Archive - Apr 11, 2012

The real problem with CDS trading by large banks such as JPM is not the speculative positions but instead the vast conflict of interest between the lending side of the house and the trading side

We all know that central banks and governments have been actively intervening in markets since the 2007 subprime mortgage meltdown destabilized the leveraged-debt-dependent global economy. We also know that unprecedented intervention is now the de facto institutionalized policy of central banks and governments. In some cases, the financial authorities have explicitly stated their intention to “stabilize markets” (translation: reinflate credit-driven speculative bubbles) by whatever means are necessary, while in others the interventions are performed by proxies so the policy remains implicit.  All through the waning months of 2007 and the first two quarters of 2008, the market gyrated as the Federal Reserve and other central banks issued reassurances that the subprime mortgage meltdown was “contained” and posed no threat to the global economy. The equity market turned to its standard-issue reassurance: “Don’t fight the Fed,” a maxim that elevated the Federal Reserve’s power to goose markets to godlike status. But alas, the global financial meltdown of late 2008 showed that hubris should not be confused with godlike power. Despite the “impossibility” of the market disobeying the Fed’s commands (“Away with thee, oh tides, for we are the Federal Reserve!”) and the “sure-fire” cycle of stocks always rising in an election year, global markets imploded as the usual bag of central bank and Sovereign State tricks failed in spectacular fashion.

The risk of the 30 most systemically important financial institutions (SIFI) in the world has risen over 30% in the last three weeks as the effects of LTRO fade and encumbrance becomes the new reality. This less-manipulated, government-bank-reacharound-driven bond-market sense of reality has retraced almost 40% of its improvement from its peak last November at 311bps to its best level mid-March at 171bps. The current 226bps level is extremely elevated and as one would expect is dominated by European and US banks (with US banks on average trading wider than Europeans - which may surprise many but Europeans dominate the worst names - most specifically the Spanish banks).

When building a house in Spain a substantial part of the cost now involves paying people 'off-grid' or 'under the table'. This seems endemic and we imagine is partially historic but IF it is increasing in extent as a result of the financial crisis it is an important trend. Extrapolating this trend out to the whole population, one suddenly realizes that the private sector could be slowly going 'off-grid', further starving governments of revenue and thus the means of the economy’s and therefore the government’s recovery. The downward spiral will continue until eventually social unrest will rise to the point where there will be a “European spring”. One country will ditch the Euro and/or their cumulative debt holdings and/or move back to their own currency. The pain of action will be less than the pain of in-action. So here we sit watching a couple of PIGS not trying consciously to fly but flapping their baby wings anyway. We watch on, content in the knowledge that PIGS can’t fly… Until, that is, the first one takes flight.

Following the all time record high February budget deficit of $232 billion, the US March budget deficit number is in, and in addition to being bigger than expected, coming at $198.2 billion on expectations of "only" $196 billion, the government outlay in the past month also is the largest March deficit on record. This brings the total deficit in fiscal 2012 to $779 billion, which is to be expected for a country gripped in total political chaos and which is unable to either raise revenues or lower spending. What is more disturbing is that over the same period (Oct 1 2011 - March 31, 2012), the US government issued $792 billion in debt, a trend that will continue. What is most disturbing is that the comparable tax revenues net of refunds, "matching" this increase in deficit and spending, are only $693 billion, in other words the US government is funding well more than half of its cash needs with debt rather than with tax revenue. Just like Japan.

Here come the headlines from the beige anachronism:

• FED SAYS ECONOMY EXPANDED AT MODEST TO MODERATE PACE IN MARCH
• FED SAYS MANUFACTURERS CONCERNED ABOUT RISING PETROLEUM PRICES
• FED: HIRING WAS STEADY OR SHOWED MODEST GAINS IN MOST DISTRICTS
• FED SAYS `UPWARD PRESSURE ON WAGES WAS CONSTRAINED'
• SOME FED DISTRICTS SAY RISING GAS PRICES MAY INHIBIT CONSUMERS

Where is the beige app? or beige pdf straight to kindle? What is this - book thing? Anyway no QE on the horizon based on this.

No, not the kind you actually use in your car. The other kind: that which Europe would kill to be able to get at even a 500% higher price. From a peak at $15.78 in Q4 2005, Natural Gas (front-month futures) has now fallen to a lowly $1 handle for the first time since Q1 2002 on its way perhaps to its all-time low of $1.02 in Q1 1992.

