Archive - Aug 2010 - Story

As more and more pundits, and amateurs, debate the endless futility of the bond bubble, as in does one exist or are nominal rates, in addition to swap spreads, going negative, the one real asset - gold - is surging to highs last seen in early July. Of course the bond debate is silly: it merely indicates a flight to safety in a time when stocks continue to live in a fantasy neverland of "timid" inflation, when the reality is accelerating deflation for levered goods, and rising inflation for goods "for the rest of us." As for those who never see a bond auction failure (and no, explaining the dynamics of a ponzi dutch auction is neither necessary nor sufficient), they will be absolutely correct- until they are wrong. And since we have gotten to a quantized state where even a rise in rates (due to the Fed's stance on liquidity) is virtually equivalent to a failed auction, the distance from the base orbital to the energized level, to keep the quantum analogy, is far closer than most believe. But such is the way in a ponzi non-gold standard system, in which endless credit is chasing extremely finite cash flows. Ssince we have now moved past the point where incremental debt creation can fund viable, cash flow generating assets, any incremental debt serves no role save for window dressing. Whether or not there is a formal announcement by the UST of a failed auction is irrelevant. In the meantime, gold is brushing all these pointless discussions aside and doing its thing. However, gold likes to keep it complicated, and has once again inverted its 120 day correlation with stocks, hitting the lowest level since March 2009. In other words, if stocks are correlation to inflation, gold is now a deflation benefiting asset. Which is also wrong, as gold merely is seen increasingly as an alternative to the great alchemy experiment in the bottom of the 9th being conducted by the Central Banks of the world, which is the last hope to preserve the status quo. In other words, gold is merely the hedge to whether either side in the bond bubble debate is right.

What if we told you there was a trade that was appealing, obvious, talked about daily and yet you hadn't heard of it? Would you be interested? What if we told you there are fixed income instruments being bought with a higher yield than US treasuries in currencies that are undervalued; and there is a high probability these currencies will soon appreciate; and the yields on the bonds will decline? What if we told you the same institution that is buying the bonds controls the timing of the bond's underlying currency appreciation and is directly responsible for the current undervaluation of the currency, and the higher yield offered? What if we told you the institution was China?

- Faros Trading

The Congressional Budget Office (CBO) estimates that the federal budget deficit for 2010 will exceed $1.3 trillion—$71 billion below last year’s total and $27 billion lower than the amount that CBO projected in March 2010, when it issued its previous estimate. Relative to the size of the economy, this year’s deficit is expected to be the second largest shortfall in the past 65 years: At 9.1 percent of gross domestic product (GDP), it is exceeded only by last year’s deficit of 9.9 percent of GDP. As was the case last year, this year’s deficit is
attributable in large part to a combination of weak revenues and elevated spending associated with the economic downturn and the policies implemented in response to it.

Philly Fed comes in at -7.7, trouncing expectations of 7.0, and is the lowest number since August 2009, and first contraction since July 2009. Was the number even in the range of bearish expectations? Where is Steve Liesman - the survey respondents need some perking up: "the region’s manufacturing executives expect growth in business over the next six months, but optimism has waned notably in recent months." Those who look at the chart and think they are seeing the ECRI Leading Indicators are forgiven.

This write-up is in response to a question regarding what would happen if both the stock market and the bond market were to blow up at the same time. I’m assuming the only way this happens is via massive bond defaults. Certainly not saying this is necessarily going to happen, but it is worthwhile to think through extreme events. And it’s not a stretch to think that Greece, a Baltic country with a debt-to GDP ratio of around 500%, and many US states are expecting. Defaults, that is. It is worth understanding how people and institutions respond to an unsustainable debt burden on a societal scale, and how to make money on it. The unexpected results of a promiscuous consequence-free debt binge will have extreme consequences for shaken money-makers.

Just Reuters headlines for now: the CBO has reduced its 2010 budget deficit from $1.368 trillion to $1.342 trillion, even as it kicks the can down the road yet again, raising the 2011 budget deficit estimate from $0.966 trillion to $1.066 trillion: in other words a net deficit increase by $44 billion. Good thing nobody even cares about the 2012 number now that Mayan apocalypse predictions are fully priced into a Dow 36,000 number.

As a reminder, today is POMO day #2. The Fed will monetize (but don't call it that or you will get Tim Geither's panties in a bunch) anywhere between $2 and $2.5 billion. And with the implicit 10-20x leverage by the Primary Dealers, the otherwise vapor volume, the "mo[r|m]onic robot" acceleration effect, this meager reliquification amount could be sufficient to push stocks up by about 0.5-1.0%. This will be even easier now that many shorts have leaned into the market post the horrible Initial claims number, and a manufactured short squeeze courtesy of the Fed and State Street is all but guaranteed. In other words, be very cautious shorting today - here there be printers.

