Archive - Nov 13, 2011 - Story

Back in May we penned, "Why A Hedge Fund Comprised Of Junior Congressional Democrats Should Outperform The Market By 9%" in which the simple conclusion was that insider trading is not only rampant in Congress, but completely unregulated, as it is perfectly legal for Congressional staffers to trade at their leisure on inside information: an exemption which the beta chasing 2 and 20 crowd on Wall Street would sell their first through fifth born to be granted, now that their glaring inability to generate alpha is laid out for all to see. Tonight we were happy to see that 60 Minutes has finally brought this gross and criminal injustice to the general public, and we expect that Congress will promptly legislate itself into actually complying with laws meant for the mere mortals out there. That said, we fully commiserate with the pathological excrement that makes up House of Representative these days: it is indeed a sad day when a Congressional member has to rely on honest work to make their millions as opposed to perfectly legal trading on inside information predicated upon laws that these very congress men and women legislate. Something tells us all the world's banana republics are just staring at the US with sheer and utter amazement as layer after layer of the unprecedented depravity of American society is exposed for all to see.

The last time Whitney Tilson presented his "investing thesis" case in public, he got promptly anihilated as was to be expected - there is a reason why real hedge funds keep their positions secret. This time, "it will be different." Incidentally, it is not a hedge fund manager's job, no matter how tiny said hedge fund is, to plea to the broad investing public: it makes one appear like a petulant child. Their job is to outperform the S&P since inception: a task T2 still seems to find daunting...

When dealing with the daily barrage of headlines from Europe, it is easy to get lost in the trees and forget what the forest looks like. That's perfectly understandable - after all, it is precisely the intention of the Eurocrats to confound everyone with noise, so any track of the fact that the big picture is unfixable is if not lost then promptly forgotten, with reactionary newsflow dominating the flawed decision-making process. Luckily, the fact remains that no matter what, no matter the scale of lies out of Europe, the problem still remains: the math just does not make any sense. Conveniently reminding us precisely of this, we present to our readers the must read presentation by Swiss private bank Pictet titled "Decision time for monetary union" which puts the forest right back into focus, and explains why all attempts to kick the can down the street will be met with a prompt and furious response by the bond vigilante crowd, which has now officially been thawed out of cryogenic stasis. Because, all noise aside, the Eurozone has two options - continue the current course which is catastrophic: "Current response to the crisis has created conditions leading the euro area towards depression" or accept the reality and do something about it, yet "things are going to get worse before European authorities decide to wheel out their heavy artillery." Said otherwise: lose-lose. So without further ado, let's dig in...

UPDATE: TSYs just opened (after being closed Friday) with a 4-7bps bear steepener and 2s10s30s rising 8bps. ES is pretty much in line with CONTEXT at 1269 now all the risk drivers are open.

As EURUSD toys with 1.38 and AUD outperforms, the USD is leaking lower (-0.2%) from Friday (after closing the week almost perfectly unchanged Friday-to-Friday). Gold and Oil appear to be basking in the glow of increased macro and geopolitical tensions as $1795 and $99.50 (respectively) have already been broken this evening. It appears Silver and Gold are tracking each other as Oil follows the USD and Copper is the major outperformer so far (in early trading).

In yet another accounting error (or not), a sovereign nation accidentally missed a large amount of debt that it owed. Bloomberg (via The Economic Observer) is citing data from Beijing Fost Economic Consulting that ~3tn yuan ($473bn) of debt in township governments was not included in China's National Audit Office reports. This is not a drop in the ocean as it raises the local government debt load by around 30% and represents debt in vehicle financings and bank loans. Of course, we should remain calm and walk (not run) to the exits as GDP, inflation, and whichever macro data point you choose that has subliminally met expectations recently is completely accurate - have no fear.

Looking ahead in the upcoming week, markets will likely scrutinise the first steps of the new Greek and Italian governments. The appointment of key cabinet positions will be of relevance to establish credibility. However, it may be a bit too early for the first concrete policy steps. Beyond politics, three themes dominate the data schedule. First, there is a raft of Q3 GDP releases in Europe (Germany, France, Eurozone, Hungary, Poland, Czech Republic). The numbers will likely still be mixed with more uniform weakness expected in the Q4 numbers. Second, we will see the beginning of the monthly survey season with the US Empire and Philly Fed releases. Finally, there is a raft of Fed speakers scheduled to talk about the economy and Fed policy. Less thematic but also relevant are retail sales numbers in the UK and the US. Of course, we will have a look at the monthly TIC numbers to gauge the capital flow pressures for the Dollar.

