Archive - Jul 15, 2011

Today's bad economic data trifecta is complete, with the UMichigan consumer confidence number plummeting to 63.8 from 71.5, and well below consensus of 72.2. The number is far below the lowest Wall Street prediction of 68 (upper end of range was 75) and the worst since March 2009. The good thing for the Fed's QE3 plans is that high future inflation expectations are getting unanchored, with 1 year expectations down from 3.8% to 3.4%, and 5 Year down to 2.8% from 3.0%. A little lower and it will be just right.

The latest June economic datapoints in the form of Industrial Production and Capacity Utilization confirm the weakness is far more than just a soft patch: IP was up 0.2%, missing expectations of 0.3%, with the prior now having been revised to negative 0.1% from up 0.1%. Capacity Utilization was unchanged at 76.7% on expectations of a rise to 76.9%: this is what happens when the economy is still struggling with an inventory hoarding glut. And with inventories continuing to rise and being the only silver lining, expect these indicator to post further weakness well into Q3. Naturally, Japan is to blame once again: "In the second quarter, supply chain disruptions following the earthquake in Japan curtailed the production of motor vehicles and parts and restrained output in related industries; the production index for overall manufacturing was little changed for the quarter."

So much for the Empire Manufacturing index being a harbinger of an economic pick up. With virtually everyone on Wall Street expecting a positive print, with the average at +5.00, the actual number of -3.76 comes as yet another confirmation of the (f)utility of Wall Street groupthink. While it was a modest bounce from the June -7.79, this first July manufacturing indication, which coming negative means the contraction is now well into its second month, and has ugly undertones for Q3 GDP, which we expect most banks will revise their expectations lower in the aftermath of yesterday's JPM downgrade of the US economy. And while there was some good margin news with Prices Paid dropping by 13, or more than Prices Received which declined by 6 points, a far more troubling indicator this month is the collapse in the Number of Employees Index to 1.11 from 10.20, or the lowest of 2011. This is not good for July NFP numbers after the already atrocious June employment data. Elsewhere on the inflationary front, CPI missed expectations of a -0.1% drop, instead printing at -0.2%, the lowest since June 2010. The reason was the 4.4% plunge in the Energy Index, the largest drop since December 2008. That said, the core CPI was unchanged at 0.3%, higher than expectations of 0.2%, due to increases in prices for shelter, apparel, new vehicle, used cars and trucks and medical care. In other words: all the things that people need right after food and gas. We would venture to guess that in addition to S&P < 1,000, core CPI coming in negative is the other QE3 gating factor.

It is simply a damn shame that it has come to this. What the political powers that be in Europe have done in their grasp to disseminate obvious mis/disinformation is to sow the seeds for history's first Pan-European bank run! It is more than obvious to the entire world that 18% of the EU is Literally Junk, Carried As Risk Free Assets at Par Using 30x+ Leverage. What is the purpose of attempting to conceal facts hidden in plain site?

All you need to know about Citi's $1.09 beat of $0.96 consensus EPS: "Citigroup’s total allowance for loan losses was $34.4 billion at quarter end, or 5.4% of total loans. The $2.0 billion net release of credit reserves was 37% higher than the prior year period as credit quality continued to improve during the second quarter. More than half of the net credit reserve release was attributable to Citi Holdings. Consumer loans that were 90+ days delinquent, excluding the Special Asset Pool (SAP), fell 46% versus the prior year period to $9.9 billion, or 2.3% of consumer loans, while corporate non-accrual loans fell 56% to $4.8 billion and consumer non-accrual loans fell 39% to $8.4 billion." Translated: the "improvement" in mortgage loan standards (despite the ongoing foreclosure moratorium) is what "urged" the bank that it should provision less, and drive EPS higher. In other words of the $4.3 billion in pretax net income, almost half came from loan loss reserve releases. Since Q2 2009, loan loss reserve changes have reduced pretax income by $5.6 billion and added to pretax income by $11.2 billion. And that is what in the New Normal, is called "Income".

Risk-aversion prevailed during the early European trade ahead of results from the EBA's stress tests later, where 10-15 banks are expected to fail the test, together with S&P's warning related to a potential US sovereign downgrade. This resulted in weakness in European equities, led by financials, with particular underperformance seen in the Italian FTSE MIB index, whereas the Italian/German and Spanish/German 10-year government bond yield spreads widened to intraday highs. However, as the session progressed, equities came off their earlier lows, with some volatility observed due to option expiries in key European indices. Elsewhere, EUR/USD received support on the back of market talk of US corporate and Asian names buying in the pair. Moving into the North American open, markets look ahead to key economic data from the US in the form of CPI, Empire manufacturing, and industrial production figures. In fixed income, another Fed's outright Treasury Coupon Purchase operation in the maturity range of Jul'15-Dec'16, with a purchase target of USD 2.5-3bln.

Several important economic updates due today, among which CPI, Empire Index, Industrial Production and UMichigan consumer confidence. There is a small QE Lite Pomo today closing at 11 am. The Stress Tests are released at noon. Expect more European headlines to whip the EURUSD, and thus ES, around.

Bond markets have seen subdued trading but Greek bonds are again under pressure and the Greek 10 year yield has risen to 17.37% in increasingly illiquid trade. The dawning reality that the U.S. will be downgraded due to its appalling fiscal position led to new record nominal gold and silver prices yesterday. Denial regarding the possibility of a U.S. default continues with some analysts denying that such an event is “possible”. US Federal Reserve Chairman Ben Bernanke warned overnight that a default on America's debt will spark a major crisis and send shockwaves through the global economy. "The Treasury security is viewed as the safest and most liquid security in the world, and the notion it would become suddenly unreliable and illiquid would throw shockwaves through the entire global financial system," he told a congressional committee.

The reason we have not been covering this year's iteration of the European stress test closely (and the reason why we will not even mention next year's, if there is a Europe next year) is because it was guaranteed apriori that it would be just as farcical as its original version, and result in glaringly failing institutions in the 91-bank sample tested as "passing." Sure enough, The Independent has just reported that all Irish banks have passed the test "comfortably" - a list that includes such horrors as Bank of Ireland, Allied Irish Banks and Irish Life and Permanent Plc, which even Moody's suggested would have to fail to avoid last year's farce when AIB passed only to have to be bailed out two months later. And with that we can close the book on this year's stress test before it is even released.

A week earlier, we presented Moody's proposed take on which banks are at risk of failing Europe's Stress Test version 2 (which is nothing but another huge waste of time), the results of which are due to be announced later today. The event will likely be market moving although we expect it will be at most 3 months before a bank that passed the test fails in spectacular fashion, laying the groundwork for next year's Stress Test part 3: the most stringent of all, and so forth. Below is RanSquawk's comprehensive take on what to expect from today's announcement. "Last years stress test results indicated that despite a modest capital shortfall of EUR 3.5bln, overall, the EU banking system was well capitalised and that there was no major risk stemming from sovereign exposure. However, policy makers suffered a massive credibility blow after Ireland was forced to seek monetary assistance after Irish banks lost access to capital markets following revelations of massive financing gaps which in turn endangered the country itself. As such, this year’s stress tests, which have been carried out on 90 banks, have been designed to be more stringent in nature and should provide market participants with some degree of relief."

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The Treasury had to sell $66Bn worth of notes this week and there was no POMO for the Fed to bid with. The US could have been really screwed but, luckily, the market crashed and everyone panicked - INTO TREASURIES! Isn't that convenient?

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