Archive - Feb 17, 2010 - Story

Frequent readers are aware that in the past month, Zero Hedge has speculated on both the direction of Chinese UST holdings as well as the identity of the direct bidders. Our thesis, presented over a month ago, was that Chinese accounts, operating as UK-based direct-bidders, are perpetuating a form of covert easing, by buying treasuries which never hit the TIC account as a Chinese counterparty and thus remain under the radar, being relegated to UK purchases for all official purposes (whose holdings have spiked in 2009). To be sure, this theory was met with some skepticism within the Zero Hedge community. The just released TIC data, which highlighted the biggest monthly drop in Chinese holdings in years (and biggest UK holdings surge), provides yet another piece of the puzzle, has increasingly led experts to concede that something is off about Treasury holding patterns. (No such ambiguity exists when it comes to MBS: everyone is hitting the Fed's bid there).

Confused by recent proclamations by Hoenig, Plosser, and other unnamed Fed members, who want an end to QE? Even more confused that this could actually happen? Andrew Smithers, former head of SG Warburg asset management before starting Smithers & Co., may have some iconoclastic insight into this development, which at its core is fundamentally deflationary, and a stark refutation to everything the Fed (presumably) stands for. A paradox? Smithers breaks the "Econ 101" mold in this fascinating interview with Kate Welling. The most provocative perspective: Smithers goes against the grain of every economic textbook which says the only way to inflate debt away (deleverage) is by, well, inflation. Instead, what Smithers suggests is a slow, gradual process of deflation, in which incremental cash flow is converted into equity, and pushes debt out. Indeed, this is precisely what we have been seeing especially in the REIT sector where numerous names, courtesy of BofA, have raised equity on the basis of imaginary valuations, which may just become a self-fulfilling prophecy if enough people buy into them, and by throwing cash at these companies, allow them to lower their debt-to-capitalization ratios. Then again, with another half a trillion in equity needed for the REIT sector to fund itself out of a mid-term funding crisis, that's purely a pipe dream. However the bigger picture of the Smithers perspective is that this deflationary approach is exactly what the Fed may be engaged in. By distracting the increasingly more vocal inflation hawks, who anticipate that inflation is and always will be the driving motive of the Chairman, Bernanke could very well be pursuing just the opposite: a slow-bleeding deflationary trend.

The 3-min. bar traders are now getting roundhouse kicked daily by the gyrations in the Euro, periodic utterances from various Fed Heads, and Mr. Blankfein's ability to vaporize both puts and calls by reversing course with various "Risk On" or "Risk Off" chants.

The IMF just announced it would resume selling the balance of its preapproved for sale gold, of which 191.3 tons remains. The sales would be in a phased manner over time to avoid disrupting the gold markets. This is not major news as this is inline with the IMF's September 2009 announcement to sell 403.3 metric tons of gold. As is well known the IMF has already sold 212 metric tons. Nonetheless, gold is selling off after hours. Full press release attached.

After pretty much two weeks waiting since what we thought was the last meaningful turn in risk appetite (towards risk appetite), I think the markets have reached a possibly key pivot area. I will start with commodities where the pivot is the clearest on the day. Copper has retraced 61.8% of the recent sell off, and posted a quite nasty indecision candle on the day. If we gap lower tomorrow and close below 319 this would be a major evening star. Also note that today's pivot also corresponds to the level at which copper broke through the support of the bullish channel in place since March 2009. Gold similarly has hit an intermediate resistance at 1,120/1,125. As long as we do not post a daily close above that level there is risk to retest at least 1,074 before having a shot at further upside, and if we venture below 1,060 then we are headed for 980/1,008 which is the massive support zone (if broken this invalidates further upside for the medium term). - Nic Lenoir

With the threat of sovereign default and contagion now pervasive within the Eurozone periphery, it is relevant to quantify the relative exposure of various banking centers' assets as a percentage of host countries' total GDP. The reason for this is that in Europe for many countries a sovereign default would not have as great an impact, as a risk-flaring contagion impacting these countries' primary financial entities, whose assets account in some cases for multiples of host GDP. For example in Switzerland, the assets of the top two banks, UBS and Credit Suisse, alone account for nearly 600% of the country's GDP. And while Switzerland is relatively isolated from the budget and deficit crises in the PIIGS and STUPIDs, other countries such as Italy, Belgium and ultimately France, Germany and the UK, are much more exposed.

No need to even comment any more.

Much has been said on these pages and elsewhere about the dangers embedded within quant groupthink, in which an ever increasing prevalence of fewer performing factors means that more and more speculators (note: not investors) line up on the same side of the trade pushing up offers, only to experience a regime change based on some heretofore unexpected exogenous event which renders existing signal translation models useless, and causes all former buyers to join the sellers. Whether that would result in a bidless market remains to be seen. If October 1987 is any indication, all signs point to yes. Yet in a sign that at least the bigger bankers may be anticipating just such an outcome, the Economist has disclosed that JP Morgan, in addition to reserving for general loan loss provisions on its balance sheet, has now taken a $3 billion reserve against quant error (yes, quants can be wrong... and for a lot of money at that). Just how many other investment banks demonstrate this kind of prudence? Without any specific regulatory guidelines for quant capital provisioning, we have no idea. While the bulge brackets may have joined JPM in a comparable form of "insurance" it is a certainty that the thousands of newly cropped up quant trading firms not only have no such reserves, but should a dramatic market reversal transpire, it is inevitable that wholesale asset dumping will have to take place to cover losses. And this assumes no leverage. Is the market prepared for such a contingency?

