Archive - May 2012

If you're not familiar with the concept of "Cost Shifting", the deadly (to your competition) effect of negative margins or believe that Google is search engine or ad co., then this article/video is a must read/see.

What we have is a Central State and an economy that has borrowed and squandered trillions of dollars on consumption and malinvestment in unproductive "stranded" assets. The debt and risk pile up, while the labor that results from consumption is temporary and does not create wealth or permanent employment. Figuratively speaking, we're stranded in a McMansion in the middle of nowhere, a showy malinvestment that produces no wealth or value, and we're wondering how we're going to pay the gargantuan mortgage and student loans. Debt and the risk generated by rising debt create a death-spiral when the money is squandered on consumption, phantom assets, speculation and malinvestments. Sadly, that systemic misallocation of capital puts the job market in a death spiral, too.

Remember that very disappointing Q1 GDP print of 2.2%? Well, Goldman just dragged it even lower.

Back in the middle of March, when all was sunshine and unicorns in the post-LTRO world of recovery and another sustainable recovery, we were vociferous in our noting that nothing has been fixed and LTRO3 is not coming. Sure enough, here we are a few weeks later and the encumbering stigma that we were the first to point out (and call Draghi out on) is now wider than at any time since the LTRO program began with the banks that took LTRO loans now trading wide of pre-LTRO levels (fully stigmatized despite all that extra liquidity). Today saw the Stigma spread between LTRO and non-LTRO banks jump its most in 2 months to over 160bps (its highest in almost six months). There is however a troubling conundrum facing the ECB. The banks that need another LTRO (or liquidity) no longer have performing collateral to pledge and other banks that would like liquidity will not take it since they now understand the encumbrance and stigma that is attached to that decision. The ECB is snookered (and so is it any wonder that Draghi is playing for time) and perhaps this is why we are seeing the EUR leak lower against the USD as markets anticipate some more direct monetization mandate-busting action by the ECB (shifting the Fed/ECB balance and implicitly the flow between the two that we have also pointed out as critical). Either way, there is no LTRO3 coming anytime soon and together with this morning's jumps in liquidity funding costs, the vicious circles are ramping up again in Europe.

Remember the headline frenzy from last summer. It's baaaaaaaack. From Athens News:

A shocking and possibly groundbreaking turn of events. According to Net television, Pasok head Evangelos Venizelos has agreed to sign a letter related to the memorandum with Syriza chief Alexis Tsipras. What that letter will say is as yet unknown, but Net are standing by their sources. The temperature in the coalition room just spiked up.

This could go either way: if spun as pro-bailout, expect a 100 pip surge in the EURUSD. If not - don't, especially if it turns out to be an "agreement" with changes any of the terms of the Greek bailout, something Germany will not take too kindly to.

The latest out of the doomed continent:

• EURO ZONE DEBATING DELAY OF EUR5.2B MAY 10 PAYMENT TO GREECE - DOW JONES
• SOME GOVERNMENTS CONCERNED ABOUT MAKING A PAYMENT TO GREECE AMID POLITICAL TURMOIL

And so the check bounces, which is ironic, because as we repeatedly explained, the Greek bailout is not about Greece: it is merely to allow Europe to bailout its banks via ECB and Troika funded interest payments and using Greece as a passthru vehicle. Luckily, that particularly aggravating farce may soon be ending.

Update: Here we go - SPAIN TO NATIONALIZE BANKIA LATER TODAY - ABC

The reality is Greece is largely noise. Greece will eventually leave the Eurozone, but not this month. The hardliners inside Greece will realize they need some time to organize. The markets will have spooked the hardliners outside of Greece that they should play nice for a little bit, because forcing Greece out now won’t do them any good whatsoever. With Greece largely a sideshow at this stage, the attention is really focused on Spain and Italy. The fact that Greece might lead the way out of the Euro is having a big impact on these countries. That realization combined with the already obvious problems at the sovereign and bank level caused markets to sell off. The Spanish 10 year bond is back above 6%, dropping 20 bps today, which is a significant move. As we wrote about last Friday, there are no natural buyers, so this move occurred in an illiquid market. There is more room to run, but moves in Spanish and Italian bonds are already starting to have a less direct impact on stocks than they did earlier in the morning.

