Archive - Aug 2010 - Story

Now with an extra dose of decoupling, brought to you from the fine folks at Goldman Sachs.

Since early April, the yield on 10-year Treasury notes has dwindled from 4.0% to below 2.5% on August 24th. Meanwhile, the 12-month change in the Cleveland Fed's median CPI has hovered feebly between 0.5% and 0.6% since March. These abnormally low interest and inflation rates are fanning fears of renewed GDP contraction, a plunge into price deflation, or both. Boardrooms and blogs are humming with rumors of a 'QE II' (Quantitative Easing II) program to counter a chilly deflationary dip. One reason fears are so acute is that the Federal Reserve's main policy tool, the overnight interest rate on Fed Funds, is flatlined at zero. Moreover, via 'extraordinary measures' beginning in September 2008, the Federal Reserve added some $1.4 trillion of securities, including $1.1 trillion of MBS (mortgage-backed securities), to its balance sheet in a stimulus bid. Yet despite these heroic efforts, economic leading indicators have turned weak this summer, as sinking Treasury yields add to the disquiet. In its August meeting, the Federal Reserve downgraded its economic outlook, and backed away from plans to let its enlarged securities holdings run off as MBS mature. Instead, it committed to buying about $18 billion of Treasuries from mid-August through mid-September, mostly in the 2- to 10-year range, by reinvesting MBS principal payments. It also set a $2.05 trillion floor for its securities holdings -- thus freezing 'QE I' in place (perhaps forever) and hinting that a larger 'QE II' could follow. But if QE I isn't working, what hope would QE II have of achieving its purpose in a fresh emergency? This paper discusses a faster-acting alternative, which is feasible within the existing statutory and institutional structure -- namely, targeted purchases of international reserve assets instead of Treasury notes.

The Bank of Japan Plutocrats are under pressure to leave their mistresses and finally crawl out of their Opium Dens.

Instead of admiring their 17-year old massage girls with "great interest", they must turn their attention to financial matters and begin the task of Yen intervention by taking "swift" and "bold" action to punish the speculators.

Stock futures are already giddy in early action.

America has long had a working group on financial markets (whose sole purpose some suggest is to keep stocks from plunging in times of turbulence), so why not have a working group on that other much more critical phenomenon of US society: a trend of unprecedented unequal wealth distribution, which can be summarized as simply as pointing out that 1% of US society holds more wealth (or 33.8% of total), than 90% of the remaining portion of America (26.0%), and also is in possession of more than half of all stocks, bonds and mutual fund holdings in the US. Well, there is, even if is not formally recognized, and made up of the same distinguished professionals as the PPT (Geithner, Bernanke, Gensler and Schapiro). Hereby we present some of the key findings of the Working Group on Extreme Inequality.

A floundering Jim O'Neill has never seen decoupling as wide as it is now, and the man is now openly hallucinating, seeing every non-developed country as a potential BRIC (see this Friday's FT OpEd: How Africa can become the next Bric). Well, of course, China needs its resources. Soon every open mine will be a "BRIC" to be exploited by Chinese interests, which come, see, and suck the place dry as they build yet more vacant cities, ghost towns, and highways to nowhere, hoping they can sustain the illusion of the world's greatest bubble for a few more months. Which is precisely all those who are betting on a collapse of China are playing it not with China CDS, but those of Australia: for when the worm turns, Bad in Beijing, will be nothing compared to the Massacre in Melbourne. Yet even Jim's nagging conscience is not allowing him to blindly continuine to ignore the other side of the coin, namely that he is once blatantly wrong, and decoupling never did, and never will occur: "What can emerge if Ben Bernanke and the Fed is wrong? What if this
slowdown is sustained, and we actually move into another recession? The
American Dream needs something new. In conventional terms, it needs
booming private investment and booming exports. And they might happen. I
find it hard to see how net exports were such a genuine real negative
contributor to Q2 GDP as reported today, and I strongly suspect this
will be reversed. But what if it isn’t? The scope for more conventional
fiscal stimulus is hardly available. So in this light, the US needs its
own BRIC equivalent. How about something real on the infrastructure
front ? ( a nice mode of transport downtown Manhattan from JFK would be a
sign). How about literally some forced measures to shift the auto user
on masse from conventional fuels ( combined with a major hike in
gasoline taxes)?" Jim's conclusion: now that China is actively moving to developing its own middle class, perhaps it is time for the US to finally roll over and admit its consumer are on longer the world economic dynamo. He asks whether it is time to "borrow a few hundred million BRIC consumers?" Surely China will be ecstatic that the US will now be funding the development of its own middle class. As for ours...Oh well.

