April 5th, 2012
A major potential negative catalyst for financials globally is rapidly approaching as 114 banks are on review-for-downgrade by Moody's across 16 countries. Why do we care so much about ratings given their historical credibility? Ask James 'Jimmy-boy' Gorman of Morgan Stanley who is currently begging cap-in-hand to Moodys not to downgrade his empire bank, since he knows (and so it seems does the CDS market) that, as the FT notes, a downgrade could also force the bank to provide additional collateral to back its vast derivatives business - where it acts as one of the largest counterparties. In Europe, the fun heats up in the next few weeks as first Italian banks (4/16), then Spanish banks (4/23) and then Austrian (4/30) face from 1 to 4 notch downgrades and the potential to lose their short-term (funding-/CP-related) Prime-1 top rating, implicitly raising funding costs (and liquidity concerns) even further.
Whatever one thinks about Lord Wolfson’s euro-skeptical meddling, it certainly has been entertaining. The British baron’s offer of a £250,000 prize for the best ideas to deal with a possible breakup of the eurozone has brought all sorts of people out of the woodwork. (Including this precocious 11-year old.) But one of the most fascinating ideas on the shortlist has come from Neil Record — although I’m not sure that my takeaway was his main intent. Suppose that a country does leave the eurozone — this was the starting premise of all the responses to Wolfson’s essay contest. Greece, as the weakest link, seems the most likely candidate. But on the other hand it’s possible that one of the strongest countries chooses to go its own way. Of course we’re talking about Germany. Whether it remains in the euro or decides to take its chances by introducing a new Deutschemark, the fact is that in the case of a euro breakup, Germany is where it’s at. Its fiscal position and reputation for prudence is among the strongest of all developed countries. If it were on its own then its currency would rise to reflect this. So, to the extent that you can choose, you will want to get your banknotes from Berlin
Presenting European and US equity and credit markets' performance from the Thanksgiving Day lows. Can you spot the odd market out?
You don't spend over $1 trillion in nine months unless something very, very bad is coming down the pike. That something "BAD" is the collapse of Europe's banking system: a $46 trillion sewer of toxic PIIGS debt that is leveraged at more than 26 to 1 (Lehman was leveraged at 30 to 1 when it went under).
The New York Fed's Brian Sack, better known by everyone as the head of the Plunge Protection Team, is gone.
In what could be one of the better deals encountered on Ebay, one can submit a winning bid for none other than the country of Greece, currently going for the modest price of $1,550 (although with 6 more days left in the auction, there is a small chance Goldman will outbid and use it as LTRO 3 collateral). Of course, since the country is worth much less than the debt (all 7 subordinated classes of it) any new equity buyer would assume, this is a trick auction: our advice - settle for nothing less than getting paid as much as possible for "buying" the country.
Much has been made, and rightly so, of the echoing crisis that is evolving in Spanish bank and sovereign credit (and equity) markets in the last few weeks. The impact of the LTRO on the optics of Spain's problems hid the fact that things remain rather ugly under the surface still and with the fading of that cashflow and reach-around demand from the Spanish banking system, the smaller base of sovereign bond investors has shied away. Stephane Deo, of UBS, notes that while the Spanish budget is a positive step (with its labor market reforms), Spain's economy remains weak and will face a severe recession this year followed by still significant contraction next year. However, he fears the measures announced may not be enough to calm investor angst as he doubts the size of fiscal receipts numbers and the ability to half the deficits of local authorities. Furthermore, the measures will have a large impact on corporate earnings - implicitly exaggerating the dismal unemployment numbers (which is increasingly polarizing young against old) with expectations that the aggregate unemployment rate could well top 26% and youth well over 50%. This will only drag further on the housing market, which while it has suffered notably already, is expected to drop another 25% before bottoming and credit is contracting rapidly (compared to a modest rise overall in Europe). Spanish banks remain opaque in general from the perspective of the size and quality of collateral and provisioning and Deo believes they are still deep in the midst of the provisioning cycle and tough macro conditions will force restructuring and deleveraging. Spain scores 5 out of 5 on our crisis-prone indicator and markets, absent intervention, are starting to reflect that aggressively.
Pop quiz: What is the common theme among the following "best of breed" 2 and 20 (at least) hedge funds, whose YTD performance is presented below?
As we discussed here just two weeks ago, there is a growing concern that Japanese officials will decide to turn the currency war amplifier volume to 11 and devalue the JPY. With carry trades unwinding rapidly, JPY continues to strengthen (much to their chagrin) but now we are seeing very aggressive positioning in 5Y JGB breakevens (or inflation bets) which implicitly belie devaluation expectations. The key being that, breakevens spiking implies a market expectation that the BoJ will finally be forced to stimulate inflation, as Andy Xie recently pointed out, but going the hyper-inflate path and crushing the JPY. This instead of the alternative, for an economy which is now no longer in a trade surplus, which is a collapse in bonds which has its own very nasty endgame (where, as a jarring reminder, if bond yields rise to 2 percent, the interest expense would surpass the total expected tax revenue of 42.3 trillion yen).
For everyone who wants to see a simple yet explicit example of how the BLS' relentless propaganda courtesy of perpetual prior "adjustments" trickles down in terms of media propaganda, here it is.
This brings the saying "Too much of anything is a bad thing" to a whole new level!
If you spend your day listening to mainstream financial media you could be forgiven for believing that things have never been better for corporate balance sheets - exceptionally high levels of cash and fortress-like conservatism for example. However, in the trenches of reality, from a high-yield and investment grade credit market perspective (and perhaps this is why credit markets are expressing considerably more concern than equities still) there are three trends that point to deterioration and far-from-Nirvana cash-flow protection that should be paid close attention to.
Last week Mario Monti, like a good (ex) Goldmanite, did his best to buy what Goldman is selling, namely telling anyone gullible enough to believe that the "European crisis is almost over." Funny then that we learn that just as this was happening, Ben Bernanke held a secret meeting with the entire banker caretel, in which discussed was not American jobs (seasonally adjusted or otherwise), nor $5 gas, but... helping European with its debt crisis. But, but... Mario said. In the meantime, European spreads are back to late 2011 levels.
Today's aggressive intervention by various monetary authorities to prevent the Swiss Franc from trading anywhere close to its fair value (yes "intervention", the same that happens each day in other capital markets, like stocks and commodities, read gold) reminded us once again that it is always and only a central planner's world. Yet while it is easy to assume there is some big black box doing all this manipulation, the truth is that the decision chain ultimately ends with carbon-based lifeforms, who push the buy or sell button, respectively: i.e., the human element. Which is why we wanted to present our readers the decision making chain expressed in flesh and blood terms, namely the people who over and over demonstrate to the market just who is in control.
If Goldman's recent predictive track record is any indication, tomorrow's NFP will be a disaster.