Archive - Oct 12, 2011 - Story

With the market now responding almost exclusively to political developments (in a bizarro way of course: US-China trade war is bad for the USD, hence good for stocks), fundamentals long forgotten, and as a result HFT algos now moving primarily to FX trading (just read the following story about a Reuters data feed break causing a currency spike), focusing on politics, especially with both the US and China having fired the first trade war shots, will be unfortunately increasingly more important. Thus, here is what to expect out of our (and by our we naturally mean Wall Street's) "best and brightest" representatives today.

Only the most drunk on hopium (and Absinthe) among us can harbor any doubt that the eurozone, and hence the common monetary union currency the zEURq.bb, can survive without a dramatic change in the current European monetary (and fiscal) structure and an unprecedented overhaul to the status quo. But it can be done: after all there are numerous case studies across history, when various fiat monetary unions either succeeded or failed. Ironically, according to a just released report by UBS' monetary expert Stephane Deo (which we will discuss more later), three of the better such examples ironically can be traced to none other than the good old United States, which, and this may come as a surprise to some of our readers, had several failed monetary union regimes in the past before it finally arrived on the current stable (relatively speaking) "dollar" solution. So here, courtesy of UBS, are the lessons that Europe can hopefully learn (once again) from America's bitter experience in this matter. Because the alternative to success is failure (more on that shortly), and as UBS notes, "The economic and political consequences of a monetary union break up are also so severe as to deter all but the most determined – or to deter all but those already suffering extraordinary economic distress (occasioned by war or by depression)." So without further ado...

Chaos theory states than in complex systems, a butterfly flapping its wings in Japan can cause tornadoes in California. Whether or not that is true, a Banker in Belgium buying Greek bonds can impact the lives of factory workers in Germany. Europe continues to head down the path of making the system more complex than ever and ensuring that no bad lending, investing, or borrowing decision is ever punished.

The Slovak Parliament rejected the EFSF ratification bill late yesterday, which spurred risk-aversion overnight and in early European trade. However, in a stark reversal of fortunes, market sentiment changed following news that a new bill could be introduced in the Slovak Parliament as soon as this afternoon. Also, markets took positively comments from Chancellor Merkel who said that the EFSF changes will get full approval before the EU summit on the 23rd October, as well as a much lower than anticipated USD-allotment in the ECB's 3-month USD-operation, which waned some concerns surrounding the Eurozone banks' funding. Strength in equities weighed upon Bunds, whereas the Eurozone 10-year government bond yield spreads with respect to Bunds narrowed across the board. Bunds came under further pressure following a "technically uncovered" 30-year bond auction from Germany. Elsewhere, moving into the North American open, WTI and Brent crude futures ventured in positive territory as risk-appetite gathered pace and the USD-Index weakened... Moving into the North American open, markets look ahead to minutes from the FOMC meeting of 20th-21st September, together with the API inventories report. Any comments pertaining to the EFSF ratification in Slovakia will also be keenly watched. In terms of fixed-income, USD 21bln 10-year Note auction, allied with Fed's Outright Treasury Coupon sales in the maturity range of Mar'13-Oct'13, with a sale target of USD 8-9bln are scheduled for later in the session.

• Senate Passes Measure on China’s Weak Yuan (Bloomberg)
• Meet the next "axis of evil" - Beijing and Moscow to put $1bn each in fund (FT)
• Berlusconi’s future in balance (FT)
• Juncker lists 10 steps to stem euro zone crisis (Reuters)
• Paulson & Co warns of asset redemptions (FT)
• Pimco’s Balls Says Merkel-Sarkozy Plan Isn’t Signal to Buy European Debt (Bloomberg)
• EU banks face higher capital thresholds (FT)
• Europe Must Do More to Resolve Crisis: Geithner (Bloomberg)

We are confident the spinmasters will spin the first major domino in the muni crisis as bullish: after all it "removes uncertainty." Bloomberg reports that "The city of Harrisburg, Pennsylvania, facing a state takeover of its finances, filed for bankruptcy protection following a vote by the City Council, according to a lawyer for the council.Mark D. Schwartz, a Bryn Mawr, Pennsylvania-based lawyer and a former public finance banker for Prudential Financial Inc., said he filed the documents by fax to a federal bankruptcy court last night. The filing couldn’t be confirmed with the U.S. Bankruptcy Court in Harrisburg.The state capital of 49,500 faces a debt burden five times its general-fund budget because of an overhaul and expansion of a trash-to-energy incinerator that doesn’t generate enough revenue. “This was a last resort,’’ Schwartz said in an interview after the council voted 4-3 to seek bankruptcy protection. “They’re at their wits’ end.’’While bankruptcy would mean the loss of state aid under a law passed in June, it would be preferable to a proposed recovery plan, said Councilwoman Susan Brown-Wilson." Well, at least Jefferson County will not have the dubious legacy of being the first muni to push everyone else over. And now that the precedent has been set (yes, Virginia, it can be done) watch as tens if not hundreds of other cash-strapped towns, cities, localities and other entities follow suit promptly to quite promptly.

As often happens the case on up market days, the futures have managed to creep up higher in the overnight session, driven primarily by a rise in the EURUSD. This in turn has been pushed modestly up by the usual rhetoric BS: on one hand EU’s Rehn said there is a fairly good chance of averting a European calamity; on the other hopes for expanded EFSF remain intact as Slovakian leaders ready to meet to lay groundwork for another vote after rejecting bill first time (mind you nothing but hopes). Yet the biggest drive of futures being up is... the outbreak of trade war between China and the US! That's right, an event which in anything but the ultra-short term is disastrous for risk assets as it is nothing short of complete Nash Equilibrium collapse, is pushing ES double digits higher simply because it is forcing the USD lower. As Bloomberg's TJ Marta writes in a note, the USD is down 1 to 2+ standard deviation versus most major currencies overnight after U.S. Senate passed legislation aimed at punishing China for keeping its currency undervalued; GBP/USD +2.0 std. devs., 1.2% overnight; has broken to high since Sept. 19; slow stochastics are rising from oversold levels, supporting continued rally. Only significant correlation during the past 90 days, S&P500, has rallied and supports strength in cross; next technical resistance overnight high and support during July at 1.58, and then 1.59, which held as support  during Feb., March, June. Yet the most important push has been seen in the EURUSD which has done one of ye olde 200 pip moves higher on nothing but hope (because it certainly isn't the third failed Bund auction in a month) and deterioration in the dollar's status, because apparently a collapse in China-US trade relations is beneficial for Europe... So sit back, wait for Barroso to address the parliament expressing his hope for hope for hope, and watch as the EURUSD melts up taking stocks higher with it as China and the US accuse each other of starting the Second Great Depression.

Support is at $1,600/oz, $1,580/oz and below that strong support is seen at the lows reached on September 26th of $1,532.70/oz. Market participants are divided as to whether this is consolidation prior to a resumption of the bull market, whether a further sell off takes place or whether a bear market has commenced. Strong physical demand being seen internationally, but especially in Asia, would suggest that gold may have bottomed and the bull market is set to continue in the traditionally strong autumn and winter months. The fundamental factors that have driven the gold market in recent years - macroeconomic, monetary, systemic and geopolitical risk – also suggest gold’s bull market is set to continue. Geopolitical risk is seen in the bizarre alleged plot by the Iranian revolutionary guard to use a purported Mexican drug dealer to assassinate Saudi Arabia's ambassador to the United States.