Archive - Sep 23, 2013

The process the Fed is wrestling with is no different than that of the drug addict. After a certain point, dependency develops. Then the withdrawal process is so painful it is not willingly accepted. The drug analogy is appropriate up to a point. Here is a major problem with the analogy. The drug addict brings the outcome on himself. Those who will suffer the most for the Fed’s actions are not responsible for the pain they will endure. Regardless, the pusher has made most of us junkies. We have been forced into an economic haze that seems real but is not. Whether we know it or not, we are hooked. A great “drying-out” period lies in front of us. Few have understanding of what “economic cold turkey” means, but we will all learn.

"My daughter was raped and abducted," said a Mexican farmer.  President Obama says, "What's different in America is it's easy to get your hands on a gun."

The Germans will be getting out the beer and drinking a double dose of the amber nectar not only because MuttiMerkel as she is known (otherwise known as ‘Mother’ Angela Merkel) was reelected on Sunday 22nd September, but also because new reports issued today show that the Eurozone is doing better than expected.

In case there was any concern that the umbilical cord between US corporations and government has never been thicker (especially in light of recent revelations that the NSA views the AAPL Borg Collective as useful "zombies", abusing their credit cards just so they can be spied upon in new and improved ways) the New York Police Department is here to remind everyone of just that.

It was fun while it lasted but it seems a recognition that the Fed will have to Taper at some point sooner rather than later (for these four reasons) combined with the Washington anxiety hotting up seems to have sparked a "sell the news" event on the back of good news (China PMI, EU PMI, Merkel, AAPL). Perhaps, just perhaps, the final short overhang was wrung out inlast week's epic spike courtesy of a Fed that didn't like how consensus was in line with them. Notably, bonds are rallying in a very old-normal rotation to weak growth/safety manner and are near post-FOMC low yields. Gold remains well above its pre-FOMC lows and the USD remains well below pre-FOMC levels. In other words, US stocks have given back the most of all assets impacted by the un-Taper.

Once upon a time, US thrift institutions were the primary provider of credit to keep the American housing market humming along. Then the great Savings and Loan crisis happened, and by and large thrifts disappeared from the housing credit landscape. The result was the advent of Fannie and Freddie (i.e., the GSEs) as the "rug" that tied the US housing market room together. The chart below shows the dramatic increase in the role that the GSEs started playing following the S&L crisis, and which culminated with the great financial crisis, or rather the failure of the GSEs a month ahead of the Lehman bankruptcy.

New Revelations Are Breaking Every Day

Much attention has fallen on the Fed's recent announcement that a new fixed-rate, full-allotment overnight reverse repo facility is in the works (so much so that both shadow banking experts Singh and Stella have opined on the issue). It appears that despite the Fed's "best efforts" at communication, not enough clarity has been shed on the topic. So here is Bill Dudley's explanation.

Last week we destroyed in detail the fallacy that the plunging participation rate in the US was related to demographics. Despite Ben Bernanke's comments during his press conference last week that demographics play a role, it seems Fed's Dudley and Lockhart have a different view - in line with ours.

• *DUDLEY SAYS UNEMPLOYMENT RATE DECLINE `OVERSTATES' PROGRESS
• *LOCKHART SAYS A NUMBER OF EXPLANATIONS FOR PARTICIPATION RATE (as we covered here)
• *U.S. FED'S DUDLEY SEES 'HOLLOWING OUT' IN LABOR MARKET INCLUDING FACTORY WORKERS
• *LOCKHART: LOWER PARTICIPATION MAY MEAN LOWER ECONOMIC POTENTIAL, WHICH IS A CONCERN

What now? Instead of demographics (the aging of America fallacy), it is a 'hollowing out' of our manufacturing base and this leads to lower economic growth potential. It seems Stockman's 'born-again jobs scam' is very real.

