Archive - Apr 18, 2011

RANsquawk Market Wrap Up - Stocks, Bonds, FX etc. – 18/04/11

Things like this don't all happen at once, today just happens to be a day that the S&P happens to mention that we are standing dangerously close to the ledge. Brazil was much smaller than Greece when they defaulted in 1983 and they took the US economy down with them...

A quick look at today's just released total debt to the penny from the Treasury may crimp the artificial smile of even such die hard administration sycophants as Moodys. Why: because the total debt, as we predicted when we observed last week's 30 Year auction, is now at $14,305,336,580,992.11. This is a problem because as anyone who rails against the broken US fiscal apparatus should be able to tell you, the debt ceiling is $14.294 trillion. In other words we have now officially breached the debt ceiling by $11 billion. So why has the US not filed a notice of default yet? Because the actual debt that matters for legal purposes is the debt "subject to the limit", which is $52 billion less than the total debt primarily due to $10 billion held at the Federal Financing Bank, and $41 billion in unamortized discount: a number which fluctuates in time depending on how much over or under par bonds are issued, but which ultimately will be zero at maturity of all debt (haha). In other words, as of today, the US Treasury has dry powder for just another $41 billion in issuance, or just over your average 5 Year auction. This can be seen best on the following chart from the Treasury where the total debt line has just passed the limit.

So it starts. Where will it end?

Two interesting charts indicate that following the earlier S&P announcement, which for the first time saw a risk aversion reaction that resulted in a selloff in equities and bonds, the 10 Year is surprisingly rich to the ES. In fact, a quick look at the chart below shows that while most asset pair (FX, Crude, ES) continue to correlate tightly following the downgrade, the 10 Year point is a major outlier. What is even more curious is that while the 10 Year may be outlying notably, the actual curve itself, as depicted by the 2s10s30s continues to correlate perfectly with ES despite some earlier choppiness. For those so inclined, an appropriate convergence trade would be a 2s10s30s neutral: essentially locking out for parallel curve shifts to moves in the ES, while trading the 10 Year spot for a compression trade with the ES, but keeping the wings of the butterfly constant as both the ES and the 10 Year is bought. This trade makes even more sense if the Fed proceeds with one of its late MOVE dumps, whereby it sells vol via off-balance sheet SPVs.

Earlier during the S&P conference call, one of the participants asked the brilliantly simple question: with the Fed monetizing debt, why should the US even bother to collect taxes? When one steps back from the apparent insanity of this rhetorical question, it does present a very good though experiment: after all what better way to stimulate the consumer part of the economy than to let 'taxpayers' no longer be that, and retain 100% of their cash. In the meantime, since nothing impacts bond yields, the statists will say, the Fed can continue to monetize debt indefinitely: after all we have a printing press and a reserve currency (an argument so asinine even the S&P laughed at it), until we get to a point where consumers have no choice but to lever up in the face of rampant inflation. And don't forget - the Fed can print an infinite amount of Treasury puts to where it alone pins yields to desired levels. While we hope to see much more discussion over this very simplistic yet so crucial question in the future, for all those (and at about 53%, it's not that many) in the US population who pay income and other taxes, courtesy of the White House, here is a schedule that shows where tax dollars are being spent. And don't forget: the Fed continues to match roughly one dollar for every dollar reimbursed back to the IRS.

This leads one to ask, “what is the Fed combating now?” And it’s not just Japan (the adjusted monetary base went vertical back in January). So what is requiring $200 billion per month? Also, we need to consider just how desperate the Fed is. QE 1 saw the Fed pumping $50 billion per month into the financial system. QE 2 saw $100 billion. Now we’re at $200 billion per month.