There is much debate over whether the Federal Reserve should tighten or further ease monetary policy. This dichotomous framing overlooks another possibility, which is whether the Fed should change the mix of its stance, tightening in some areas and further easing in others. In particular, there are strong grounds for the Fed to abandon its support of the Treasury bond market and to raise gradually the federal funds rate (to say one per cent), while simultaneously increasing its purchases of mortgage backed securities. If permissible, the Fed should also purchase state government bonds according to a per capita formula. Such a recalibration of policy could have positive effects. Increased purchases of MBS will help the housing market, which remains at the heart of the US economy's problems. Declining house prices continue to inflict financial losses on banks and consumers, and the prospect of further price declines deters buyers and undermines new construction. Increased MBS purchases could help stem this problem by further lowering mortgage rates. That would help households by facilitating more mortgage refinancing, help banks by reducing foreclosures and help the construction industry by making home ownership cheaper.

German Bundesbank executive Thilo Sarrazin has sparked a new uproar by saying that "all Jews share a common gene" and also attacked the Basques in Spain the same way in a newspaper interview. This comes only a few days after Sarrazin came under fire in Germany for using shock talk about the country's Muslim immigrants, Turks, Middle Easterners and Africans when he presented a new book. Sarrazin’s new book, whose title translates as “Germany Eliminates Itself,” sparked a heated debate. A spokesman of the Bundesbank so far only said that the book is Sarrazin's personal opinion, not exactly distancing itself from Sarrazin's xenophobic bouts.

When Zero Hedge first admonished our readers in June of 2009 to stay away from markets in light of a general deterioration in market structure, which included a regulator-authorized form of structural frontrunning in the form Flash trading (not to be confused with the imminently following Flash crash), an unprecedented mismatch between stock valuations and economic reality, and Wall Street continued attempts to reflate the ponzi merely for the sake of proving that it can be done, we never expected that retail would take to our warning with the ensuing solemnity. Yet with 16 consecutive outflows from domestic equity mutual funds, shut downs by legendary hedge fund managers such as Druckenmiller and Pellegrini (and many more Tiger derivative blows up to be disclosed soon, once the full extent of the carnage of the flattening of the steepener bandwagon trade is fully appreciated), virtually everyone is asking themselves how did Wall Street not only get it all so wrong, but how on earth is the primary business of the post-facelift Wall Street, which is no longer investment banking, but merely trading (with or without flow-facilitated prop frontrunning) going to sustain the recent record headcount levels (hint: it won't, and many more banks will soon let go thousands of additional staffers as key revenue sources have now disappeared forever), and most importantly, why is this time different? Why did the "dumb money" for the first time ever, not bite on the Wall Street siren song lure of an economic "rebound", but instead has hunkered down, proving that not only is Wall Street nothing more than a pure-play enabler of the ponzi regime's status quo, but that all those who were warning that the economy is far more dire than Wall Street represents, were proven right. These same individuals (and bloggers), first validated in predicting the downward direction of the economy, will see their pessimistic forecasts about stocks validated next. Yet while that happens, all those who still somehow find this a surprising development, are now left proposing hypothesis as to what went wrong. Such as the following piece by the Financial Times.

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Not China, not Russia, not North Korea, not Iran, not terrorists...According to Mike Mullen, the Chairman of the Joint Chiefs of Staff, the "single biggest threat" to American national security is the US national debt, which is either $8.85 trillion (public debt), $13.4 trillion (total national debt), $20 trillion (total debt including GSE debt), or $124 trillion (total debt including unfunded obligations), depending on one's definition of the word "debt." And as Zero Hedge has long been warning, the imminent increase in interest rates (sooner or later), will eventually put the country in an untenable funding position. "Tax payers will be paying around $600 billion in interest on the
national debt by 2012, the chairman told students and local leaders in
Detroit." The Chairman (the real one, not his pale imitation over at Marriner Eccles) politely forgot to add that the successful rolling of nearly $600 billion in debt per month is likely an even greater threat to national security.

