Archive - May 24, 2011

Out of the blue, ES just dropped a good 5 points. Yes, in the good old PCP (Pre-Central Planning) days, this was perfectly normal, but since now we have a whole army of millisecond, algorithmic robots and a whole floor at 33 Liberty dedicated exclusively to making sure things like this never happen, it is rather disturbing. And in tried and true (anti) correlation fashion, the USD/JPY are jumping against all carry crosses. As far as we know this was not predicated by any news: granted, export news out of Japan were horrendous (12.5% Y/Y drop), but those should have been mostly priced in. Having observed the overnight futures every day for the past two years, this kind of thing "just doesn't happen" any more, which is why we are eagerly searching for what may have been the catalyst. If we find one, we will promptly update. In the meantime remember: he who defects first, defects best.

A month ago, we reported that the Japanese public pension fund, which holds JPY152 trillion in total reserves, would for the first time withdraw 6.4 trillion yen in order to cover pension payouts, a process which once started, eventually ends up with the "Illinois" conclusion where it has to issue bonds to pay accrued pension obligations. The reason why the Japanese pension fund is particularly important for japan is that not only does it have implications for the welfare system of the land of the rising sun, any future dispositions will explicitly affect the supply and demand of JGBs, of which pension funds have traditionally been a major buyer. Not only that, but as Dylan Grice reminded us some time ago, a liquidation process would also impair US Treasury holdings: " As Japan's retirees age and run
down their wealth, Japan's policymakers will be forced to sell assets,
including US Treasuries currently worth $750bn, or Y70 trillion "eight
months" worth of domestic financing." Today, another SocGen analyst, Takuji Okubo, presents a realistic outlook of what will happen when one takes government projections to the pension system and applies realistic assumptions. In a nutshell, instead of a build up of JPY100 trillion over the next 15 years, pension reserves will likely decline by JPY36 trillion, a swing of almost 140 trillion, or nearly $2 trillion in incremental and very marginal JGB and treasury demand actually becoming supply. And in a world in which the Fed is suddenly (allegedly) pulling out as the biggest source of sovereign paper demand, this swing factor out of Japan will have substantial implications for the bond market, especially when coupled with a Japanese economy that suddenly finds itself on the rocks.

It may not be directly related to finance or theft via financial innovation, but for anyone who has not turned on The Weather Channel, there is currently a super cell of Tornados impacting Oklahoma state and nearing Oklahoma City, where at least one F5 Tornado is rumored to have touched down and 2 people have died. Follow the livestream of what can only be classified as the sequel to Twister below.

A few days ago we presented a realistic, if somewhat somber, outlook of what would happen when (not if) Greece finally pulls the plug on its vegetative existence, and its paralyzed body will no longer serve as a breeding ground for maggots of the financial innovation variety. Today, we present a far more comedic one, courtesy of the ECB's Christian Noyer, who makes it all too clear: Europe is not in it to bail out itself and its banks which would topple like a house of undercapitalized, under-MTMed, and uber mismarked cards, but only to protect those poor sad souls of Greece from the "Horror" that would be unleashed when a Greek free fall bankruptcy finally arrives. Truly, the humanist ECB is doing god's work on earth. Try not to laugh while reading this.

Today, France tried the oldest trick in the diplomatic book, presenting what it wishes was reality as reality, when it said that China had backed its candidate for the IMF presidency under Christine Lagarde. That's great, only it's totally false. Not only has China not endorsed Lagarde, but according to a statement just released by Jianxiong He of China, as well as every other BRIC, the developing world has just put its stake in the ground and is firmly behind a non-European candidate, stating that "we also believe that adequate representation of emerging
market and developing members in the Fund’s management is critical to
its legitimacy and effectiveness." Not surprisingly, the BRICs reference an old promise by none other than Jun(c)ker which "declared that “the next managing
director will certainly not be a European” and that “in the Euro group
and among EU finance ministers, everyone is aware that Strauss-Kahn will
probably be the last European to become director of the IMF in the
foreseeable future”." By creating the BRICs (and South Africa which is a co-signator of the statement), Goldman may have just created a New New World Order Frankenstein monster which will refuse to blindly go with the demands of its now insolvent master. In the meantime, the diplomatic faux pas by the French, if anything, will merely antagonize China, which has so far refused to unpeg the CNY only due to demand by the US to do precisely that, as any accession to foreign demands would be seen by China, and its billion plus producers (and eventual consumers), as a sign of weakness.

According to Dow Jones and now CNBC's Kate Kelly, the AIG offering is due to price at $29 as underwriters supposedly have succeeded in the last minute scramble to get enough bid interest above the Treasury's breakeven price of $28.70. That's a $0.30 buffer. Surely this will inspire much confidence in the deep order book of institutions which despite having access to limitless zero cost cash, still barely chipped in enough to avoid major 11th hour embarrassment for Tim Geithner. In the meantime here is the math for determining just how taxpayers are winning on this deal: Treasury gets $5.8 billion in cash proceeds (200MMx $29), which is immediately offset by $35 billion in debt issued today, another $35 billion tomorrow, and $29 billion on Thursday. One step forward. Fifteen steps back.

Today's case of alleged (and rather substantial) commodities manipulation comes courtesy of two veteran BP traders and Norwegian tanker giant Frontline. Earlier today the CFTC charged James Dyer and Nick Wildgoose -- former senior traders at oil major BP -- with a manipulative trading scheme. Reuters reports: "The complaint, among the agency's biggest charges of wrongdoing in energy markets, said the scheme yielded more than $50 million in unlawful profits." The two traders, currently working at Arcadia and Pernon Energy, are controlled by Cyprus-based Farahead Holdings, a company controlled by Norwegian shipping magnate John Fredriksen who runs the Frontline, the world's largest tanker company. And since tankers tend to benefit from high crude prices, the question is not why Frontline was doing it, but which other tanker companies have also dipped in the pot but yet not been caught. Also not unexpectedly, at the heart of the charge is the easily manipulated linkage between physical and derivative commodities, which the traders exploited profitably for quite a while.