Not on even a Sunday is the headline barrage over:

• MARIO MONTI ASKED TO FORM NEW ITALIAN GOVERNMENT
• MONTI TO MAKE COMMENTS AFTER ACCEPTING OFFER TO LEAD ITALY
• MARIO MONTI THANKS NAPOLITANO FOR OFFER TO FORM GOVERNMENT
• MARIO MONTI SAYS ITALY MUST BE PROTAGONIST IN EUROPE
• MARIO MONTI SAYS HE'LL ACT TO SAVE ITALY FROM CRISIS

And so the international advisor to Goldman Sachs drones on. In the meantime, the €300 billion in BTP sales is set to resume in just over 13 hours.

Over the weekend we get a historic, and peaceful, overthrow of a 17 year ruler (Italian at that), an event that is supposed to make everything better, and all the EURUSD can achieve is a meager 30 pip push higher in the first minutes of FX trade resumption? Is the market, perhaps, skeptical for once?

There is one simple rule for investors: avoid all things beginning with “Euro-”. Eurotunnel ended in bankruptcy. Eurodisney was a disaster for public shareholders. And so the Euro itself is following the same path. European politicians are faced with one problem: none of their plans to end Europe’s debt crisis has worked. Absolutely nothing. Which is not that surprising – since when does adding debt solve a debt problem? Fishing in Lake Acronym yielded only meager catches like SGP (“Stability and Growth Programme”, a paradox), SMP (“Securities Market Programme”, which has less to do with market than with manipulation), and, finally, the bazooka: the EFSF (European Financial Stability Facility). “Stability” sounds good, and “Facility” leaves the uninitiated in the dark as to whether this is another debt pyramid and who will ultimately foot the bill. The idea behind the EFSF must be so good the agency wants to keep it to itself and prefers not to shed light on the mechanism behind it. Based on leaked drafts and comments in the press it could look like this.

One of the last remaining Germans at the ECB, Jens Weidmann, gave an interview to the FT earlier today, in which the president of the Bundesbank, shared some pragmatic responses to questions about the depths of ECB intervention in the capital markets. The man who on Tuesday clinically stated explicitly that the "ECB can't print money to finance public debt" (to which he adds today that "this is a very fundamental issue. If we now overstep that mandate, we call into question our own independence"... odd, never prevented the Fed from questioning its own independence), follows up with some much needed clarity on just where the ECB sees itself in the coming weeks and months, touches on the rumor that sent stocks surging on Friday, namely that it would proceed to fix interest rates (it won't), and shares some rather amusing observations on the recent revelation that the ECB has become a weapon of political (de)stabilization: after all it took the ECB's bond buying program - the SMP - just two days of not buying Italian bonds for Silvio Berlusconi to resign after BTPs hit an all time rock bottom price. Yet the most amusing slap in the face of the Eurocrats is precisely what we mock every single day, namely the perpetually changing nature of the EFSF on a day to day basis, confirming the cluelessness of the continent's leaders, and which has cost Europe all credibility in the face of capital markets, explaining why the EFSF has to resort to not only buying its own bonds, but issuing terse statements denying anything and everything: "EU governments have decided how to finance the EFSF. They agreed on guarantees for the EFSF and, in their last meeting, on two options on how to leverage the EFSF – by an insurance model or a special purpose vehicle. Instead of working on implementing these approaches, we now have the next idea that is completely out of the realm of what has been discussed previously. I don’t think it builds confidence in crisis resolution capabilities if from week to week, from one meeting to the next, you are questioning your last decision."

