Archive - Dec 7, 2011

It seems everywhere we look, talking heads are arguing that they expect a positive resolution to the EU debacle and yet market positioning does not suggest this is the case at all. Of course we have seen snap-back rallies and sell-offs but the dissonance between the seeming consensus of unbridled optimism that European policy-makers 'get it' and the market's anxiety should be very worrisome - especially for the 'money-where-your-mouth-is' crowd. Morgan Stanley put it best recently as they noted their sense that most investors assume there will be some solution found (or put another way, very few assume that the alternative - a catastrophe of disorderly banking and sovereign defaults - is a base case) but few investors seem willing now to position for that benign outcome (most evidently seen in European Sovereign debt markets currently).

Deutsche's Jim Reid, like us, is less optimistic and notes the same disconnect as he argues that at this point: "Who can honestly say they know exactly what rescue plans the EU governments are still discussing...". Investors are rightly confused and we agree with Reid that we don't think there is any chance of a quick fix to all of this. Furthermore, we fear that any belief in a reversion to pre-crisis levels of sovereign risk on the back of a solution is a pipe-dream as it is clear that risk premia are embedded now (like skews in options prices post 1987) and it is far more likely that Europe stabilizes at much wider levels - more like other leveraged regions.

This is a man who just a year or two ago was so arrogant of his power that he committed blatant perjury in front of Congress (the famed “debt monetization” lie)… NOW writing a letter to politicians whining about how unfair the media has been regarding his monetary actions. This is a massive and I mean MASSIVE shift for Bernanke.

The stock and bond markets are gearing up to celebrate the EU's approval this Friday of "fiscal union," the necessary surrender of sovereignty that's needed to seal the bondage of the EU's hapless citizenry to the banks and the lapdog bureaucrats slavishly devoted to their dominance. "Fiscal union" is the code-phrase for the EU nation agreeing to automatic sanctions (penalties) should their borrowing exceed what is deemed prudent. In this sense, it's little different from the 3% deficit limit that the member states agreed to via the initial treaty but conveniently ignored. The "teeth" of automatic sanctions is supposed to force nations to "tighten up" their fiscal and tax policies (including collection)--"austerity" at the fundamental economic and governmental levels. In other words, "Oops, we borrowed too much, default looms, let's paper over the insolvency by really really really promising to borrow less from now on." The mechanisms of the overborrowing--overleveraged, politically dominant banks and the euro--are left untouched. Why? For the "obvious" reasons the mechanisms of EU governance has been captured by the banks and their apparatchiks, and as a result of the quasi-religious devotion of the Eurocrats to the single currency, a catastrophically wrong-headed fantasy that they cannot give up without losing face.

Presented with little comment, except to say reality is returning as credit markets are starting to price in some disappointment. Italy 5Y is underperforming as the basis trades we mentioned yesterday are unwound and Italy 10Y has broken back over 6% as their curve remains inverted. Spanish 10Y spreads are up over 35bps today and 50bps from yesterday's tight print as Belgium and Italy follow suit. The swing in Spanish 10Y spreads, on a percentage basis, is massive, empirically, from a 4.5 standard deviation compression on Monday to a 2.5 standard deviation decompression today as today's widening in the biggest relative jump since July 11th - more small doors and large crowds?

As usual some highly pragmatic observations on the roller coaster stock market from the Fermentation Committee chairman.

More excellent independent research was released yesterday confirming gold's unique role as a diversifier and foundation asset in the portfolios of investors, especially at a time of heightened currency and investment risk. The independent research from highly respected New Frontier Advisors (NFA) confirms the importance of gold as a portfolio diversifier to investors in Europe and to investors exposed to the euro. During a period of extraordinarily serious economic uncertainty in the Eurozone, continued concerns about economic growth in the US heading into an election year, and the possibility of an economic slowdown in China, the World Gold Council (WGC) wanted to examine the relevance of gold as a strategic asset for euro-based investors to protect their portfolios and to mitigate the systemic risks being faced. The report, ‘Gold as a strategic asset for European investors’, commissioned by the World Gold Council, explores gold as a strategic asset across five sets of asset allocation studies, including four using historical data spanning 1986 to 2010, and one using the 1999 to 2010 time frame. The third party research builds on the now considerable research and academic literature showing that gold adds significant diversifying power due to its low or negative correlation with most other assets in an investment portfolio. Gold’s relevance as a strategic asset is continuing to grow. This will continue in a world facing the real risk of a global recession and even a Depression, poor investment returns, currency devaluations and wars and very high monetary and systemic risk. Put simply, when used as a foundation asset, gold has preserved wealth throughout history and again today. 

Mr President,

To overcome the current crisis, all necessary measures to stabilize the euro area as a whole will have to be taken. We are confident that we will succeed.
We are convinced that we need to reinforce the architecture of Economic and Monetary Union going beyond the indispensable measures which are urgently needed to cope with immediate crisis resolution. Those steps need to be taken now without further delay. We consider this as a matter of necessity, credibility and confidence in the future of Economic and Monetary Union.

Misquoting Shakespeare before the market open may seem like blasphemy but in a follow-up confirmation of a thesis we proposed back in July, Luxor Capital expands on the idea that something rotten is ahead for the state of Denmark. As with many of these crises, the heart of the Danish problems lie in a commercial and residential real estate boom and looming bust and with the capital/equity remaining so low in the Danish banking system (and a pitiful funding profile), it seems increasingly evident that public balance sheet support will become necessary (and perhaps not sufficient). How ironic that we pointed out, back in July, the probability that Germany will need two insolvency funds, a South-facing and now a North-facing one. Having traded in the mid 20s during H1 2011, CDS now stands at 106bps (off its September peak of 158bps) and given the interest we are seeing from hedge funds in this relatively lower cost short, we suspect this week's modest decompression will accelerate.

