Archive - Jul 29, 2010 - Story

The "Pretence of Knowledge" was the title of economist Friedrich Hayek's 1974 Nobel speech. In his first few sentences, he described the then-prevailing economic condition in words appropriate to today:

“[this economic condition] has been brought about by policies which the majority of economists recommended and even urged governments to pursue. We have indeed at the moment little cause for pride: as a profession we have made a mess of things.”

Hayek's words in 1974 were not meant to describe today's condition, although they were extremely prescient. His hope was that the limits of knowledge would be recognized by the economics profession so that we would never reach our current situation.

Hayek's call was for professional humility at a time when Keynesians arrogantly believed they could manage the economy and the business cycle.

Earlier we highlighted a very sternly worded anti-US essay on the front page of the primary communist party daily. Some thought it was merely yet more posturing. Alas, they may have been very wrong. Associated Press reports that Google has now been completely blocked from mainland China access, with few if any details coming from Google itself, meaning this was another unilateral muscle flexing exercise by China. However, as far as Google is concerned, and judging by BIDU stock after hours, it may well be game over for the great Chinese decoupling experiment.

Tomorrow's GDP report will be a major market catalyst as it will either confirm that an inflationary double dip has now arrived and the Fed will have no option but to print, or it will come "just better than expectations", once again sending the market into a lithium-deprived paroxysm of intraday jerkiness. Yet in the medium run, tomorrow's number is very much irrelevant, especially if Jan Hatzius' latest analysis on the impact of various trends at the local, state and federal level turns out to be correct. Goldman's analysis is based on the following assumptions: (1) Congress will not extend emergency unemployment benefits beyond the current expiration date in November 2010, (2) state governments will need to make do without any additional federal fiscal aid beyond what was included in ARRA, and (3) Congress extends the lower- and middle-income tax cuts of 2001-2003 as well as the Making Work Pay tax cut of 2009 but not the higher-income cuts of 2001-2003. The latter is of particular significance because as Bloomberg reports, Obama is about to take populism into high gear, as Geithner will next week bring the proposed tax cuts for the rich directly to the masses (and the corrupt simians in the Senate). Obviously the financial implications of that one move alone will be disastrous and even if tomorrow's GDP number prove better than expected, the market may ultimately trade off on the devastating impact from the expiration of the most important subset of tax cuts. Which is why, going back to Hatzius, the Goldman economist states: "The overall impact of fiscal policy (combining all levels of government) is likely to go from an average of +1.3 percentage points between early 2009 and early 2010 to -1.7 percentage points in 2011, a swing of about -3 percentage points. We estimate that the boost to the level of GDP starts to decline in mid-2010, first gently and then more forcefully, setting up a significant negative impact on GDP growth in late 2010 and 2011." The only thing Hatzius forgot to add is brace yourselves for impact. Yet somehow Goldman's own David Kostin projects that 2011 S&P EPS will grow by double digits... even as the firm's own economic team anticipates an economic crunch. This is precisely the conflicted double speak that we have grown to love and expect from the Wall Street sellside.

Earlier today we noted that the biggest buzz on Wall Street is the recent suggestion by MS and ML's Harley Bassman that the GSEs should provide some form of autorefi program to take borrowers to market rates. As this would impact a vast majority of the 37 million of mortgages outstanding backed by the government, not only would this housing stimulus have a huge impact on consumption appetites, but it would be a political coup as all of a sudden the administration would find tens of millions of giddy homeowners who are paying far less monthly, and quite satisfied with the way Obama has handled things. It is thus likely that this program will take off shortly (if at all) just before the mid-term elections to neutralize all the pent up discontent focused on the administration. Yet there may be less than meets the eye. As Market News points out, over the past 24 hours Wall Street has gone into overdrive analzying the consequences, both positive and negative, of such a move. Below are the conclusions.

