Archive - Jul 16, 2012

From Goldman: "Cutting the IOER rate down to zero could be harmful to market institutions. Chairman Bernanke made this argument himself in Q&A at the July 2010 Humphrey-Hawkins testimony: “The rationale for not going all the way to zero has been that we want the short-term money markets like the Federal funds market to continue to function in a reasonable way, because if rates go to zero, there will be no incentive for buying and selling Federal funds overnight money in the banking system. And if that market shuts down, people don’t operate in that market, it will be more difficult to manage short-term interest rates when the Federal Reserve begins to tighten policy at some point in the future.”

The reason for the ramp in risk as attributed by various buyside desks as to what recently has become the trademark of more hope, prayer and magic from Jefferies' (yes, Jefferies is driving the market for once, who wouldathunk it) David "SPOOS" Zervos, whose latest note that the Fed will follow the ECB and cut its overnight excess reserves rate to -0.25% has picked up some traction, and is causing a modest rise in risk markets. Here is the problem: the Fed will NOT do this, and certainly will not do this for months and months as not only would it destroy the US money market, general colalteral, unsecured and virtually every other overnight market instantaneously (and not even Ben is that dumb to trade a few trillion in private sector overnight funding for 10% in the S&P), but even as Zervos says this is nothing short of a thought experiment in what may happen: "Whether it happens or not is not the point. The issue is that we are not priced for it AT ALL." Correct David: they are unprepared because it will not happen. The Fed will do much more LSAP, and even that other flow-based lunacy, NGDP targeting, before it decides to blow up overnight markets (not to mention destroy the entire Primary Dealer risk analytics system all of which is based on positive flow from Reserves). Because if the Fed telegraphs it is ending the inflows from reserves experiment started 3 years ago, we better be having 4% GDP growth. Reality check: we have 1.1% Q2 annualized GDP. Finally, that whole ECB experiment with negative Deposit Rates led to... absolutely nothing... correction: it led to yet another plunge in Spanish and Italian yields: something the Fed is quite aware of.

Can a declining economy offset the impact on inflation of debt creation and its monetization, with the result that inflation falls to zero, thus making the low interest rates on government bonds positive? According to his public statements, zero inflation is not the goal of the Federal Reserve chairman. He believes that some inflation is a spur to economic growth, and he has said that his target is 2% inflation. At current bond prices, that means a continuation of negative interest rates. The latest news completes the picture of banks and central banks manipulating interest rates in order to prop up the prices of bonds and other debt instruments. We have learned that the Fed has been aware of Libor manipulation (and thus apparently supportive of it) since 2008. Thus, the circle of complicity is closed. The motives of the Fed, Bank of England, US and UK banks are aligned, their policies mutually reinforcing and beneficial. The Libor fixing is another indication of this collusion. Unless bond prices can continue to rise as new debt is issued, the era of rigged bond prices might be drawing to an end. It would seem to be only a matter of time before the bond bubble bursts.

The IMF believes that advanced economy deficits will decline by about 0.75 percentage points of GDP this year which 'strikes a compromise between restoring fiscal sustainability and supporting growth". However, continued focus on nominal deficit targets runs the risk of compelling excessive fiscal tightening if growth weakens. In addition, there is a risk in the United States of political gridlock that puts fiscal policy on autopilot and results in a sharp and sudden decline in deficits—the “fiscal cliff.” What is more troubling is the significant upward revision to all of the peripheral European nations (with Greece now at 171% Debt/GDP in 2013 versus 160.9% forecast only 3 months ago). While the average debt-to-GDP ratio among advanced economies is projected to continue to rise over the next two years, surpassing 110 percent of GDP on average in 2013, debt ratios will by then have peaked in several advanced economies - though rather explosively they do not see debt ratios for Spain and Japan stabilizing.