Yesterday we reported that the freeze in the Europe repo, asset backed paper and money markets is a broad indication that the shadow banking system - the primary conduit to broader disintermediated financial stability or in this case distress - on the continent has now locked up, which means that the three traditional bank transformations of risk, maturity and liquidity now have to be undertaken by the very non-shadow banks whose existence relies day to day on the ECB and the Fed, without any 3rd party market intermediaries (incidentally we are looking forward to tomorrow's quarterly update of the US shadow banking system and will post promptly). Today, the ECB has just confirmed our worst fears, in that the shadow situation is likely worse than expected.

Many EU leaders seem to actually believe that the Treaty changes are important.  The reality is the market could care less about treaty changes.  The market cares about only one thing, that the ECB will announce new, bigger, more aggressive sovereign purchases.  That’s all the market cares about.  The market believes that the treaty changes provide an excuse for the ECB and IMF to ramp up their efforts.  The EU can do all the treaty changes it wants, but if it is not followed up with aggressive new printing policies, the markets will sell-off.

All you need to read.

As the attached chart showing USD liquidity swap line usage by the ECB, or more specifically by European banks, we have now seen a surge to levels last seen in August 2009. However, more importantly this is where the usage was for the first time after the failure of Bear Stearns, and when everyone thought all had been fixed... until Lehman came. We are there now, in other words, we have just experienced a behind the scenes Bear-type event. What is disturbing is just how fast the rate of change was this time around compared to before, when it took months to get to $50 billion. Now, it was one week. When "Lehman v2.0" hits and it will hit, the next step function in the Fed's global bailout will be so big and so fast, it will induce vertigo.

• According to the FT, last-minute negotiations have commenced to create a much bigger financial "bazooka" to present at this week's EU summit that could include running ESM and EFSF together as well as winning increased support for the IMF. However, the report was later denied by a senior German government official
• According to a senior German government official, he is more pessimistic than last week on overall summit deal. He also said that he can't foresee running EFSF and ESM simultaneously, and he is not sure if the summit will reach conclusion on using IMF funds in the Eurozone crisis
• ECB funding to Italian banks rose to EUR 153.2bln at the end of November from EUR 111.3bln at the end of October
• Bund futures received a boost following a strong Bobl auction from Germany
• ECB allotted USD 50.685bln in its 3-month USD operation vs. Exp. USD 10bln
• CHF moved lower after the SNB slashed its 7-day USD repo rate, and weakened further after a Swiss minister said that Switzerland is still looking at negative rate options

• Euro zone leaders may raise ESM, EFSF capacity limit (Reuters) - since denied by Germany
• EU talks on doubling financial firewall (FT)  - since denied by Germany
• Martin Wolf: Merkozy failed to save the Eurozone (FT)
• Ireland to seek cheaper bail-out (FT)
• Fast-track ‘fiscal compact’ drawn up (FT)
• Clarke rejects call for EU power grab (FT)
• Obama Sets Campaign Theme as ‘Make-or-Break Moment’ for the U.S. Economy (Bloomberg)
• Spain Weighing a Fast, Costly Cleanup of Banks (WSJ)

As expected, virtually everyone, or a total of 39 banks (compared to 2 the week prior), scrambled to receive dollars from the ECB following the cut in the USD swap line rate from OIS + 100 to OIS + 50. Specifically, $50.7 billion in 84 day swaps (34 banks asking for dollars at a new and reduced rate of 0.59%) and $1.6 billion in 7 day swaps (5 banks at 0.58%) was just opened for a total of $52.3 billion. The expectation had been that just about $10 billion would be demanded, indicating how close to the cliff Europe's banks had been. This compares to just over $2 billion in the week before, and demonstrates the severity in the funding market that threatened to topple European banks like dominos last week until precisely a week ago the global central bank cartel announced an emergency dollar funding band aid. Reuters confirms: "Banks took more than $50 billion from the European Central Bank on Wednesday in its first offering since slashing the cost of borrowing dollars, a sign that some euro zone banks have problems finding dollar funding as the region's debt crisis intensifies." Elsewhere dollar libor continued to rise, passing 0.54% for the first time in years. This will continue rising as the self-reported dollar funding cost closes down to the OIS+50 differential, or where European banks can borrow from the Fed. And now that the dollar funding squeeze has been confirmed, all eyes turn to the ECB's LTRO announcement tomorrow. "What really matters is what the ECB does tomorrow afternoon, and in that especially what they do with the long-term refinancing operations (LTROs) and on the collateral rules," Societe General economist Michala Marcussen said. "What would be extremely helpful right now is if we get longer maturity LTROs." The ECB is expected to announce ultra-long 2-year or even 3-year refinancing operations after its meeting on Thursday." Needless to say, all these are stopgap liquidity measure to fix what is increasingly a pan European (in)solvency crisis, and thus will achieve nothing in the long run. And what is worse is that the non-USD liquidity indicators have once again hit an inflection point and turned negative: 3-mo Euribor/OIS spread rose to 1.002 vs 0.999 yesterday, near last wk’s high of 1.006 which was most stressed since March 2009. In other words, as we have been saying, the funding squeeze has now managed to shift away from USDs and is impacting the EUR market itself, something the Fed has no control over.