Archive - Aug 7, 2011

Yesterday it was an editorial piece in the main Chinese media outlet Xinhua. Today, China brings its message of helpless (for now) fury to the FT, where Yu Yongding, a former member of the Monetary Policy committee of the Chinese Central Bank has just said what everyone who realizes that mean reversions after 30 years worth of a "great moderation" can and will be a nasty, nasty thing, thinks. Namely: "the situation is ultimately unsustainable. The longer it continues, the more violent and destructive the final adjustment will be. " He is referring to the relentless recycling of Chinese trade surplus in the form of US paper which is increasingly looking like it will never get repaid. His chief rhetorical question is key: "The question is: what losses is China willing to bear in its foreign exchange reserves in order to slow the pace of the renminbi appreciation?" And that's the ballgame. Just like in Europe the question is what amount of gross economic loss is Germany willing to sustain in order to backstop Europe's insolvent countries (and with an imminent French downgrade looming, it will be the only country doing so in the form of sole EFSF funding) simply to keep the euro up and running, and its export sector humming courtesy of no return to a DEM, so in China the question now is how much risk is the country willing to take with its US-based paper holdings in order to keep its own export sector moving along courtesy of a weak CNY. Ironically, the longer Germany and China pretend all is good, the greater the impairment of their natural import partners. And in a globalized economy, even having the cheapest (no matter how artificially contrived) currency does nothing if the global economy tanks and import level implode. Alas, it will be too late for Germany and China to do anything about their flawed mercantilist policies at that point, as the third and final depression will be here. And what is the right move? The former PBOC member spells it out: "The danger for China is that it does not learn the right lesson – namely, that now is the time to end its dependency on the US dollar." And therein lies the rub.

So simple Einstein can understand it...

Over the past several months, I have been debating with my good friend and mentor David Kotok of Cumberland Advisers over the impact of the new FDIC insurance assessments on the money markets. David as well as another friend, Jim Bianco, insist that the imposition of the new deposit insurance assessment on all bank liabilities net of capital is blocking Fed monetary policy. I totally disagree.

What Zero Hedge has been saying for well over half a year has finally hit the mainstream, with pundit after pundit "suddenly" coming out of the closet and making the uber-bold proclamation that "QE3 is here." Yawn. That said, since Goldman's opinion is the only one that matters (see previous posts on this matter, especially those referencing the activities of one Bill Dudley at one "Pound and Pence"), here is Jan Hatzius explaining how the whole world now looks up to Bernanke to pick up the QE torch lit up in the past week by the SNB, the BOJ and the ECB, and take Central Planning^TM to escape velocity (which may well be needed if we hope to get Mars to bail out the Earth shortly). Specifically, when discussing what the Fed will announce on Tuesday, naturally follows Monday, or the day in which risk comes home to roost, Hatzius says the following: "First, we expect them to expand the scope of their “extended period” language to cover not just the exceptionally low funds rate but also the exceptionally large balance sheet. For example, they could rewrite the current forward-looking language in the statement to say that economic conditions “…are likely to warrant exceptionally low levels for the federal funds rate and exceptionally large asset holdings for an extended period” (our suggested change in italics). Indeed, our baseline expectation is that this change will occur at the August 9 FOMC meeting, although it is a relatively close call. Second, we expect the composition of the Fed’s balance sheet to shift toward longer maturities. This could happen via an increase in the average maturity of its reinvestment of MBS paydowns and/or a change in the reinvestment policy for its Treasury portfolio. However, we do not yet expect this for the August 9 meeting, although it is possible." Operation Twist 2 it is then, with unlimited purchases in the 2-7 year range to keep the yield at a sturdy 0%, and the 2s10s to surge record highs (alas, QE3 means inflation, inflation, inflation down the line) in a last ditch attempt to bailout America's financial system, which unfortunately has just entered wind-down mode.