The Fed's currency swap with the ECB is nothing more than a covert bailout for European banks. Philipp Bagus of Mises.com explains how the USD-funding crisis occurred among European banks inevitably leading to the Fed assuming the role of international lender of last resort - for which US taxpayers are told to be lucky happy since this free-lunch from printing USD and sending them overseas provides an almost risk-free benefit in the form of interest on the swap. Furthermore, the M.A.D. defense was also initiated that if this was not done, it would be far worse for US markets (and we assume implicitly the economy). The Fed's assurances on ending the bailout policy should it become imprudent or cost-benefits get misaligned seems like wishful thinking and as the EUR-USD basis swap starts to deteriorate once again, we wonder just how long before the Fed's assumed role of bailing out the financial industry and governments of the world by debasing the dollar will come home to roost. As Bagus concludes: "Fed officials claim to know that the bailout-swaps are basically a free lunch for US taxpayers and a prudent thing to do. Thank God the world is in such good hands." and perhaps more worryingly "The highest cost of the Fed policy, therefore, may be liberty in Europe" as the Euro project is enabled to play out to its increasingly centralized full fiscal union endgame.

The second bond auction of the week prices uneventfully, with the Treasury selling $21 billion of 10 Years at a yield of 2.043%, better than the 2.045% When Issued, and better than last month's 2.08%. Yet keep in mind that inbetween the March auction and today, the 10 year hit nearly 2.40%, so don't let the apparently stability give the impression that there is no volatility under the surface. Unlike the yield, the Bid To Cover dropped from last month's 3.24 to 3.08, which while week for recent auctions was just below the TTM average of 3.12. What is of note is that Dealers had to once again take down more than half the auction, or 50.5%, with the last time there was more than a 50% takedown being back in November 2011. Of the balance 11% went to Direct, and the remainder or 38.5% to Indirects. Overall, a quiet auction and now we just have tomorrow's $13 billion 30 Years to look forward to as total US debt approaches the $15.7 trillion milestone next on its way to the $16.3 trillion debt ceiling breach in 6 months. In the meantime enjoy fixed coupon bonds: for in one month, the FRN cometh.

Back in June 2011, Zero Hedge first pointed out something very troubling: the labor share of national income had dropped to an all time low, just shy of 58%. This is quite an important number as none other than the Fed noted few years previously that "The allocation of national income between workers and the owners of capital is considered one of the more remarkably stable relationships in the  U.S. economy. As a general rule of thumb, economists often cite labor’s share of income to be about two-thirds of national income—although the exact figure is sensitive to the specific data used to calculate the ratio. Over time, this ratio has shown no clear tendency to rise or fall." Yet like pretty much every other relationship in the new normal, this rule of thumb got yanked out of the socket, and the 66% rapidly became 58%. This troubling shift away from the mean prompted David Rosenberg to say that "extremes like this, unfortunately, never seem to lead us to a very stable place." Which is why we are happy to note that as of last quarter, the labor share of income has finally seen an uptick, and while certainly not back at its old normal, has finally started to tick up, which leads us to ask: have we passed the moment of peak Marxism of this particular period in US history?

Despite the eloquence of our taxer-in-chief, the facts, as noted by Professor Antony Davies in this clip, are that whether you raise or lower taxes at the highest-marginal or average tax rate, the share of the GDP pie that government gets to take out of our pockets remains stubbornly flat at around 17-18%. It seems growing the pie may be a more attractive approach than raising taxes but then how would that play in an election year with below trend growth and stagnant income.

Since the 1980s, the U.S. Has Secretly Helped Japan Build Up Its Nuclear Weapons Program ... Pretending It Was "Nuclear Energy" and "Space Exploration" ...

It seems like we are back in coin-tossing mode as S&P futures are trading in a very narrow range this morning at exactly the post-NFP volume-weighted average price level. Perhaps the current sell-off in European banks will bias that coin a little to the downside...

A strong case can be made that the fundamental supports of the housing market-- demographics, employment, creditworthiness and income--will not recover for a generation. It can even be argued that housing has lost its status as the foundation of middle class wealth, not for a generation, but for the long term. Let's begin by noting that despite the many tax breaks lavished on housing--the mortgage interest deduction, etc.--there is nothing magical about housing as an asset. That is, its price responds in an open, transparent market to supply and demand and the cost of money and risk. There are a number of quantifiable inputs that feed into supply and demand--new housing starts, mortgage rates and income, to name three--but there are other less quantifiable inputs as well, notably the belief (or faith) that housing will return to being a "good investment," i.e. rising in price roughly 1% above the rate of inflation. If this faith erodes, then the other factors of demand face an insurmountable headwind, for the most fundamental support of housing is the belief that buying a house is the first step to securing middle class wealth.

The fact that the High Yield ETFs are trading at a discount should be a big concern to anyone in the high yield market, not just those who own the ETF.  There is a real risk that this discount can translate into arb activity which leads to further declines. We are very concerned that the same index-arbitrage process occurring in CDS markets can occur in the HY bond market and liquidity, as bad as it is in a strong market, is far worse in a down market.  As of yet there is no sign that this is happening in a meaningful way, but JNK has seen outflows for a few days and HYG saw outflows yesterday.