Several thought it important to begin a program of asset sales in the near future to ensure that the Federal Reserve’s balance sheet shrinks more quickly and in a more predictable manner than could be achieved solely by redeeming maturing securities and not reinvesting prepayments; they judged that a program of asset sales spread over a number of years would underscore the Committee’s determination to exit from the period of exceptionally accommodative monetary policy in a manner and at a pace that would keep inflation contained without having large effects on asset prices or market interest rates. A few suggested that the pace of asset sales, and potentially of purchases, could be adjusted over time in response to developments in the economy and the evolution of the economic outlook. The Committee made no decisions about asset sales at this meeting. - FOMC Minutes

Investors are growing more risk averse as they question the macroeconomic outlook as the government withdraws its support. Moreover, as last year’s sugar high continues to wear off, what we can expect to see is a return to what can only be described as heightened volatility in the markets, and the need to shift towards less cyclical and more defensive and income-oriented strategies that work well in a period of increased economic uncertainty. Overall, if the primary trend for the economy, credit and equity prices is down and 2009 was indeed a countertrend bounce, then the appropriate exercise is to consider ways to capitalize on the spectacular rally in risk assets off the lows last March and determine how we can all still make money in 2010 on a risk adjusted basis.- David Rosenberg

The barrage on Greek financial institutions continues, with Moody's downgrading Greek bank hybrid securities. Those impacted include National Bank of Greece, EFG Eurobank Ergasias, Piraeus Bank and Alpha Bank. The rating agency mainains a negative outlook on the bank's Baseline Credit Assessment, whatever the hell that is. The basis for the rating action is presented as follows: "Prior to the global financial crisis, Moody's incorporated an assumption into its ratings that support provided by
national governments and central banks to shore up a troubled bank would, to some extent, benefit the subordinated debt holders as well as the senior creditors. The systemic support for these instruments has not been forthcoming in many cases. The revised methodology largely removes previous assumptions of systemic support, resulting in today's downgrades. In addition, the revised methodology generally widens the notching on a hybrid's rating, based on the instrument's features." Is this a preamble to yet another general downgrade by Moody's on the country? Should the Greek Moody's rating drop to A1 or below, the Titlos SPV downgrade cascade consequences, as discussed previously, could come to the fore very promptly.

Goldman's Alec Phillips provides some perspectives on why the recent announcement that the GSEs will purchase 120+ day delinquent loans will not be a major impact to either the overall MBS market or to the Fed's QE tactics when it comes to stabilizing the market. Furthermore, in addition to not being a material mitigant to the Fed's massive balance sheet holdings, some direct implications as pertains to end borrowers include a greater incentive to foreclose, a greater emphasis on non-modification strategies, and more aggressive modification efforts. Yet the major issue, the one addressed by the Fed's Hoenig yesterday when discussing the urgent need to commence selling Fed assets asap, will likely be completely sidestepped, in essence stressing the need to find a legacy replacement through to QE when it expires in just over a month.

Have you noticed lately the behaviour of the put/call ratio? Once you read the next few lines, you will agree with us that it is a rare event. We have tracked this interesting behaviour since 2007. It is a compression event taking place in the ratio. The put/call ratio is usually defined between a mathematical range. The best example is provided at the left of the graph. The ratio will bounce around from the mean to +3 standard deviation on a sudden drop of the Dow Jones, taking it to under 13,000. That would be normal behaviour. In our present circumstances, something very different is happening.

The dollar just closed yesterday's gap. And here we were hoping that Dubai, er, Greece, and all that stuff was contained. Now that the (record) weak hands got shaken out of their euro shorts, it's time to back the truck up. And time to focus on that other STUPID member, Italy, where storm clouds have so far not been gathering. Then again, with Moody's just downgrading Greek banks' hybrid securities ratings, something tells us the Boot has just bought itself an additional temporary reprieve.

Goldman's distinctly feminine A. Joseph Cohen is out with the latest prognostication. Punxsutawney Abbey must have not seen her shadow yet again, resulting in a call for 6 more decades of Dow at 36,000, or in this case S&P hitting 1,300 by the end of the year. The fact that blind monkey, with a penchant for dart (and/or feces) throwing have had a more successful track record than AJC is irrelevant, yet disturbing . To wit: On a CNBC appearance in March 2008, she predicted S&P 500 at 1550 by end 2008, In an August 10, 2007 appearance on CNBC the Oracle of nothing predicted the S&P 500 would rally to 1,600 by December; In December 2007 A. Joseph predicted the S&P 500 index would reach 1,675 in 2008 (the S&P 500 traded to less than half, or 741.02, in November 2008).