Three things are occurring in European liquidity markets that should send shivers down the spines of the most ardent bulls or believers in the status quo muddle-through scenario. First, 3-month LIBOR is waking from the dead having risen today after weeks of flat-lining in its irrelevant manner. Second, Deutsche Bank was the main driver of today's uptick in 3-month LIBOR (joining UBS as the only other bank in the LIBOR family post LTRO2 that has raised its willing offer rate for short-term liquidity). And third, most importantly, 3-month EUR-USD basis swaps (that expensive but anonymous market-based investment vehicle to find USD funding) have exploded with their biggest deterioration in five months pushing the premium that banks are willing to pay to receive USD over EUR to its highest in almost 4 months. So while Draghi suggests that we wait to see the effects of LTRO filter through to the rest of the real economy, once again he is clearly incorrect as banks are now desperately seeking liquidity (USD-based in this case) with short-term swaps only having been worse in the middle of the crisis last Fall and UBS and Deutsche Bank willing (or forced) to pay up for short-term money.

Gold hit a 4 month low today despite deepening worries that the political upheaval in Greece may sink the country into chaos and endanger the euro zone's efforts to end the debt crisis – possibly leading to contagion and or a monetary crisis. Some decent demand from South East Asia has been reported at the $1,600/oz level and there are also reports from Reuters of a “semi-official buyer of gold” emerging “on dip below $1,600/oz”.  Gold’s weakness yesterday may have been again due to dollar strength and oil weakness - oil is now below $97 a barrel (NYMEX). It may also have been due to wholesale liquidation which created a new bout of "risk off" which has seen global equities and commodities all come under pressure. However, gold’s weakness yesterday was also contributed to by more unusual trading activity. As trading in New York got underway, there was an unusually large bout of selling with some 6,000 gold futures contracts sold in minutes and this led to gold's initial $10 fall to the $1,615/oz level. Momentum driven algorithm trading may have then led to follow through selling and the initial sell off may have emboldened tech traders to sell more leading to the falls below $1,600/oz. 

The following note from Caris & Co. on HLF (which launched Herbalife in September at a Buy and a $75/share PT) has got to be the worst sell side note in history. The catalyst, according to the firm: what David Einhorn may or may not say. Now that is true value added. Next up: Goldman goes long IBM because it flipped heads.

Because the market sure could do with some humor on this blood red morning, we bring you FX strategist extraordinaire Thomas Stolper, who sadly does not give us the latest fade trade, but decides instead to come clean with pearls as: "On our EUR/$ forecast, last revised in January, we have been both right and wrong." Surely the "right" part is what he is worried about: after all if Goldman prop (whatever it is called these days) can't take the other side of the clients' trades, nobody gets paid. Yet Tommy still gets paid the big bucks: Why? For insights like these: "Cyclical forces and continued fiscal stress account for the lack of a EUR/$ rally...and we see little chance that they resolve themselves near term for EUR/$ higher." So cutting right to the good stuff: "Our structural, long term thought framework has not changed; we think global macro and flow fundamentals still argue for a weak USD and this theme will likely overwhelm other currency market developments on a one to two year horizon." We get it: the EURUSD can't go higher, but the USD is going lower. Mmmk.

THIS is the fate that awaits the European banking system. Every single EU bank has leveraged itself based on financial models that consider sovereign bonds to be “risk free.” Moreover, EVERY EU bank is leverage to the hilt based on its OWN in-­?house assessment of the riskiness of its loan portfolio.

So what did happen in Spain today?  What is causing Spanish bonds to go down so much? The first answer is relatively easy.  Nothing much new happened in Spain today, just variations of the same theme that has been out there for weeks if not months.  What we have is a struggling country with many banks that would view struggling as a compliment. So why are bonds down so much?  Bonds are down because someone had some bonds to sell and that started the cascade.

Just for a moment imagine you are a market maker in the Spanish bond market.  You aren’t even an aggressive market maker, so you just make markets on the 5 year and 10 year bond.... You look up at the street screens and they just went offered.  Cr*p, no street bid. Now what to do? 

European equities continue the trend of the week as they move lower throughout the morning session, as no news is bad news from Greece. In the early hours of the session, reports from German press revealed that the Troika have cancelled their May mission to the country, on the grounds that the current political instability could derail the rescue effort. The continued risk-aversion in Europe is evident in the strong demand for both German and British securities, as both countries sell strongly in their respective auctions. As such, the German Bund contract has hit on all time highs several times in the session today and the Spanish yield on their 10-yr government bond remains elevated above the 6.00% mark. Overnight source comments speculated that the Spanish government are pressing their national banks to set aside between EUR 20-40bln in funds for bad loan provisions and capital buffers. The reports have weighed down on the IBEX 35 throughout the morning, which is currently severely underperforming its European counterparts.