Today was a very abnormal day in stock trading. Abnormal, because despite the massive amplitude in the intraday swing (from 1,102 to 1,116) and the nearly unchanged close, none of the "free money" monkey business occurred: there were no divergences between either ES and AUDJPY or ES and the 10Y UST. This is quite surprising and rather troublesome as it marks possibly the first time this has occurred in several months. Is some semblance of normality creeping back in stocks, as even HFTs begin to get kicked out of the market due to margin erosion and cannibalization? If so, watch for valuations to eventually promptly catch up to fair values on the margin... far lower than prevailing price levels.

RANsquawk Market Wrap Up - Stocks, Bonds, FX etc. – 29/07/10

Just because the unpronounceable volcano did not do quite enough damage, and both Hekla and Katla are taking their sweet time, the Iceland Supreme Court recently ruled on the illegality of foreign FX-linked loans, and "Icesave" is still DOA, here is Moody's with a stern warning for the country to change its anti-Keynesian ways promptly or else. "Today's rating action was triggered by the recent Supreme Court ruling on the illegality of foreign-exchange-linked loans and government's continuing difficulties in achieving a resolution to its "Icesave" dispute with the UK and Dutch governments. Specifically, the Supreme Court ruling has the potential to cause substantial bank losses on foreign currency-denominated loans to domestic borrowers and may therefore require additional government support to the banking system. Moreover, a failure to resolve the "Icesave" dispute could lead the Nordic countries and the IMF to withhold future disbursements to the Icelandic government." Zero Hedge is certainly rooting for the tiny island country, even if it is triple hook rated, as it continues to give the middle finger to all the developed world kleptocrats.

The latest update from ICI is a doozy: in the week ended July 21, domestic equity mutual funds saw a 12th sequential outflow of $1.5 billion. Even as the market has surged 10% in the last three weeks, just under $10 billion have been redeemed from mutual funds, completely invalidating the move and further justifying the skeptics who see absolutely no reflection to reality in the volumeless ramp orchestrated by a few momentum HFTs and a couple of Primary Dealers with some excess leftover Discount Window change. Not to mention that 12 weeks in a row of outflows pretty much marks game over as far as retail participation is concerned in stocks. Regardless of what the market does, where it close, how high it ramps, etc, retail just pulls money indiscriminately from the market, without any regards for what the fraudulent and fabricated current level of the DJIA may be: all mom and pop just want is to get the hell out of stocks stat and get into fixed income. The market is now completely disconnected from fund flows, and the only thing potentially keeping it in the stratosphere in addition to deranged binary concoctions are various "self-fulfilling prophecy" high gamma ETFs, which continue to push stocks away from fair value to the tune of several standard deviations. However, just like on May 6, the rubberband will, sooner or later, snap, and make May 6 seem like a dress rehearsal.

The main story making waves this afternoon is the presentation by St. Louis Fed's James Bullard titled "Seven Faces of The Peril" in which the Fed president pledges that the Fed should immediately recommence purchasing Treasurys if the deflation scenario picks up, which he notes is an increasingly likely probability. In the paper, Bullard argues that the Federal Open Market Committee’s extended period language may be increasing the probability of a Japanese-style deflationary outcome in the U.S. within the next several years, and concludes that an appropriate quantitative easing policy offers the best hope for avoiding a low nominal interest rate, deflationary outcome. "The U.S. is closer to a Japanese-style outcome today than at any time in recent history...A better policy response to a negative shock is to expand the quantitative easing program through the purchase of Treasury securities.” While of course keeping up a facade that the Fed is in control, Bullard does speculate about the downside case: “The most likely possibility from where we sit today is that the recovery will continue through the fall, inflation will start to move up and this issue will all go away. Suppose we get another negative shock, another surprise. We have to be prepared in that event to have a plan in place to do something." Yet all of this is in the sphere of probabilities of QE2.0 and for now at least, is something to consider in the intermediate future. Yet something far more sinister may be brewing just below the immediate horizon. As Mark Hanson suggests based on speculation by both MS and ML (oddly enough released concurrently, MS report attached below), the GSEs and the FHA may be preparing to imminently launch an instant auto-refi program which would take millions of borrowers to current market rates overnight! In the process $45 billion of consumer savings would be created. Welcome QE 1.999.