The firm that was long the biggest bull on Wall Street, Morgan Stanley, with its initial 5.5% target on 10 Years by the end of 2010, has finally folded: "We are downgrading our outlook for second-half growth to 2-2.5% from 3-3.5% previously. This downgrade from above-trend to below-trend growth has  important implications for forecasts of the unemployment rate, inflation and monetary policy." Ostensibly it also has implications on rates, with the firm now actively calling for a flattener, just in time for the 10s30s to start creeping out again. Of course, this being Morgan Stanley, nothing is ever easy, and the firm obstinately refuses to see the plunge in H2 GDP as anything more than just a temporary blip: "we don’t think this slowdown will last beyond H2, much less morph into a downturn. In his Jackson Hole speech, Chairman Bernanke seemed to agree that the current economic weakness does not augur a weaker outlook for 2011. We agree. Among the reasons: Downside risks probably will prompt policy actions, balance sheet repair will be more advanced, and we expect net exports to improve in the second half of 2010 and into 2011. In fact, we see no reason to downgrade 2011 and possible reasons to upgrade, especially if policy turns more stimulative." Ok, Richard Berner, your colleague Jim Caron's rates call already lost a ton of people even more money : we will be sure to remind you of the bolded statement on January 1, 2011.

Goldman's David Kostin continues to pitch the firm's recent "SIRP" investment strategy, highlighting that while the S&P was down 0.6% in the past week, the recommended trade of buying low operating leverage companies (long / short ), was up 1.5%, while a recent push into dividend payers resulted in a 1.2% move higher in the firm's dividend growth trade (long / short SPX). Some other observations in this week's summary chartology: "Companies with low operating leverage have less risk to their earnings outlook from lowered revenue guidance than stocks with high operating leverage. Shortfall in mature market consumer PC demand caused Intel to cut its 3Q 2010 sales guidance by 5% and gross margin by 100 bp to 66%, implying a GAAP EPS cut of 10.5%."

In our attempts to simplify the comprehension of the ongoing serfdomization of the US population, we would like to present one of the more persuasive charts which the administration would likely be loath to demonstrate. Having collated monthly data from the FMS' Daily Treasury Statement on incremental tax revenues (individual, gross), and new debt issuance, we observe the following rather surprising pattern: since September 2008, or the month when capitalism collapsed, and the Fed, and ever other global Central Bank had to step in as a backstop of last recourse to the western way of life, the US government has undertaken the most peculiar matching program: simply said, for every dollar of individual tax revenue, the government has issued just over one dollar of incremental debt. In other words, in the past two years, tax revenues alone would have proven insufficient by over half to fill the budget gap. In yet other words, the US Treasury is now the functional equivalent of the entire US population and then some, when it comes to keeping the US economy afloat. From another perspective, with an average take down of roughly 50% of each recent auction by Indirect bidders, nearly a quarter (half of half) of US budget deficit needs is funded directly by foreigners. Should (in)formal trade wars escalate, and should the US see an embargo of foreign debt participation, then overnight a quarter of US spending will be unfundable: this includes such critical key expenditures as defense and social security spending. Also, it is important to recall , that of the $3.35 trillion in debt issued over the prior two year period, the Fed has directly (via UST purchases) and indirectly (via MBS purchases, and thus the forced rotation of MBS securities into UST securities for agency holders such as PIMCO) purchased the other half. Thus between foreigners, and the Fed, the US consumer's traditional contribution to funding the US economy has been diluted by half. And unfortunately, as the chart below shows, absent some dramatic deux ex machina, there is no chance this trend in which US debt issuance is the functional equivalent of taxpayer contributions, will ever end.

What ails Japan, the United States, and many other countries is financial deleveraging. Much talk about “Japanification” over the past year or so because the Federal Reserve response to deleveraging has been to compress BOJ policies into a shorter overlapping timeframe… giving the scenario a look and feel of the Japanese experience. Aside from this policy compression, there’s nothing new in the policy brew. The monetary policy compression and fiscal insanity has arguably made the next step—a tax increase—even more imminent than when Japan instituted their consumption tax.
Central banks can salve financial system wounds, but they must heal on their own. The problems of the financial sector reflect adjustments going on at the household level. This implies that these problems will be resolved organically by debt reduction, capital losses, and rescaling of capacity.

Oil prices were higher again on Friday, in a renewed frenzy of risk appetite, as Fed Chairman Ben Bernanke gave investors the signal they had been looking for. Speaking from Jackson Hole, Wyoming, he essentially told investors that the Fed will step in if the economic recovery appears to be in serious trouble. As a result of his comments, traders and investors dumped the US dollar, which is considered a “safe haven,” and they bought equities and commodities, including oil. The fact that prices were still oversold and near support certainly did not hurt. Traders saw buying oil as a low-risk purchase, and then the Fed seemed to guarantee it. - Cameron Hanover