Archive - Sep 21, 2011

As we reported, last night a quartet of GOPers (re)sent a letter to Bernanke demanding no more QE. To be sure this was not the first such letter, and followed a nearly identical missive sent back in November of 2010. And while the ultimate purpose of this letter is unclear, and is unlikely to prevent the Fed from doing the only thing it believes it should do: i.e., spark the economy by reflating asset values, aka printing or duration extending - or the only things it knows how to do, did the republicans just shoot themelves in the foot and allign the dissenters against growing opposition to a full blown LSAP episode? Here is JP Morgan's Michael Feroli explaining why this may be the case.

In an effort to enable every insolvent, illiquid, and in-default institution in Europe to gain access to the seemingly bottomless pit of Trichet's despair, the ECB just dropped a series of eligibility requirements on collateral needs. Somewhat interestingly they dropped the requirement that the collateral be 'traded on a regulated market' - does that mean they will accept defaulted GGBs?

The chairman of the "Friends of the Fermentation" committee dives into the two topics preoccupying the world: Bernanke and Greece, and as usual, deconstructs both with his laser-focused pragmatic perspective. That both of these are closed loops that only get worse as they "get better" is becoming increasingly clear to everyone even remotely interested in events away from the top 20 items in Google Trends.

A day after the IMF warned that the world is facing a dramatic economic slowdown cliff, it follows up by pulling off the scab on a festering European wound, with Reuters reporting that according to the IMF, "Europe's debt crisis has increased the risk exposure of banks in the region by 300 billion euros and they need to recapitalize to ensure they can weather potential losses. In its Global Financial Stability Report, the IMF said it sought to "approximate the increase in sovereign credit risk experienced by banks over the past two years." Earlier this month, IMF Managing Director Christine Lagarde drew fire from European officials when she called for a mandatory recapitalization of Europe's banks. News reports last month said the IMF had identified a 200 billion euro shortfall in European bank capital, but officials in Europe insisted the figure was off the mark and the capital position of most banks in the region was solid." So what does the IMF do to address protests by the IMF that it was overestimating undercapitalization? It hikes them by 50%! Yet even so it is still €700 billion short of Goldman's estimate for a €1 trillion hole in Europe. Also, assuming European banks had three peaceful years in which to recapitalize at much higher valuations, it is safe to say they will absolutely not do it now, when the market has basically locked them out. And needless to say, when Greece defaults all these shortfall numbers will have to be revised.... by a factor of 10x... higher.

"Because it is not a liquidity crisis, it is a solvency crisis." The chart shows nothing new but present the evolution of the European solvency crisis crisply and succinctly for anyone who may be lost in the day to day headline shuffle and confuse the forest for the trees.

Europe’s fiscal and debt crises have dominated the financial news for months, and with good reason: the fate of the European Union and its common currency, the euro, hang in the balance. As the world’s largest trading bloc, Europe holds sway over the global economy: if it sinks into recession or devolves, it will drag the rest of the world with it. As investors, we are not just observers, we are participants in the global economy, and what transpires in Europe will present risks and opportunities for investors around the world. The issue boils down to this: is the European Union and the euro salvageable, or is it doomed for structural reasons? The flaws are now painfully apparent, but not necessarily well-understood. The fear gripping Status Quo analysts and leaders is so strong that even discussing the euro’s demise is taboo, as if even acknowledging the possibility might spark a global loss of faith. As a result, few analysts are willing to acknowledge the fatal weaknesses built into the European Union and its single currency, the euro. In the first part of this series, we’ll examine the structural flaws built into the euro, and in the second part, we’ll consider the investment consequences of its demise.

The contagion is getting every closer to the core, with risk in Italy (+6) and Spain (+11) getting ever closer to Austria (+5), Germany (+1) and the UK (+0.5). Also, some rumbling out of ironclad Scandinavia with Finland +7 to 81.75 bps.

• The FOMC rate-decision remains the main focus today as market participants anticipate the Fed to take further easing steps
• According to BoE’s September minutes, the MPC voted 9-0 and 8-1 to keep its benchmark interest rate unchanged at 0.50% and its asset-purchase target unchanged at GBP 200bln respectively. Most MPC members thought it increasingly likely that more QE would be warranted at some point
• CAD received support across the board following higher than expected CPI data from Canada
• Shares in BNP Paribas came under pressure on the back of market talk of a credit rating downgrade by one of the major rating agencies as early as today

First it was US money markets; then it was various European industrial concerns (which somehow double down as banks); then it was China; now the bank runs shift to insurance institutions when, as Bloomberg reports, Lloyd's of London has decided to pull peripheral Euro bank deposits. What next: complete collapse of European interbank market as bank runs become a daily thing at both the retail and institutional level? Well, we already anticipated that. But it is something totally different to see it happen in practice.

• China Faces ‘Hot-Money’ Surge on Financial Market Turmoil (Bloomberg)
• China Lending Curbs Help Propel Commercial Paper Yields to Record (Bloomberg)
• Italy plans reforms to rebuild growth (FT)
• US accused of unfair antitrust tactic (FT)
• Trichet urges EU banks to strengthen balance sheets (Reuters)
• Brazil seeks to help Europe via IMF (Reuters)
• Labour and Tories battle over IMF report (FT)
• Greek reforms undermined by stereotypes: minister (Reuters)

Today's existing home sales data, which will simply confirm that there is no hope for the housing market, will be completely ignored as everyone focuses on what gizmo Bernanke pulls out today from his magic bag of tricks.

Our thesis that global coordinated monetary stimulus is returning is playing out, first slowly, then very rapidly, with the Fed expected to announce at least Op Twist and an IOER cut at 2:15pm today, following a currency peg by the SNB, more printing promises by the BOJ, and the ECB now assumed to return to cutting rates shortly even as it purchases sovereign bonds in the open market. Sure enough, the latest entrant in the global resumption of printing is the BOE, which in minutes presented earlier, makes it clear it won't lag behind the Fed. From Goldman: "BOTTOM LINE: (i) The September MPC minutes revealed an unchanged vote (8-1 on asset purchases; 9-0 on rates). More significantly, however, for "most members" the decision was "finely balanced" and the committee was unusually forthright in signalling the likelihood of QE2. October now looks like the most likely date for a commencement of QE2. (ii) In other important news today, the ONS announced that public borrowing has been revised down by £6bn (0.4% of GDP) in 2010/11 and by £5bn (0.3% of GDP) so far in 2011/12. This potentially opens the door to a more gradual pace of fiscal tightening, with increased capital expenditure (the so-called "Plan A+")." And with that global relative FX devaluation continues, very much as expected, as does absolute devaluation of all currencies against gold, also very much as expected.

The French bank trio is once again on the ropes, with BNP leading the decliners at -5%, following the latest weekly Fed swap line release update from the ECB according to which one bank had subscribed for $500 million of dollars at emergency funding, confirming that anything coming out of the Libor market (where the average rate increased once again from 0.355% to 0.356% for the n^th day in a row) is pretty much irrelevant as no real dollar access is available at rates below the ECB's penalty rate which this week was 1.07%. The good news: this is not as bad as last week's two banks which needed $575 million. The bad news: we have reverted to the regime from a month ago when a bank, most likely the same bank, was forced to borrow from the ECB, and hence, from the Fed. Said otherwise, there has been no improvement in interbank liquidity conditions since August 17. Expect more weakness out of French banks especially if China steps up the war of rhetoric and announces that more (of its own massively levered) banks have cut liquidity connections with France.