As S&P noted in its downgrade, and made all too explicit during the follow up call, the rating agency has now started a two year timer on the administration and the legislative branch to come up with not only a solution but a credible solution by the end of 2012. Yet as Reuters points out, the "S&P's action -- downgrading its outlook on the U.S. rating to negative from stable -- does not guarantee a deal." Basically expect more posturing from both sides of the aisle, which ironically may merely lead to a cementing of intractable positions, and kick the can so far down the street that not even S&P can see where it lands: a non-compromise compromise that the Hill is so good at, yet one which won't fly any longer. " While the White House dismissed the action, saying all sides were making progress toward agreement, Republicans and Democrats remain far apart on where to make the cuts that will be needed for long-term deficit reduction. "Any call for a bipartisan agreement on deficit reduction on fiscal reform is a welcome one, and in that context, I think that (the S&P move) adds to what we believe is some momentum towards that end," said Jay Carney, White House spokesman." Yes, ironically everyone: democrats and republicans are both claiming the S&P decision, which without doubt originated from Wall Street in the first place, validates their theories. Yet the biggest winner out of all this may be the Tea Party: "It is a vindication of the Tea Party and their stance that we are spending too much," Republican Representative Blake Farenthold, a member of the House Tea Party Caucus, said in a telephone interview." Or not: if the Tea Party continues "cutting" deficits like it did last week, when it was ultimately uncovered that instead of a $38 billion cut the ultimate impact on the budget was about $370 million, the Tea Party will most certainly burn all its credibility very soon if it continues to "tackle" fiscal sustainability with the same fervor.

D'oh!

And for the most unsurprising news of the day, Reuters reports that the White House has admitted it knew about the S&P rating action on Friday. Which means that all the key bond buyers (or sellers are the case may be, Pimco), knew at roughly the same time what the key market catalyst on Monday would be (we can't wait to get a declassified glimpse of Larry Meyer's phone log over the weekend one day in the future). Which also means that today's action was a strawman in which the big boys merely waited for an opportunity to buy bonds are lower prices, which the ongoing European collapse merely facilitated. Most importantly, it is now all too clear why over the weekend, Tim Geithner's face, instead of being hard at work at finalizing his tax filing, would grace each and every TV screen. Advance damage control, TurboTax style.

Putting its money where its mouth is, Dagong has a long-standing, negative outlook on US debt that doesn’t pull any punches. From its November 2010 report: “In essence the depreciation of the U.S. dollar adopted by the U.S. government indicates that its solvency is on the brink of collapse, therefore it wants to cut its debt through the act of devaluation with the national will; such a move has severely harmed the interests of creditors.” Following suit, S&P stunned financial markets this morning by revising its US outlook to ‘negative’, citing politicians’ inability to address medium-term and long-term challenges. In total contrast, US News and World Report published an article a few days ago entitled Why you should buy U.S. Treasuries,” which amounts to the worst advice I’ve seen in years.

In release timed perfectly so as not to interfere with the congressional vote last week, late on Friday the CBO put out its comparison of the Obama's budget, proposed back in February, with the CBO baseline assumption. The bottom line, and probably the main reason for the implicit S&P downgrade of the US, is that comparison the President's budget to the CBO baseline indicates that deficits are expected to rise by 41% over the next 10 years: the CBO project a deficit of $6.7 trillion while the President's number is $9.5 trillion, a 41% increase or $2.7 trillion. Got printing presses?

There are TRILLIONS in liquidity sloshing around the system right now. Inflation is already guaranteed. Sure we might have another debt Crisis, but there is absolutely no question that we’re going to be seeing massive debt defaults in the coming months and years. Currencies will be taking major hits when this occurs.

So with that in mind, I continue to maintain that we’ll be major inflation in the markets before the end of 2011

However, this time around, bad news has resulted in stocks are tanking and the US Dollar is rallying hard. The implications of this are vast. Is the Fed telling its buddies (Goldman etc) behind the scenes that they won’t be engaging in QE 3? Is the tide of easy money finally turning? I doubt it. The Fed HAS to keep funneling the money into the insolvent big banks. Failing to do so will trigger a collapse in the interest rate-based derivatives market which currently stands at $180+ TRILLION in the US alone.