Archive - Aug 2011

The question of what the Fed will do next week in response to what effectively amounts to quantiative easing by the SNB, the BOJ and, as of today, the SNB, is preoccupying everything with a passing interest in finance. Here is the answer of JPM's Michael Feroli, who has recently surged to the league tables of least worst Wall Street economist (even if, for whatever reason, his Goldman competition still sets policy with merely one recommendation).

We warned you.

If: quote stuffing spike = true; then: market plunge. Over and over and over and over.

It was over two months ago that Zero Hedge first described why we though QE3 would ultimately appear in the form a reincarnation of Operation Twist first utilized by the Fed in the 1960s to prevent the gold exodus from the US into Europe (read more here and here), also known as Operation Twist 2. In essence what the Fed would do would be a curve patterning exercise in which the Fed would lower long-term rates by changing the average maturity of Fed holdings, in the process removing substantial duration from the markets, once again pushing investors into far more risky assets such as stocks (but certainly not gold: the CME will see to that). Today, Morgan Stanley's Jim Caron (who has yet to be right about one thing in his prior 3 year forecasts so take this with a grain of salt) explains why Morgan Stanley is a big supporter (read lobbying heavily on behalf of) of Operation Twist 2. Quote Caron: "As outlined in the recent congressional testimony, the Fed could consider several ways to ease financial conditions further. One of the options mentioned by Fed Chairman Bernanke was to provide explicit language to keep the fed funds rate and the Fed’s balance sheet unchanged for an extended period. Another approach would be to keep the balance sheet unchanged but increase the average maturity of its holdings. If this path is chosen, we believe that a significant amount of duration could be removed from the markets – to the effect of $90-150bn 10y equivalents which could lower 10y yields by 20-35bps. Let us explain." Explain away Jim.

RANsquawk Weekly Wrap - we answer questions that have come to the desk, and we highlight some of next weeks important news and data to look out for.

Not surprisingly, following the earlier downgrade of the US economy by Jan Hatzius, the firm's FX team has just released its complete list of updated FX projections based on the premise of a slowing economy, i.e., RIP Reverse Decoupling, or the key trope that drive the global economy in H1. As Thomas Stolper says, "The gist of our forecasts implies that the US will experience the largest amount of a slowdown relative to the rest of the world. And this ongoing US underperformance, partly a result of a deep protracted fiscal adjustment, will likely also warrant a prolonged divergence in monetary policy between the US and the rest of the world. These dynamics... underpin our a strong Dollar-bearish view." And here is why Goldman is about to really piss of the BOJ and the SNB, already heavily involved in FX market intervention: "The two main changes we have introduced to our FX forecasts come in response to significant appreciation pressure in the JPY and CHF. For the former, we are revising our $/JPY forecast to 77, 76, 74 in 3, 6 and 12 months, down from 82, 82, 86 previously. For the EUR/CHF, we change the path to 1.10, 1.15 and 1.20 in 3, 6 and 12 months, from 1.23, 1.23 and 1.25 previously. Overall, these changes mean that we forecast that our broad USD TWI will fall by -5.1% over the next 12 months, from –4.3% previously." Alas, it is now fireman hat time as we all prepare for an escalation in the global central banking wars as soon as Monday.

It finally feels safe to get long some stocks and high yield. The move into noon was scary. The move since then has been equally scary. S&P moving around 30 points in half an hour seems wrong, but it does feel that weak longs got culled with these moves, once, if not twice. IG seemed to get used as a hedge because people couldn't believe how far HY had dropped and didn't want to pay up, so for the first time, investors seem to have gotten themselves hedged and wedged. That should help on any move upward. I have to believe that some Eurpean investors shorted S&P into their close as the move so big and fast. They are stuck now hedged and wedged and are likely to want to close out rather than keep.

Two weeks after Zero Hedge readers were informed about it, slowly the sell side is coming to the realization that not only will the EFSF have to be expanded (that much was known), but that Germany, and specifically the outright economy, will be on the hook by an unprecedented amount of money. And expanded it will have to be: not by two, not by three, but by a cool four times, to a unbelievable €3.5 trillion which according to Daiwa's Head of Economic Research, Grant Lewis, is an act which will be necessary to convince financial markets of euro area resolve to save Italy and Spain. Says Lewis: "France, Germany contribution to EFSF’s capital would increase to 80% if Spain, Italy had to drop out of guarantee structure.  France, German contingent liabilities would be > 50% of GDP if EFSF expanded; added to France, Germany current debt may trigger downgrades to both countries." Yes... and no. As we explained when we referred to a far more accurate and complete report by Bernstein, merely a €1.5 trillion expansion in the EFSF, would mean that Germany is on the hook to the tune of €790 billion or 32% of German GDP. If France is downgraded, Germany essentially becomes the sole backstopper of the entire Eurozone, to the tune of €1.4 trillion or 56% of its GDP. Now let's assume Daiwa is correct, and the full amount under the EFSF has to increase to €3.5 trillion. That means that Germany "contin[g]ent liabilities", in the worst case scenario where France again gets downgraded, and it likely will eventually, would surge to about €3.3 trillion, or an insane 133% of German GDP!

Indeed, the only thing that could really kick off a rally for stocks would be the announcement of QE 3 (or hint of it) from the US Federal Reserve. However, even this would be short-lived. The market has finally begun to realize that the Fed can’t solve the issues that created the 2008 Crisis.  Which is why we’ve been in a free-fall for over a week now.

More evidence of European bank runs as both banks AND sovereign domicile states start to pull liquidity at the same time that said banks are trying to pull liqiodity from their customers. How do you think this will end?

More central bank intervention headlines, and the euro and stocks, which earlier were plunging without a floor, surge:

• ECB ready to buy Italian and Spanish bonds if Berlusconi commits to bring forward specific reforms according to sources
  
• ECB expects Italy to fast-track welfare reform, fiscal rule for bond purchases according to sources close to talks
• EU leaders applying intensive pressure on Berlusconi to make an announcement according to sources

Said otherwse, open the QE floodgates. Globally. Central banks now control it all. Net result, a 100 pip surge in the EURUSD, and a halt to the market plunge. For at least a few more minutes...

A wise prognosticator knows when NOT to prognosticate!  

Little by little, Italy's self-imposed exile will completely isolate it from capital markets. Here's to hoping that €60 trillion in previously undiscovered money last the country for a looooong while.

Here is your chance to see Italy's troubled PM FinMin Giulio Tremonti and even more troubled Prime Minister Berlusconi hold a press briefing on the topic of Italy's economy and market, and attempt to soothe stocks. Judging by the ongoing flash crash across various open markets, they better have something convincing to say.

The next best thing to being present at the ongoing JPM call discussing the turmoil in repo markets and overall short term credit liquidity constraints, is having the slidedeck from the presentation. For everyone curious about the gradual freezing of ultra short-term liquidity, especially in the aftermath of BoNY's decision yesterday to implement negative interest rates on deposits - a move certain to be adopted by many more, here is the answer to all your questions in a few fancy charts...