Archive - Mar 12, 2012

It will come as no surprise to any reader that volumes in general are dismal. This leads inevitably to the question of just how liquid markets are in general. This may not be a critical question for mom-and-pop buying some IBM or CAT at the margin but for institutional investors it is critical to the decision to enter a position. Pairing off reward expectations with risk concerns tends to focus too much on volatility and too little on liquidity and by looking at daily market turnover and the bid-offer spread of each asset class, UBS finds taking liquidity into account can make a huge difference to performance (and risk-appetite). Unsurprisingly, the most liquid assets are large cap equities and US Treasuries. The least liquid assets include various fixed income securities, and in particular high yield credit. Perhaps this goes a long way to explaining why US Treasuries have maintained their strength and why large cap equities have been so strong relative to credit markets (a topic we have discussed at length) as money finds its 'easiest' hole to fill and thanks to liquidity concerns, high yield credit investors remain more pragmatic entrants to an ever-inflating bubble of liquidity (as exits will be small and crowded at the first sign of tightening). We suspect the increasing dispersion between the most and least liquid securities in each asset class will likely feed on itself as fewer funds are willing to 'earn' an 'illiquidity' premium given the bigger binary risks facing all markets.

A month ago Zero Hedge, based on some Goldman observations, asked a simple question: is Okun's law now terminally broken? Today, with about a one month delay, the mouthpiece of the New York Fed (which in itself is nothing but a Goldman den of central planners, and Bill Dudley and Jan Hatzius are drinking buddies), Jon Hilsenrath shows that this is just the issue bothering his FRBNY overseers. In an article in the WSJ he ruminates: "Something about the U.S. economy isn't adding up. At 8.3%, the unemployment rate has fallen 0.7 percentage point from a year earlier and is down 1.7 percentage points from a peak of 10% in October 2009. Many other measures of the job market are improving. Companies have expanded payrolls by more than 200,000 a month for the past three months, according to Labor Department data. And the number of people filing claims for government unemployment benefits has fallen. Yet the economy is barely growing. Many economists in the past few weeks have again reduced their estimates of growth. The economy by many estimates is on track to grow at an annual rate of less than 2% in the first three months of 2012. The economy expanded just 1.7% last year. And since the final months of 2009, when unemployment peaked, the economy has expanded at a pretty paltry 2.5% annual rate." Hilsenrath's rhetorical straw man: "How can an economy that is growing so slowly produce such big declines in unemployment?" The answer is simple Jon, and is another one we provided a month ago - basically the US is now effectively "printing" jobs by releasing more and more seasonally adjusted payrolls into the open, which however pay progressively less and less (see A "Quality Assessment" Of US Jobs Reveals The Ugliest Picture Yet). After all, what the media always forgets is that there is a quantity and quality component to jobs. The only one that matters in an election year, however, is the former.  As for whether Okun's law is broken, we suggest that the New York Fed looks in the mirror on that one.

Many lessons are available to learn from the Greek debt crisis. Several more are probably to come as the intended and unintended consequences of what the Europeans have done begin to infect the bond markets. I point this morning to the vast differences now between the ownership of American debt and European debt and, as the immediate effects of the LTRO begin to wear off, several dawning realizations that I think will cause European debt to gap out against American debt regardless of the yields of Treasuries.  

Over the weekend, the BIS released its latest quarterly review of financial organizations, which despite being chock full of assorted data, merely summarizes what banks already report. As such, it completely avoids the potentially black swan areas, such as derivative, off-balance sheet and shadow banking exposure. In other words, it is largely a waste of time. One section, however, that is useful,is the analysis by Morten Bech on "FX volume during the financial crisis and now" which has created a constant time series to evaluate FX trading volumes all the way through October 2011, as opposed to the traditional BIS Triennial survey, the next of which is due in April 2013. Morten's finding: "I estimate that in October 2011 daily average turnover was roughly $4.7 trillion based on the latest round of FX committee surveys."

• Greek Bailout Payment Set to Be Approved by Euro Ministers After Debt Deal (Bloomberg)
• China Trade Deficit Spurs Concern (WSJ)
• Sarkozy Makes Populist Push For Re-Election (FT)
• ECB Calls for Tougher Rules on Budgets (FT)
• As Fed Officials Prepare to Meet, They Await Clearer Economic Signals (NYT)
• PBOC Zhou: In Theory 'Lots Of Room' For Further RRR Cuts (WSJ)
• Latest Stress Tests Are Expected to Show Progress at Most Banks (NYT)
• Monti Eyes Labor Plan Amid Jobless Youth, Trapped Firemen (Bloomberg)

Quiet trading so far with some risk off episodes in Europe (Monte Pasci halted after dropping 5%), and total confusion in the Greek bond market, with old bonds, new bonds, and CDS all trading as nobody has a clue just what is eligible for trade and what isn't (one thing is certain - GGB2s continue to trade well wide of Portugal, yielding around 18-20% for the 10 year spot). Here is how BofA sees the trading session so far.

While hardly expecting anything quite as dramatic as the default of a Eurozone member, an epic collapse in world trade, or a central banker telling the world that "he has no Plan B as having a Plan B means admitting failure" in the next several days, there are quite a few events in the coming week. Here is Goldman's summary of what to expect in the next 168 hours.

So Greece has been saved – is that right? Well according to ISDA (the International Swaps and Derivatives Association) a “Restructuring Credit Event has occurred with respect to the Hellenic Republic” which in the vernacular means the Greeks are bust; tell us something we don’t know! The importance of this statement is that credit default swaps (CDS) on Greek debt are now triggered and holders will have their losses made good. There were any number of scurrilous rumours that ISDA would not declare a credit event to preclude their illustrious members from paying out, but when the net downside of $3 billion needs to be shared out amongst the likes of Barclays, Credit Suisse, Deutsche Bank, Goldman Sachs, JPMorgan Chase, Morgan Stanley, UBS, BNP Paribas and Societe Generale, then a quick whip round in the bar after close of business and the jobs a good’un.