Archive - Dec 2011

Do we really honest-to-God no-fingers-crossed cherry-on-top believe that the powers-that-be will simply allow us to mosey up to the cashiers cage and redeem or convert our Gold for whatever monetary unit reigns supreme or is created?

Nearly two years ago, we first breached the topic of the Fed's nuclear option: the possibility (or is that likelihood) of the Fed stepping out of the continental US and proceeding to monetize European bonds. Back then we noted: "One thing learned over the past year is that everything is a distraction for something else, and that something else, quite usually without failure, ends up being the Marriner Eccles building on Constitution Avenue in D.C. What we refer to is disclosure from a paper written by none other than the Maestro Jr, in 2004, titled "Conducting Monetary Policy at Very Low Short-Term Interest Rates" (oddly appropriate). In this paper, Bernanke discusses not only the possibility of purchasing corporate assets (bonds and stocks), but emphasizes that one other security class which the Fed may be inclined to acquire under conditions such as those today, and has an explicit authority to do so, are foreign government bonds." The specific text referenced was the following: "In simple terms, if the liquidity or risk characteristics of securities differ, so that investors do not treat all securities as perfect substitutes, then changes in relative demands by a large purchaser have the potential to alter relative security prices. The same logic might lead the central bank to consider purchasing assets other than government securities, such as corporate bonds or stocks or foreign government bonds. (The Federal Reserve is currently authorized to purchase some foreign government bonds...)" So the question then becomes: with the ECB stubbornly refusing (for now) to proceed with outright monetization, and with its balance sheet already surpassing all time records as noted earlier (see below), coupled with tomorrow's LTRO which as discussed over the weekend will be a "Risk On" attempted failure, even if providing a brief relief rally in the interim, not to mention the complete lack of any long-term viability plan out of the Eurozone (EFSF failure due to lack of demand; IMF bailout plan failure due to the UK's veto and the circular joint and several funding by Italy and Spain of an Italian and Spanish bailout), will it be, once again, the Fed which at the end of the day will have to, by covert pathways or otherwise, be forced to step in and monetize European bonds: the so called Nuclear Option? Providing the latest thoughts on the topic is SocGen's Aneta Markowska...

I hate big brother.

The numbers tell us America is in decline... if not outright collapse. I say "the numbers tell us" because I've become very sensitive to the impact this kind of statement has on people. When I warned about the impending bankruptcy of General Motors in 2006 and 2007, readers actually blamed me for the company's problems – as if my warnings to the public were the real problem, rather than GM's $400 billion in debt. The claim was absurd. But the resentment my work engendered was real. So please... before you read this issue, which makes several arresting claims about the future of our country... understand I am only writing about the facts as I find them today. I am only drawing conclusions based on the situation as it stands. I am not saying that these conditions can't improve. Or that they won't improve. The truth is, I am optimistic. I believe our country is heading into a crisis. But I also believe that... sooner or later... Americans will make the right choices and put our country back on sound footing.

The Fed just released its 'framework' for thinking about planning to implement their proposals to take notice of the Dodd-Frank rules. There is little if any detail in here but the main points, via Bloomberg headlines from the 173 pages of admittedly well structured, but unclarifyingly disappointing prose are as follows:

• *FED BOLSTERS TOOLS FOR AVERTING COLLAPSE OF BIG FINANCIAL FIRMS
• *FED REGULATIONS FOCUS ON CAPITAL, LIQUIDITY, STRESS TESTS
• *FED RULES TARGET RISK MANAGEMENT, REMEDIATION, CREDIT RISK
• *FED PROPOSES `TRIGGERS' TO `EARLY REMEDIATION' OF WEAKNESSES
• *FED RULES TO LIMIT FIRMS' CREDIT RISK TO A SINGLE COUNTERPARTY
• *FED RULE REQUIRES BANK DIRECTORS TO APPROVE LIQUIDITY RISK
• *FED: FIRMS MUST ANNUALLY HAVE STRESS TESTS, PUBLICIZE RESULTS
  

And now the president explains why today's congressional vote slamming the 2 month tax extensions is not acceptable. We wonder if this means Obama's Hawaiian holiday will be delayed until this critical issue is resolved.