If there is one thing one can say about the insolvent European continent is that despite everything, it is a bastion of truth, and a knight of see-thru disclosure. After all, who can forget such brutally honest statements as "Greece will not default", or the follow ups: "Ireland is not Greece", "Portugal is not Ireland", "Spain is not Portugal", "Italy is fine", "Italy has turned down money from the IMF", "The IMF has never offered any money to Italy", and then the old standbys, "the ECB will not be a lender of last resort", "the EFSF will use 4-5x leverage", wait, make that "the EFSF will use 3-4x leverage", and last but not least, "Europe is not America" and "it is all the fault of evil CDS speculators." Well we have one more to add to the list: "the EFSF is not an illegal ponzi scheme" - because after the mindboggling report in the Telegraph yesterday that the EFSF has bought hundreds of millions of its own bonds, exposing the scam in the heart of the Eurozone for anyone to see, the European rescuer of last resort (at least until the ECB comes out monetizing and Eurobonds are issued)has no choice but to join in the parade of truths and as Reuters reports "said on Sunday that it did not buy its own bonds last week, denying a British newspaper report that it spent more than 100 million euros ($137 million) to cover a shortfall of demand. "The EFSF did not buy its own bonds and the book was 3 billion euros," an EFSF spokesman said, referring to the 3 billion euros raised in last Monday's 10-year bond issue." We are certain that in order to dispel rumors about its fraud-i-ness, the EFSF will promptly submit a full breakdown of the entities that received bond allocations (we know that Japan is good for €300 million, that China is good for €0.0, and that as Merkel said one week ago, "hardly any countries in G20 have said they will participate in the EFSF." So, because we believe everything that comes out of Europe, we are patiently waiting to see just who it was that bought EFSF bonds when nobody else did. And yet what is most troubling to us, is that it took the world 5 minutes to completely agree that the EFSF is a ponzi scheme, with nobody doubting this supposedly "refuted" disclosure for even a second. Perhaps that tells you more about the current state of Europe than anything else...

UPDATE: EFSF is denying it bought its own bonds. We suspect semantics as the denial is very specifically worded and EIB or ECB involvement is possible and frankly just as incredible. Perhaps the ECB really is the lender of ONLY resort.

We earlier discussed the desperate actions that occurred surrounding the EFSF self-aggrandizement this week and Peter Tchir, of TF Market Advisors, notes that the whole situation was bizarre and is becoming more and more Enronesque every day. But the lack of demand for EFSF debt is simply, as we have repeatedly pointed out, a factor of their own design and a symptom of the actions that a bloated lobbying IIF and the feckless politicians have taken. One of the obvious consequences of the EU and IIF decision to pursue this restructuring is they cannot fully rely on CDS, and markets will treat net exposure numbers with skepticism.

So banks will sell bonds/loans and unwind their CDS positions and manage their exposure the old fashioned way, by adding or reducing to their bond/loan position. That impact seemed obvious to everyone other than the EU and IIF. So the pseudo-private money (EU banks, EU pension funds, and EU insurance companies) are reluctant to buy EFSF bonds because they already have too much sovereign exposure, and the EU is likely to force "voluntary" changes on EFSF debt before it would on actual outright sovereign debt.  Real private money is confused by the structure. Who does that leave?  Only sovereign wealth funds and other supra-national entities.

EFSF is the bond only a mother could love.

The 'tragedy of the commons' or 'free-rider' dilemma of game theoretical cocktail parties is a great framework for considering the current tug-of-war between individual sovereign fiscal actions among the European Union and the over-arching monetary policy of the ECB. If the ECB is dovish and too many states decide to suckle on the teat of liquidity - as opposed to fiscally 'behave' - then everyone loses (as we see currently evolving). The lack of any Nash (stable and dominant) equilibrium among the European nations and their hoped-for benefactor is becoming increasingly problematic for both trading and business investment.

Nomura's Global Macro Strategy group tackle the problem that is now abundantly clear, the euro area as currently constructed is not stable and so it will have to change (hence, the Euro is dead!). The direction of travel is being set out by northern European politicians and is worth noting – more Union not less. But two points are critical to note; first that the new euro area may be so different from the one the current members signed up to as to make a process of voluntary re-application for euro stage II necessary to determine future membership, and second that any new variable geometry euro will take a long period of time to set up. How then to cover the intervening period?

Without credible pre-commitment on the part of either the ECB or the fiscal authorities, the game framework indicates either a loss of independence for the ECB under substantial political pressure to shift unilaterally to the dove camp or EFSF/IMF assistance and the pooling of fiscal risks against the backdrop of a political agenda for a new euro area.