RANsquawk Market Wrap Up - Stocks, Bonds, FX etc. – 24/05/11

A special report...With the latest ball breaking EURO BAMA updates. [ABSOLUTELY NO COFFEE OR ORANGE JUICE ALLOWED!]

So, as the government is about to unload some of its AIG shares on the market, we will hear about it all day long. It is impossible to listen to a report on AIG without someone mentioning how credit derivatives were directly responsible for the collapse of AIG which is proof that credit derivatives are bad. It also seems that everyone is convinced that it wasn’t the fault of the banks and that the bailout was justified. The reality is that AIG lost money on customized regulatory capital arbitrage pass through trades where they underestimated the risk but also gamed the system. The banks themselves were sloppy on the credit terms that they engaged AIG on, creating the margin call death spiral. Finally, it has never been made clear that AIG had to get dragged into the problem, and that AIG FP could have been ring fenced and not impacted the parent companies.

The brokers are getting pissy again - it must be that time of the month again....when vol is about to surge. In a blast to all exchange members, Interactive Brokers has just warned of imminent margin hikes due to "the recent spike in volatility of various commodity products." Of course, expecting vol (just like inflation), one can argue, is more important than even experiencing it. And it promptly becomes a self-fulfilling prophecy. In other words, should other brokers and/or exchanges follow suit with this preemptive margin hike warning, it may be time to step to the sidelines. Then again, in centrally planned, manipulated stock (and now all other) markets, this is easily the best decision regardless...

According to the just released minutes from the April 4 and 25 discount rate meetings, two Feds: the Dallas and Kansas City Feds, continued to request an increase in the discount rate by 25 bps from the current 0.75 bps. As a reminder the discount rate was first (and last) hiked back in February 2010, when the Fed, wrongly tried to telegraph the all clear on the economy, which was then hoped to have entered a virtuous cycle, only for everyone to realize it had only entered the conclusive phase of QE1. Since then it has held constant at 0.75 bps, even as it continues to be purely a formality, with just a few million dollars borrowed at the discount window by various banks who wish to avoid the Discount Window stigmata. Therefore, instead of actually determining interest on existing last ditch overnight liquidity requirements, any move in the Discount Rate would instead simply put more confusion on the path the Fed has set off on with regard to tightening/loosening. In other words, despite all the posturing by ever more Fed presidents, just two Feds are willing to put even one metaphoric cent where their mouth is.

Once again Zero Hedge is just a week or so ahead of the "experts." A week ago, in a post titled "April Vehicle Assembly Rate Collapses, May Industrial Production Estimates To Be Cut" we concluded "Expect to see drastic downward cuts to May Industrial Production and next, to Q2 GDP." Enter JPMorgan's Michael Feroli with "Motor vehicle sector to drag on Q2 growth." Full text: "We are revising down our outlook for the annual growth rate of real GDP in Q2 from 3.0% to 2.5%. The main factor behind our revision is weaker output of the motor vehicle sector. Based on industry data we project that real output in this sector will decline at around a 20% annual rate, which would subtract 0.5%-point from GDP growth. From an expenditure category perspective, we see most of this weaker output making itself felt in a softer pace of inventory accumulation (with some offset though weaker imports). A portion of this shortfall reflects supply chain disruptions associated with the Tohoku earthquake. Anticipating a fading of those disruptions, auto production schedules look for a rebound in output in the third quarter, which, along with somewhat lower gasoline prices, supports the case for an acceleration in growth next quarter to 3%. The change to our second quarter growth forecast is modest enough not to have a significant impact on our projections for labor markets or inflation. We continue to anticipate a first Fed rate hike in 13Q1." Next up: Goldman revising their Q2-4 GDP "hockeystick" to be more reminiscent of a "baseball bat."

Obama says we should "look forward" instead of prosecuting Wall Street fraud. That guarantees that we will have more economic crises.

Similarly, if we only "look forward" and never look back at unanswered questions, it will ensure more hanky panky in Iraq ... er, Libya ... um, Iran or elsewhere ...

Discussing population dynamics in elite (or is that elitist, let's just call it Wall Street) circles has always had an aura of taboo about it, due to the inevitable degeneration of any conversation into Malthusian rhetoric, especially if one of the speakers had had a little too much to drink. And for better or worse, name-dropping Malthus does not garner brownie points, nor will it lead to another horrendous straight to HBO faux morality tale about this or that. That stigma, however (and luckily) has not prevented Deutsche Bank's Sanjeev Sanyal (yes, there are people at DB who do think originally and whose day is not taken up by trips to and fro Englewood Cliffs) from penning a must read macro analysis titled "The End of Population Growth" which we will discuss more in depth shortly, but wanted to bring readers' attention to one particular chart: namely that comparing world fertility rates in 1950-1955 and 2010-2015. The surprising implication of the below chart leads Sanyal to declare that the period set to begin in just 10 years "will be one of the most important turning points in history" simply because: "the human race will no longer be replacing itself by the early 2020s. Population growth will continue for a few more decades because of momentum from the age structure and people living longer but, reproductively speaking, our species will no longer be growing." And since global reproduction will not be net additive, it will be net subtractive... and on a long-enough timeline the world's population will drop to zero...