RANsquawk US Afternoon Briefing - Stocks, Bonds, FX etc. – 29/07/10

As we wrote earlier, Greece is currently paralyzed, literally, due to a wholesale shortage of fuel at gas stations, as drivers of trucks carrying the precious commodity have been striking for several days. As noted previously, the government invoked a war-time mobilization measure forcing the strikers to stop striking or face civil penalties and jail time. Shockingly, this had absolutely no impact ont he angry mob. In order to make its point even more clear, the government accentuated its overturn of labor rights by firing tear gas at protesters, according to the Guardian. And, in an amusing turn of events, the IMF delegation which was rumored to be passing by at just this time to conclude the backroom deal in which US taxpayers would fund a few hundred more billion of failed Greek programs, was subjected to a Greek parliamentary guard wearing the traditional skirty attire, screaming in a bullhorn that the truckers were merely engaged in a modern remixed version of sirtaki and there was absolutely nothing to see there (obviously the guy had just graduated from the CNBC School for People who Want to Fabricate the Truth Good).

The Fed came, saw, and conquered the mortgage market. The 30 year Freddie fixed just dropped another 2 bps from the prior week to 4.54%, a fresh all time low, and more billions in margins chopped off from the profit line of mortgage originators everywhere, now that the Fed and Pimco are the only two entities remaining in the mortgage market, even as consumer cash flows are under more pressure than ever confirming that in this bizarro market just as one wants to buy, the right button to push is sell and vice versa.

Yesterday's "paper" (more in the napkin sense than as a synonym for "intellectual effort") by Mark Zandi and Alan Blinder, which was nothing more than a glorified cover letter for selected perma-Keynesian posts in the administration's Treserve complex, was so outright bad we did not feel compelled to even remotely comment on its (lack of any) substance. A man far smarter than us, Stanford's John Taylor (the guy who says the Fed Fund rates should be -10%, not the guy who says the EURUSD should be -10), has taken the time to disassemble what passes for analysis by the tag team of a Princeton tenurist (odd how those always end up destroying the US economy when put in positions of pwoer), and a Moody's economist, who is undoubtedly casting a nervous eye every few minutes on the administration's plans for EUCs and other jobless claims criteria. Below is his slaughter of dydactic duo's demented drivel.

When I began writing ten years ago, I would offer that the opposite of love wasn’t hate; it was apathy. I shared that thought after tech stocks dropped 40% in less than two months and then recovered half those losses the next two months. We all know what happened next; the tech sector melted 70% the next few years. Wash and rinse, Pete and repeat; we’ve seen that sequel again and again and again. From the homebuilders (real estate) to China to crude oil, a “new paradigm” arrived. Every time was different and each offered a fresh set of forward expectations that would finally prove historical precedents need not apply. I traded all of those bubbles thinking quite sure they would follow the path of false hope and empty promises paved by their predecessors. That proved true as the real estate market crashed, China imploded under the weight of the world, and crude crumbled just as it seemed ready to stake claim to the new world order. While those bubbles hit home for many Americans, they’re hardly unprecedented through a historical lens. - Todd Harrison

In an interview conducted with Business Week, Nassim Taleb discusses his view of the biggest black swan in the market currently, and isn't shy to call government debt a "Pure Ponzi scheme." - When asked where he the biggest potential source of systemic fragility is, he responds: "The massive one is government deficits. As an analogy: You often have planes landing two hours late. In some cases, when you have volcanos, you can land two or three weeks late. How often have you landed two hours early? Never. It's the same with deficits. The errors tend to go one way rather than the other. When I wrote The Black Swan, I realized there was a huge bias in the way people estimate deficits and make forecasts. Typically things costs more, which is chronic. Governments that try to shoot for a surplus hardly ever reach it. The problem is getting runaway. It's becoming a pure Ponzi scheme. It's very nonlinear: You need more and more debt just to stay where you are. And what broke Madoff is going to break governments. They need to find new suckers all the time. And unfortunately the world has run out of suckers." Alas, Taleb is wrong: Ponzi or not, today's UST auction will likely once again come at a multi year high Bid To Cover as the suckers (especially those who recycle Fed discount window money) just refuse to go away.