Archive - Jul 26, 2011

Watch Kansas Fed's (non-voting) Hoenig, long the only sane and dissenting voice at the Fed, discuss Fed monetary policy live at the House Financial Services subcommittee chaired by Ron Paul (and this time the audio actually works).

Just because we needed some fireworks, here is Obama, providing the catalyst. Watch for a very indignant Boehner TV appearance in T minus 5...4...3... And yes, this will not help the consensus-building effort.

Earlier today, while discussing the implications of a US debt downgrade on a SIFMA call, JPM head of fixed-income Terry Belton told listeners that a US downgrade could cost the US an additional 60-70 bps in incremental interest. That's per year. He also added that US asset managers are unlikely to sell Treasurys on a downgrade, but that's irrelevant. Nobody can predict what all the knock off events from a US downgrade would be, as the Citi presentation from yesterday indicated. Should there be a downgrade, investors may not sell Treasurys, but they sure will be forced to sell other lower rated instruments to keep the overall rating distribution of their portfolio in line with mandated rating requirements. Which in turn, following margin calls, will result in, you guessed it, selling of Treasurys. Yet this debate is the topic of another post. What is more important is that on the same call, Belton said that a 70 bps increase in interest would result in an incremental $100 billion in interest expense each year. As a reminder, this is roughly the amount that the NPV of a realistic deficit reduction plan over 10 years would chop off from the US deficit on a yearly basis. Simply said: the US downgrade alone, now virtually taken for granted by everyone, will offset any beneficial impact from any deficit reduction that will have to happen for the debt ceiling to be increased. And that, ladies and gentlemen, is why cash flows matters.

And away goes trouble down the drain...

Today's "Breakfast with Dave" from David Rosenberg is a veritable chartapalooza, the inspiration for which appears to have been the "reversion to the mean" theme presented in yesterday's IMF chartpack, presented here. There is, however, one section that is unique: that dealing with gold, and more specifically, why in Rosenberg's opinion gold is still quite cheap and why it is trading at about 50% of what the Gluskin Sheff strategist would consider bubble value. As Rosie says: "we have liked gold for a long time and we remain very constructive. It is more than just a hedge against recurring bouts of global financial volatility. The growth rate of gold production is roughly stagnant while the growth rate of fiat currency in most parts of the world continues to accelerate. It's all about relative supply curves - the supply curve for bullion is far more inelastic than is the case for paper money. It really is that simple." Indeed it is: when one strips out all the fancy talk, mumbo jumbo, and syllogistic gibberish out of modern economic theories, be they neoclassical Keynesianism (or, god forbid, just classical), chartalism (sorry, infinite debt-money issuance won't work: in two years we will all see why), or any other attempts to reduce a broken imbalance in supply and demand propped up by the "invisible hand", it is all about supply and demand. Sure enough, one thing we have an infinite supply of is fiat money, and the resulting debt necessary to "back it up." As for demand, well that's another matter. With gold: it is just a little inverted.

As anyone who follows the restructuring process (and religiously reads debtwire) will tell you, the first sign of smoke is when a creditor retain legal bankruptcy counsel, promptly followed by financial, which in turn, or at least 95% of the time, leads to a dropping off of bankruptcy docs at the local bankruptcy court, or Southern New York. And where there's smoke, there's Alabama fire. According to blog al.com, the Jefferson County Commission has just retained the services (at $975/hour) of Ken Klee, of LA-based Klee Tuchin, best known for advising Orange County on its Chapter 9 filing back in 1994. And with this the probability that Jefferson County will conclude that the time to file its own Chapter 9 in two days, is virtually a certainty (and sorry, no bankruptcy lawyer will advise his clients not to file for bankruptcy. Hourly retainer, remember?). And with the US debt situation still unlikely to be resolved within 48 hours, the last thing the market needs is to worry not only what known on effects this mega-municipal bankruptcy case will end up generating, but who else will file after. That said, we are confident the market will surge even more as it digests these news. Why? Two words: Bernanke Put.

Just like in previous auctions post the end of QE2, so today's just concluded $35 billion 2 Year auction closed off with Direct Bidders once again surging to take down nearly as much as the Indirects. Foreign institutions (Indirects) were responsible for 27.67% of the total allocation, while Directs rose from 13.53% to 20.03%: Chinese proxies, Fed, who knows. It wasn't dealers, who supposedly took down just over half or 52.30% of the auction. Otherwise, the bond priced at a 0.417% high yield, modestly higher than June's 0.395% same with the Bid To Cover, which came at 3.14, just higher than the 3.08 previously. With the When Issued trading at 0.42% there were no major surprises into the pricing. Overall, nothing notable except for the increasing role that Direct Bidders continue to play in each and every issuance now that the Fed is briefly not monetizing treasury debt. We expect more of the same in the remaining 5 and 7 auctions in the balance of the week.And an amsuing comment from TD's Richard Gilhooly: "Given the bid in the Treasury market today as spreads widen in Agency paper and mortgages, belatedly in swap spreads, it would suggest that we are seeing an ironic flight to quality into the asset class that is at risk of downgrade." Yeah, who cares though.

I first started coming regularly to Daet, in the Bicol region of the Philippines, more than 13-years ago. Wages for unskilled workers are about $4.65 per DAY. If you buy food from the local markets or vendors and prepare it yourself, you can have quite a decent meal of fresh local fish, rice, and vegetables for less than $1 per person. If you have a place to stay, even adding in a few luxuries (beer is about 50c a bottle, for example), you could live well here on $10 a day. Down the road from my wife’s small hotel is a vacant beach lot for sale. It’s priced at about $35,000, and the owners have spent a considerable amount of money improving it with access ramps and other structures leading down to the water. The land is already planted with some crops, and there are ponds suitable for fish farming. Of course, construction costs here are quite cheap by western standards, and you could build a nice three-bedroom home for around $60,000. In total, that’s less than $100,000 for a spacious beachfront home in a quiet, clean, pristinely beautiful place where living costs will only run $10/day.