As expected, here come the first two doves "explaining" the reasons behind Bernanke's taper surprise last week:

• DUDLEY SAYS FED MUST ACT ‘FORCEFULLY’ TO PUSH AGAINST HEADWINDS
• DUDLEY: MAY TAKE CONSIDERABLE TIME TO REACH 6.5% JOBLESS LEVEL
• DUDLEY SAYS ECONOMY STILL NEEDS `VERY ACCOMMODATIVE' POLICY

And Lockhart adds to the chorus:

• LOCKHART SAYS FED FOCUS SHOULD BE FASTER U.S. ECONOMIC GROWTH
• LOCKHART HAS BACKED FED'S ASSET PURCHASE PROGRAM
• LOCKHART SEES `SOME SLOWING' IN U.S. PAYROLL GROWTH

Translation: much more "high-quality collateral" to be extracted from the system.

If the Fed was worried about 'froth' in the markets earlier in the year, then this chart should have them panicking. Of course, as Jim Bullard noted Friday, there is no bubble because everyone knows there is no bubble but judging by the massive surge in covenant-lite loan issuance, there is a bubble in forced demand for leveraged loans. At $188.7 billion, the 2013 issuance of these highly unsafe loans (which have seen huge inflows since the Fed started talking taper back in May) is almost double that of the peak of the last credit bubble in 2007 and is five times the size of 2012 YTD issuance at this time. As Reuters notes, Covenant-lite loans used to be reserved for stronger companies and credits, but are now so common in the U.S. leveraged loan market that investors are becoming wary of some credits with a full covenant package. With corporate leverage at all-time highs, what could go wrong?

Despite exuberance at European and Chinese PMIs, the US clean shirt just skidded with a miss. Against expectatins of a high YTD 54.0 print, PMI posted 52.8 - its lowest in 3 months and falling for the second month in a row. New orders fell at the slowest pace since April (boding ill for durable goods) and the employment sub-index grew at the slowest pace in 3 months (suggesting payrolls will not hold up well). Of course, as Markit notes, bad news is good news "as far as policymakers are concerned there are some worrying signals in relation to the sector’s growth momentum, which vindicate the Fed’s decision to hold off on tapering its asset purchases."

UPDATE: AAPL +5.7% on revised guidance

Despite concerns about supply (and 'change') the lines we saw on Friday and the disappointments in the UK have been dismissed by the latest Apple press release as opening weekend iPhone sales top their record at 9 million sales (compared with the 5 million sold at iPhone 5 launch and 6-7mm units expectations).

APPLE SAYS OVER 200M IOS DEVICES RUNNING IOS 7
APPLE 9M NEW IPHONE 5S AND IPHONE 5C MODELS SOLD IN 3 DAYS
APPLE SAYS OVER 11M UNIQUE LISTENERS USED ITUNES RADIO
APPLE SEES 4Q REV. NEAR HIGH END OF $34B-$37B, EST. $36.11B

The share price was up over 4.5% from Friday's sub-50DMA close in pre-market trading; but is fading back now.

Recall that three weeks ago we warned that "Monti Paschi Faces Bail-In As Capital Needs Point To Nationalization" although we left open the question of "who will get the haircut including senior bondholders and depositors.... given the small size of sub-debt in the capital structures." Today, as many expected on the day following the German elections, the dominos are finally starting to wobble, and as we predicted, Monte Paschi, Italy's oldest and according to many, most insolvent bank, quietly commenced a bondholder "bail in" after it said that it suspended interest payments on three hybrid notes following demands by European authorities that bondholders contribute to the restructuring of the bailed out Italian lender. Remember what Diesel-BOOM said about Cyprus - that it is a template? He wasn't joking.

Following the FOMC surprise, no less than twelve Fed speeches will provide some "clarifications" on where the Fed now stands. It is very likely that this subject will continue to dominate the discussions of market participants. At the same time, US data will get scrutinized after the recent weakening and to see how warranted the Fed's concerns were. Two US consumer sentiment surveys, durable goods orders, and the third reading of Q2 GDP are important. In addition, monthly consumption and income data for August provide more information on the third quarter and of course there will be interest in the latest weekly claims numbers after some distortions in recent readings.