• Sarkozy Calls Crisis Meeting to Avert Loss of AAA Rating (London Times, subscription required)
• Spain just says no to austerity - after all the bankrupt country can place Bills at 4% so all is good: Spain Restores €500m of Spending (FT)
• US Banks Receive Basel III Boost (FT)
• Citigroup's Sweetheart Deal Flunks Smell Test (Bloomberg)
• BOJ May Expand Corporate Loan Program to Help Weaken Yen, Sankei Reports (Bloomberg)
• Goldman's 2027 Call Means China Must Get Busy (Bloomberg)
• Double-dip recession talk will be heating up (Post)
• China Says Local Govt Borrowing Risks Manageable (Reuters)
• U.S. Must Tackle Deficit Without Denting Recovery (Reuters)

Welcome to the half a century. Treasuries surge. Futures plummet. Can't wait for Rosie's note.... Or Liesman's spin

Continuing claims at 4.478MM on expectations of 4.5MM; previous 4.452MM revised to 4.491MM.

Those receiving Extended Benefits and EUCs increased by over 300k (+49,229 and +260,105) week over week

However, don't panic - the depression may be over... in 2099.

• Asia stocks rise on Applied Materials outlook; Ringgit, Taiwan Dollar gain
• Asian computer shipments signal extended consumer spending slump in US.
• China allows Ringgit to trade vs Yuan in domestic market.
• China may ban copper producers who violate environment rules for two years.
• Clinton to urge global aid for Pakistan to match Haiti response
• SEC will vote next week on rules that may make it easier to oust directors.
• Treasury 10-Year yields near 17-month low as Fed, Japanese investors buy.
• US banks receive Basel III boost, Rewrite of rules could cut in half new capital required.
• AIG sets stage for first bond sale since bailout.
• Applied Materials guides Q4 EPS, revs above consensus.

Way back in the 1960’s analysts were worried about the multi-decade increase of debt. Some focused on personal debt burdens, some looked at corporate gearing, and others feared government deficits, but for years and years these worrywarts were proven wrong, as the economy powered higher and higher making the critics look like idiots. Statistics on almost all types of debt showed a high correlation between their increases and increases in measures of economic health like the GDP, average personal net worth, and the country’s standard of living. Underneath this positive economic view, seemingly out of sight to everyone, a slow weakening was taking place. As the years went on, the dollar increase in debt necessary to generate a dollar increase in GDP kept growing. Back in the late 1940’s and 1950’s, it took about a one dollar increase in debt to generate a one dollar increase in growth, but in each succeeding decade the amount of debt necessary to generate a dollar increase in GDP kept growing. Through the most recent decade, it seems to have taken more than five dollars of debt to produce one dollar of growth, and over the last few years the numbers might have gone into reverse, or perhaps only toward infinity, as all the increase in debt does not seem to create any growth. - John Taylor

RANsquawk European Morning Briefing - Stocks, Bonds, FX etc. – 19/08/10

Canada’s economic soundness has garnered renewed interest amongst foreign investors. The country was fortunate to escape the economic crisis unscathed, unlike the rest of the world. It boasts one of the strongest financial systems on the globe, ranking best in the world by the World Economic Forum. While it appears that the Canadian economy remained unscathed throughout the financial crisis of 2007-2008, further deterioration of public finances combined with declining exports while commodity prices remain high may put further pressure on the Canadian economy. With the global economic recovery in doubt, Canada’s resilient economy is beginning to mimic that of the United States in 2006-2007

Goldman's Richard Ramsden has cut his Price Targets and EPS estimates virtually across the board for his coverage universe, while keeping ratings the same, on increasing concerns that loan shrinkage at banks, and portfolio run offs will pressure bank Net Interest Margins/Income, in what he dubs as the "Turning Japanese" syndrome. The primary culprit - lack of loan growth as not only are banks squeezed by declining LT rates, but by an increasing lack of willingness by US consumers to borrow: "Loans were down 1% this quarter, with chargeoffs remaining a big source of shrinkage. We analyze the economic factors driving loan growth and conclude that year-over-year growth will not turn positive until 2011. Run-off portfolios which account for 10% of system wide loans will drive a further 3% shrinkage in 2011." Ramsden rhetorically asks: "Shrinking loan levels and low interest rates have prompted many to ask if we are headed down the same path as Japan in the late 1990s." And while the banking analyst is contractually obligated to answer every question bullishly (no matter if real or rhetorical), we are confident that particular question has only one correct answer, and it is most certainly not "No."

It was a brief 24 hours ago that we suggested putting on a Nikkei-S&P convergence arb with the provision that "this is the cheapest and easiest way to hedge what is becoming
increasingly inevitable: that the BoJ will have no choice but to follow
our own Fed down the rabbit hole of money printing." A few minutes ago the Dow Jones released the following: "The Bank of Japan will consider taking
additional easing steps to cope with a rising yen and falling
share prices, the Sankei Shimbun reported in its morning edition." The BOJ will hold an emergency meeting policy meeting at 5 am GMT at which point the specifics of the easing measures will be announced.