The IMF just took a bucket of bath-salts to world economies as it slashes growth expectations for every major global economy (and emerging nations suffer too). Noting that Q1's upward surprise was "partly due to temporary factors", they reduce 2012's overall global growth to 3.5% adding that developments during the second quarter have been worse. Job creation has been hampered - with unemployment high in many advanced economies, especially among the young in the euro area periphery; but incoming data from the US also suggests less robust growth than forecast previously. While distortions to seasonal adjustment and payback from the unusually mild winter explain some of the softening, there also seems to be an underlying loss of momentum. Growth momentum has also slowed in various emerging market economies, notably Brazil, China, and India. This partly reflects a weaker external environment, but domestic demand has also decelerated sharply in response to capacity constraints. The baseline projections in this WEO Update incorporate weaker growth through much of the second half of 2012 in both advanced and key emerging market economies, reflecting the setbacks to the global recovery. Downside risks to this weaker global outlook continue to loom large. The most immediate risk is still that delayed or insufficient policy action will further escalate the euro area crisis. How long before those Q4 hockey-stick earnings forecasts get reduced?

While economists may waste lots of hot air debating this, that and the other about the future growth trajectory of the US economy, in the aftermath of Goldman's cut of US GDP to just a 1.1% annualized rate of growth. And with the fiscal cliff, debt ceiling, Europe, China, and a plethora of other unknowns up ahead, this number will certainly decline further. Now here lies the rub: as the chart below shows total US marketable debt has doubled in the past 4 years, or an annualized growth rate of just above 21%. And as Zero Hedge has shown before, total US Debt/GDP is on the verge of crossing 102%, the highest since WWII. Simply said, the divergence between the two data series will only accelerate as every incremental dollar of debt generates ever less bank for the GDP buck. And that, from a "sustainability" perspective, is what the problem is in a nutshell.

While European and US equity and credit market seem somewhat asleep this morning (despite quite significant moves in FX, Treasury, and Commodity markets), there is some stirrings in Italian and Spanish Senior and Subordinated debt markets. No matter how much de Guindos denies-denies-denies, the fact is the market has been increasingly pricing in subordinated bank debt impairment and now senior bank debt is inching wider also after the ECB's 'suggestions' came to light this weekend. Subordinated Italian and Spanish bank debt is at its worst since mid-December and the decompression trade we suggested is moving slowly on our direction.

Just as we speculated less than an hour ago, here comes Goldman with its take of retail sales and its impact on GDP: "Retail sales decline more than expected in June. We revised down our Q2 GDP tracking estimate by two tenths to +1.1%. The Empire manufacturing survey rebounded somewhat in July although the details were mixed."

From Albert Edwards: "I want to share with you news that the S&P is on the verge of an “ultimate” death cross (see chart below). This is where a 50-month moving average (currently at 1152) falls below the 200-month average (currently 1145). The Trend blogspot (link) tries to make some sense of this very rare event. They note that the averages came close to crossing in 1978 towards the end of the 1965-82 secular bear market, but just held. By contrast Japan suffered a monthly death cross in 1998 and 14 years later we are still in the firm embrace of the bear. Watch this space."

Once again the reflexive response that bad is good is occurring in risk markets. No ssoner had the dismal retail sales number printed than we are seeing Treasury yields tumble (within a basis point or two of record lows), the USD snap lower, and Gold snap higher. It seems the relatively sanguine nature of stocks this morning was the target for gold and USD's move but ince again we remind any and every dip-buyer that NEW QE can't come when everyone expects it and asset values are at least primed for a little jump (not within mult-year highs) as the deflationary threat Bernanke is primarily concerned with is clearly not evident.

Today's advance retail sales for June was simply abysmal, printing at -0.5% on the headline, and -0.4% ex autos. Expectations were for a print of +0.2% on the headline and unchanged less autos. Gas was not the culprit either as ex autos and gas the miss was -0.2%, on expectations of a +0.2% print. This was the third consecutive drop in a row: the longest since December 2008, when the US economy was flat out imploding. Expect furious Q2 GDP revisions imminently once the sellside community plugs this number into bean counter abaci. Goldman will likely cut its recently downgraded Q2 GDP from 1.3% to 1.1% or even sub 1.0%, which is essentially stall speed. Finally, today's number confirms our biggest worry: the spike in May consumer credit was not for discretionary purchases: it was for staples. Do the math. Finally, building material & garden eq. & supplies dealers down 1.6%, the biggest sequential drop aside from gas stations. At least housing has "bottomed." Of course, EURUSD spiking on expectations of more imminent NEW QE.