So much for the IEA's intervention. Crude is once again comfortably over $100, and by the looks of things will be heading far higher before long. Yet the climb back to triple digits was not easy. Note the numerous plunges in CL where crude prices would tumble for no other reason than having way too many trigger-fingered headline scanning algos trading each and every commodity, and massively overreacting to the smallest piece of good or bad news. Elsewhere, we expect rumblings about gas at the pump, which is now set to resume its climb to $4.00/gallon to once again return, as economic models have to be adjusted even lower as that great whooshing sound is America's marginal discretionary purchasing capacity entering millions of gas tanks side by side with the unleaded.

The map below, which shows the gravity of America's pervasive pension and healthcare liability underfunding problem, should certainly raise a few eyebrows. Sourced from the IMF's Article IV presentation which in turn sources the data from the Pew Center, the map shows that even despite the near doubling in the S&P since the March 2009 lows, there are still at least 9 states that have a minimum 35% underfunding in their pension and liability obligations. As a result, we expect that just like in the case of Illinois recently, many more states will be forced to issue debt to fund various entitlement plans on a "paycheck to paycheck basis." It also means that ever more states will begin scrambling after high beta, low quality, and very high risk stocks (in many cases selling CDS), in order to refill their coffers. We can only hope that the biggest dip buyer of NFLX stock today is not the Louisiana Retirement Fund system (for example), but we have a feeling we would be quite wrong.

For those who live and breathe solely to know how Stevie Cohen has performed at any given moment, we have an update. According to Bloomberg's Hedge Funds brief, SAC Capital told investors last week that his main hedge fund is up 9.2% year to date. It is unclear if he provided any further insight into the firm's troubled relationship with various regulators and law enforcement officials. Some other fund update from Bloomberg. Balestra Capital Partners LP was negative 2.37 percent last month and has lost 7.63 percent year-to-date, according to its monthly results and commentary sent to investors. Brencourt Advisors LLC’s $260 million Brencourt Multi-Strategy Fund lost 90 basis points to drop year-to-date returns to 2.84 percent, according to an email update sent to investors. The merger arbitrage fund gained 22 basis points last month and has returned 2.17 percent through June 30. The Brencourt Credit Opportunities Fund lost 0.95 percent and has returned 3.39 percent in 2011. Broadfin Capital LLC’s Broadfin Healthcare Fund LP returned nearly 9 percent in the second quarter, according to its quarterly letter to investors, a copy of which was obtained by Bloomberg. Long positions in Alkermes Inc. and Hi-Tech Pharmacal Co. Inc. “were the largest drivers of the fund’s performance,” the letter said. The New York-based fund is managed by Kevin Kotler. Summarizing returns by strategy for 2010 and 2011 (table below) shows quite vividly that what worked back in 2010 is no longer in vogue, although the main exception - the best strategy for both years - continues to be Mortgage-Backed arbitrage. Although most curious for some may be that none other than John Paulson is now officially the biggest fan of John Boehner. Read on.

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ISDA is rapidly deteriorating to rating agency status when it comes to credibility. After it made it all too clear in the past few weeks that no matter what happens it would never "determine" Greece (or any other European insolvent country) to have breached a CDS trigger (as that would apparently destroy the world), the same trade association (logically enough comprised of the same firms that make up the heart of the status quo) has joined the rating agencies, and as of last night the CME, in making it all too clear that a debt ceiling plan (preferably Reid's because it achieves absolutely nothing) has to pass, or else, after it earlier announced that the US has precisely 3 days to cure any missed debt payment before US CDS are triggered. Obviously this can not be allowed to happen, so expect this latest development to be used by the president in his nighlty scaremongering session.

Less than an hour ago, Boehner had another TV appearance discussing his proposed plan. Judging by the networks' reaction even the general population is getting exhausted with this neverending soap. So here, courtesy of Bloomberg All, are the summary points he touched on. Nothing notable except for his assumption that the plan has a chance of passing both the House and the Senate, and that the house may vote on his plan as soon as Wednesday.

Is a second recession in so short of a time in the offing? It certainly seems that way. The hope for a continued recovery has grown dim as of late as many of the economic indexes are moving towards contractionary territory.  As we posted recently in "EOC Index Shows Economic Weakness" there are several concerns pressing the US economy and, in the words of David Rosenberg, chief economist at Gluskin Sheff, “one small shock” could send us into a second recession.  With the recent release of the Chicago Fed National Activity Index our proprietary economic index is just one small step away from crossing the 35 mark which has always been a pre-cursor to recession. We have discussed many times recently that with the unemployment rate remaining high, housing prices slipping into a secondary decline, consumer and business spending slowing, while gas and food prices remain high eating up more than 20% of consumers wages and salaries.  Add on top of these factors the likelihood of a Greek debt default, a slowdown in the Eurozone, a weaker dollar and Washington locked in debate over the debt ceiling - well, the list of risks far outweigh the positives.  However, that doesn't seem to deter Wall Street economists and main stream media which seem to all be wearing an extremely thick pair of rose colored glasses these days.   However, it doesn't take an economist to figure out that any one of these factors could send us tumbling into a second recession.