaker than expectations of 0.9%, further confirming the deflationary phase of the current economic cycle, and further boxing the Fed which now needs to do something drastic before a full blown deflationary wave sweep the economy.

Just a quick update following last night's observations. AUDUSD has confirmed the break of the support of the ending triangle here, and Gold has also broken through channel support. - Nic Lenoir

• Buffett Shortens Bond-Holding Duration After Inflation Warning (Bloomberg)
• No Need for New Fed Stimulus (WSJ)
• UK RICS House Price Balance for July -8% - lower than expected: UK Economic Fears Rise As House Prices Dip (FT)
• Fed Efforts to Spur Growth May Move Markets More Than Economy (Bloomberg)
• Unemployment: What Would Reagan Do? (WSJ)
• China July Trade Surplus Surges as Imports Soften (BusinessWeek)
• China Tells Banks to Take Back Trust Firms Loans, People Say (Bloomberg)
• Incomes Fall in Most Metro Areas (WSJ)
• Shirakawa Signals Japan Recovery Withstanding Yen’s Advance (BusinessWeek)
• Housing Gauge Signals First Price Drop in a Year (BusinessWeek)

• Australia business confidence falls to lowest in 14 months on higher rates.
• British July same-store sales rise 0.5%: British Retail Consortium.
• China to close factories in energy drive; move affects 2,000 industrial companies.
• China’s July trade surplus surged to $28.73B, helped by 38.14% jump in exports.
• Mkts await outcome of Fed meeting; risky assets rise in anticipation of easing measures.
• Oil falls to below $81 as traders look to Fed for possible stimulus.
• Ambac's Q2 loss narrows to $57.6M from year-ago's loss of $2.37B.

The NFIB Small Business Report came in at 88.1, down from 89.0 but just beating the expectation of 88. Yet there was nothing optimistic in the index itself: "The Index of Small Business Optimism lost 0.9 points in July following a sharp decline in June. The persistence of Index readings below 90 is unprecedented in survey history. The performance of the economy is mediocre at best, given the extent of the decline over the past two years. Pent up demand should be immense but it is not triggering a rapid pickup in economic activity. Ninety (90) percent of the decline this month resulted from deterioration in the outlook for business conditions in the next six months. Owners have no confidence that economic policies will “fix” the economy... Bottom line, owners remain pessimistic and nothing is happening in Washington to provide encouragement. Confidence is lost. At least the “real variables” (hiring, capital spending and inventory investment) did not deteriorate substantially in July. The damage to the Optimism Index was done by expectations for business conditions for the second half – owners predict that the economy will not improve appreciably, at least on Main Street. Big banks and big manufacturers may be doing well, but the small firms are not. If this doesn’t change soon, the success of the large firms will be imperiled as well." And guess where the bulk of hiring in America comes from. The double dip recession in an ongoing depression continues to remind everyone it is not going away.

The Chinese Shanghai index was lower by almost 3% overnight after a series of disappointing economic releases out of the country. The first showed a further cooling in property prices, leaving many to speculate if the housing ponzi was not beginning to unravel/ As Xinhua reports: "Housing prices in major Chinese cities rose 10.3 percent year on year in July, down from the 11.4 percent growth in June, the National Bureau of Statistics (NBS) said Tuesday. It was the third consecutive month that China's property prices rose at a slower pace and the lowest growth rate in six months." Adding to the downward pressure was news released from the Customs Administration (which we will spread later), which indicated that "China's exports rose 38.1 percent year on year to 145.52 billion U.S. dollars in July, but the growth rate was down from the 43.9-percent surge in June, the General Administration of Customs (GAC) said Tuesday." Concluding the Asian trifecta of negative news, was the Bank of Japan's refusal to further ease its monetary policy. US futures are lower by about 0.5% although all the action in the US will be focused on the FOMC statement released early this afternoon.

RANsquawk European Morning Briefing - Stocks, Bonds, FX etc. – 10/08/10

Things are a-brewing. Chop will lead to trend within a month.