In what has become a typical pattern; Europe has a summit, everyone says this, that, their own variation of that and the other to appease their citizens and it is not until days later that some sort of reality begins to be released to the Press. Not only has this become the pattern but it generally comes over the weekend when the markets are not open and when no one is paying much attention. It is a purposeful scheme and useful I suppose for dampening effects and it allows the bliss to continue. In the meantime there is no ESM in place, only $65 billion left in the EFSF after Spain and Cyprus are funded and the German Constitutional Court declared over the weekend that there would be no ruling on the ESM until September 12. The Golden Rule lives on; “He that has the Gold rules.”. For those that believe in the usefulness of firewalls, which would not include me, you are now staring at bricks to build dollhouses and it is not just the flank but the center that is fully exposed and vulnerable. This is Vichy reborn and Anschluss déjà vu and the takeover of Poland just accomplished on a different battlefield. The weapon is money and not armaments and while the stench is more polite the demand for victory has not lessened.

Here are the key highlights from the just released Citigroup Q2 earnings:

• Net Income of $0.95 or $1.00 excluding CVA and one time loss; Exp $0.86
• Citigroup Net Income of $2.9 Billion; $3.1 Billion Excluding CVA/DVA and the Loss on Akbank;
• Citigroup Revenues of $18.6 Billion; $18.8 Billion Excluding $219 Million of CVA/DVA and the $424 Million Loss on Akbank; Exp. $19.01 Billion
• Where the bottom line beat came from: Loan Loss Reserve Release of $984 Million in Second Quarter, or 35% of pretax net income.
• Complete freeze in capital markets:
  
  • Fixed Income markets revenue plummets from $4.7B in Q1 to $2.8B in Q2 (and down 4% Y/Y from $2.9 billion)
  • Equity Markets revenue slides 39% sequentially from $776MM to $550MM, down 29% Y/Y from $776MM. It's a zombie zone out there
• Total Securities and Banking revenues slide 22%, yet Expenses decline just 4%
• And just like JPM, Americans can't wait to hand over their deposits to Citi: Citigroup Quarter-End Deposits of $914 Billion, 6% Above Prior Year Period
• This compares to total Loans of $655 billion or a $259 billion mismatch; we know that this surplus is what JPM uses as funding for its Treasury/CIO group. Does Citi also use the excess deposits to fund its internal hedge fund?

Even with Citi reporting a miss on the top line of $18.6 billion (Exp. $19 billion), but a bottom line beat courtesy of more loan loss reserve releases amounting to $984 million, or 35% of the entire pretax net income number, sentiment has been very quiet this morning, with hardly any sharp moves, aside from the now usual leak in Spanish sovereign bonds, following Bloomberg's confirmation of the WSJ story that the ECB is willing to impair Senior bondholders, while Swiss nominal bonds continue to trade below 0.4% and the EURUSD drifts lower. Today's lethargy may be interrupted at 8:30 am when the Empire Manufacturing and Advance Retail Sales data are released, but unless we get another massive, and very convenient, EUR repatriation out of Europe at just the moment when the US market opens, we doubt much will happen today ahead of Bernanke's semi-annual congressional testimony tomorrow.

Contrary to popular delusions, money flows in Spain are once again deteriorating rapidly, with the country's bank borrowings from the ECB soaring by €50 billion in June according to the Bank of Spain, the second highest ever, to a record €337 billion. While this is bad for Spain, it is good for Italy, which saw its June ECB borrowings rise by only €9 billion, to a record €281 billion, although well below Spain's total - something Italy, which led Spain in ECB borrowings since mid-2011 will be delighted to hear. What however, is rather curious, is that the Spanish TARGET2 net liability soared to €371 billion (-€40 billion in autonomous factors accounting for the lower total number), forcing the ongoing implicit German bailout of the periphery to accelerate to a record €729 billion as noted previously. As a result, for the first time ever, Spanish TARGET2 liabilities represented over half of total Germany TARGET2 claims. Just as we predicted several months ago, German funding of peripheral current account balances is the only "source of capital" for these countries in what is rapidly becoming the latest 'flow of funds' mercantilist scheme, one which can only sustain for so long by definition. In the meantime, now that we are in the exponential phase of the TARGET2 blow out, expect the next German update to indicate well over €2 billion per day in implicit European bailout spending.