Around the world, starting Monday, all eyes are on the markets. The tension is palpable. The uncertainty is ample. And anger is heavy in the air. As predicted, the debt ceiling deal was not only NOT enough to assuage economic fears, it actually exacerbated them, triggering a flight from the Dow, and creating a decisive opportunity for ratings agency S&P to cut the once perfect U.S. credit rating from AAA to AA+. At Alt-Market, we often talk about points of balance, and how certain moments in history become highly visible indicators of balance lost. If we pay close attention, and know what we are looking for, these moments can be recognized, allowing us time to shield ourselves from the explosion and the resulting financial shrapnel. The past two weeks have culminated into one of these defining events that tell us the tide has fully turned, and something new and dangerous is just over the horizon. The question now is; what should we expect? The nature of the credit downgrade situation is not necessarily “unprecedented” in history, but it is surely unprecedented on the scale we see currently in the U.S. It is difficult to predict how exactly the investment world will react. Some consequences, though, are probable, if not inevitable. Let’s examine the events we are likely to see in the coming weeks as well as the coming months, as nations attempt to adjust to America’s final plunge…

Citi's head FX guy Steven Englander is barely back to the US, and already is pouring the daily dose of fire and brimstone (much deserved) into a market that after nearly 2.5 years of unprecedented complicity, is about to realize that every escalator action has an equal and opposite express elevator reaction (oh, and those same HFTs that make money in an upward momentum environment, are just as effective at putting a minus sign in front of all their signals, wink wink). Some key soundbites from his just released note on what to expect (spoiler alert: nothing good): "The accelerated timing is a surprise and comes at a point at which global market sentiment is extremely weak, so it seems more likely that the reaction in markets will be negative than positive" ..."there may be concern in FX markets that the EUR AAAs are not solid, given the political and economic issues facing the euro zone and how conditions have worsened since the agencies last commented on ratings"..."a downward shock to markets is likely to be USD positive in the near term. This is hardly USD positive once things settle down, but before they settle down, the short term will likely dominate the long-term"..."The odds are that the week will start with FX investors challenging the SNB and MoF to intervene in size"... most importantly, why Europe is sweating bullets after the last bailout attempt announced from Friday has now gone up in flames and the EFSF is seen as being on edge of functionality: "In terms of FX market impact, the biggest would come from a downgrade of one of the AAA eurozone countries who back the EFSF’s AAA rating. This would mean either dropping the EFSF AAA or increasing the contributions of the remaining AAA."and on the topic of everyone's most favorite Federal Reserve: "A Fed response is likely to emerge only if there is turmoil in markets." And here we were warning anyone who cared to listen that the Fed needs a 25% correction before QE3 comes. Well, you may just get it very soon.

The market has taken a nasty hit this past week, and as expected, investors have turned bearish.

As of yesterday, anyone wishing to pad their holdings of precious metals in response to what is about to be a perfect storm in risk, using one of the biggest vendors of gold and silver has to wait until Asia open, as the firm's checkout counter has just decided to enter suspended animation until 8pm today. "*Attention – Due to the uncertainty in the global precious metals markets, we will not be able to accept any additional orders until the global markets re-open in Asia. We expect to be accepting orders around 6:15 pm EST. Sunday August 7th, 2011, following the market open." Implication: the opening print in gold will not be the closing print from Friday. That much we can guarantee you.

Yesterday we showed that when it comes to projections, the CBO's own track record makes S&P shine in comparison. Apparently this fact was not lost on S&P itself which sent out a note explaining which "clarified assumption used on discretionary spending growth." Basically, as S&P says, "Our ratings are determined primarily using a 3-5 year time horizon. In the near term horizon, by 2015, the U.S. net general government debt with the new assumptions were projected to be $14.5 trillion (79% of 2015 GDP) versus $14.7 trillion (81% of 2015 GDP) with the initial assumption – a difference of $345 billion." So yes, while by 2021 the difference could be $2.1 trillion based on the CBO's current baseline model, the truth is that the CBO's own estimate on revenue and spending projections in a decade will likely have a +/- $10 trillion margin of error. So does anyone really care? In essence all S&P did was point out what Zero Hedge and others have been saying: that a "deficit cutting" plan which is massively back end loaded and has about $20 billion in cuts over the next year is absolutely without credit or merit. And the disingenuity on the side of Treasury to believe that someone would think otherwise is simply appalling. That said, while the markets look set to crash very shortly, the overabundance of catalysts means that it will be more than just the downgrade that throws risk into a tailspin. Although prepare for an all out onslaught by the Treasury on S&P as a scapegoat. After all in USSAA(negative outlook) it is never our fault: it is always someone else's.

CBO spins an an important report. Why?

What is the difference between -13 and +7?  The answer is 20.  Twenty is the market-based pricing of the cost of the FDIC asset-based fee assessment.  For the first time, we were able to see its impact.  It is important to understand this calculation in order to fully appreciate what is happening in the financial markets.