I’m not sure exactly when it happened, but Europe has finally starting dealing in the truth. Draghi can’t point out the limits of sovereign debt purchases often enough. The EU, usually happy to let completely false rumor after false rumor to drive the markets, took the time to quash the idea of EFSF and ESM being increased in size. Not just, once, but twice, as Merkel has said it on the 13th, and it came out after yesterday’s conference call. They even took the time to point out that they hadn’t been able to agree on 85% agreement. That could easily have been buried or ignored, but yet they chose to highlight it after their call yesterday. Finally, they even went ahead detailing the relatively puny IMF/Central Banks bailout fund. The fund was disappointingly small at €150 billion, rather than the €200 billion that had been expected. The UK is out, but so are Portugal, Ireland, and Greece. Those 3 not being in makes sense, but this is the first time that I can remember that the EU gave us the numbers straight. Usually they would have announced the big number with caveats about various “stepping out countries” and “yet to be ratified” countries. Estonia, which has no debt, is not going to participate. Again, makes sense, but is a step away from the EU making everything sound bigger and grander than in the past.

Today's 5 Year bond auction merely confirmed what we already knew from the 1 month Bill auction (and recurring negative yields thereof), namely that heading into year end everyone is scrambling for the "safety" of uncle Sam. The auction priced at a fresh record low yield of just 0.88%. In other words people will collect less than 1%/ year to hold US paper for 5 years. Naturally, the market is telegraphing that either it either does not buy any optimistic views about the LT economy, or, far more likely, is betting that very soon Bernanke will extend the ZIRP promise well beyond mis-2013 as Bernanke is left with no choice but to push the risk free security further and further to the right, and force everyone to chase every more duration, and go into risky assets to reflate if not the economy, then at least the stock market. Otherwise, the Bid To Cover dropped to a 4 auction low of 2.86, although above the 12 auction average of 2.83%, with Directs, Indirects and Dealers taking down 9.1%, 50.6% and 40.3%, respectively. Oddly enough, following yesterday's collapse in 2 Year Indirect interest, today foreign buyers, who tendered a total of $22 billion at a 79% hit rate, once again took down more than half the auction, and the highest since August 2010's 50.8%. Overall, this is merely more year end liquidity shennanigans, as equities experience a short squeeze, while credit parks all the money it can find in the safest paper. What this means for tomorrow's LTRO tender interest is still unclear.

Update: Payroll tax extension vote fails, as expected:

HOUSE HAS VOTES TO REJECT SENATE TAX PLAN; VOTE CONTINUING

Watch as the house votes on the Senate proposed two-month payroll tax extension, coupled with a motion to go to conference.

The death throes of the debt-based consumerist lifestyle are already visible beneath the glossy propaganda of "rising revenues this Christmas season." Those revenues were obtained by selling goods at below cost, in the absurd hope that income-strapped, over-indebted consumers would make profitable "impulse buys." As Mish has documented, the "impulse buys" are being returned even before Christmas to the tune of hundreds of millions of dollars. The Fed is desperately attempting to re-inflate the debt bubble by lowering interest and mortgage rates and buying up all sorts of semi-toxic/impaired debt. What the Fed dreads is the reality we all feel and see: fear of the future due to diminished wealth and insecure incomes. If your assets have fallen in value, you feel poorer because you are poorer. Borrowing more at any interest rate will not make anyone feel wealthier. People who fear their income may plummet due to layoffs or their hours being cut are not in the euphoric mood to borrow more, and banks which cannot dare to lose more money loaning to people who will default have cut off credit to millions of previously rabid consumers of debt. Ask yourself this simple question: how much stuff could people buy if they could only spend surplus cash, after all their expenses and debt servicing payments were paid in full?

The chart below is the bid to cover on the US 4 Week Bill auction. Needless to say, it just yielded 0.000%. We will leave it up to readers to figure out why the announcement of the result at 11:30 am today led to a violent sell off in EURUSD.

A brief moment of American Santa lore... 

So the market has completely latched on to the idea that LTRO is back-door QE. Does this make any sense and can it even work? So banks can borrow money for up to 3 years from the ECB.  They can buy sovereign bonds with that money.  Those bonds would be posted as collateral at the ECB. The bull case would have banks buying lots of European Sovereign Debt with this program. The purchases would be focused on Italian and Spanish bonds with maturities less than 3 years. Buying bonds with a  maturity longer than the repo facility is risky.  The banks would need to be assured they can roll the debt at the end of the repo period.  Some may be convinced, but the bulk of the purchases will be 3 years and in so that they loans can be repaid with the redemption proceeds. So banks buy the bonds and earn the carry and all is good?  Not so fast. The LTRO can help the banks with their existing funding problems without a doubt, but it is unclear that encourages new bond purchases. I think we have already seen the initial impact.  There will be significant interest in tapping the LTRO for existing positions.  Some small amount of incremental purchases may occur at the time, but the banks will use this to finance existing positions. Now we will wait to see rates do well, but will be disappointed.  The big banks with risk management departments will decide to decline.  The risk/reward just won’t be attractive to them. In the end, this won’t do much for the sovereign debt market, but will shine a spotlight on which banks should be shorted and will possibly expedite their default.