Archive - Nov 2011 - Story

As expected the latest spike in the market is on nothing more than a central planner usurping the role of the Fed and making it appear that the Doves are in charge. In this case it is the first Dovish dissenter on the FOMC in years, Chicago Fed's Evans who just petulantly said that he expects the policy rate to stay low for longer than mid-2013. Indeed, the guy who got slapped down by none other than Bernanke forcing him to "dissent" is now making his outlier opinion seem to be fact. That this is identical in credibility to Hoenig saying that he expects the Fed to hike the rate to 4.5% by the end of the year is irrelevant: the market has smelt liquidity blood and is in a frenzy for a few more minutes until the realization that the only variable here, the ECB, has just said it will not monetize.

We discussed the sudden and scary drop in the EUR-USD cross-currency basis swap last week and how it is perhaps a cleaner view of the funding crisis in Europe than the delinquent Libor market. Since our first discussion, the 3 Month EUR-USD basis swap has widened even further - only worse in the heart of the crisis in Q4 2008. As if that was not enough, GDP-weighted European Sovereign risk is back up to its highest levels ever as the clear message from the markets is the ring-fencing and backstopping of sovereigns and financials respectively is simply non-existent.

The following note from JPM's Ken Landon summarizes what, in the aftermath of an ECB which as Yves Mersch just noted, will not intervene in the markets due to the realization that monetization will bring about the 4 horsemen of the apocalypse, is the greatest threat to investors: political instability, manifested either formally in the form of elections, or informally, in the form of occupations, riots, revolutions, civil wars, alien invasions, etc. And of course, to JPM, just like to everyone else threatened by the upcoming end of the status quo, the bad guy suddenly is the ECB, which had made it all too clear since inception it will not monetize debt. Yet somehow now that we are approaching the endgame it appears this was not very clear. So the plan is to shame them into monetizing everything, Weimar flashbacks be damned. To wit: "The ECB does not operate in a political vacuum. It is the only entity that has the capacity to be the lender of last resort in the Eurozone. Without this, the Eurozone does not have much longer to exist. It will implode. With the ECB decidedly on the sideline, investors are reduced to the state of having to read the tea leaves of national politics. For example, today and tomorrow are crucial days for the formation of the Monti-led government in Italy. Will he be given a strong mandate? Even if he is, will the new government be able to come up with a credible plan that investors will have confidence in?... Greece remains a wild card with the main opposition party refusing to sign a declaration of support of the October agreement.  When politics dominate markets and economies, you can be sure that uncertainty will reign and that growth will suffer." So without further ado, here is the complete list of what to look for in the next several months on the all too critical political front, courtesy of UBS.

They are, however, together with Morgan Stanley, Jefferies and all the other banks that have a gag order on Comcast, perfectly hedged... In other news, clueless copy and paste journalists turned financial pundits will still call bottoms.

We will present the following quick note Bloomberg without any commentary because it could well come from any post we ourselves could have written.

ECB Governing Council member Yves Mersch said that monetizing government debts "is tantamount to inflation" and "not feasible." To use inflation to lower the fiscal burden "would reduce incentives for governments" to tackle their debt burdens and "would raise the risks of even higher future inflation and greater output volatility. Uncontrollable wage-price spirals would be likely." Mersch said in a speech in Frankfurt today. He also added that you can not make the ECB as a "lender of last resort for governments" and that governments must live up to own responsibilities.

And scene.

“Asset Swaps” make it more difficult for banks to sell. Banks will often buy a fixed rate bond and enter into an interest rate swap to “effectively” turn it into a floating rate asset.  It should come as no surprise that banks that rely the most on rolling over short term debt are the ones most likely to asset swap bonds – yes the “weak” banks are the ones that hold bonds in this form.Asset swaps work fine so long as the underlying bond never becomes a “credit” problem.  So long as it moves more in line with rates than with credit it is a sensible strategy.  As Italy and Spain have become credit problems, they are no longer moving with rates, and these positions are adding to the problem.

So with Europe threatening to bury the world again, here is today's "decoupling" attempt to pull the world out by the bootstraps courtesy of the US with what is naturally better than expected data, just like China last week.

• US Empire Manufatruing (Nov) M/M 0.61 vs. Exp. -2.00 (Prev. -8.48), above zero for the first time since May; Prices Paid Index lowest since Novembever 09 at 18.29 down from +22.47 in Oct  - source
• US Advance Retail Sales (Oct) M/M 0.5% vs. Exp. 0.3% (Prev. 1.1%), ex Autos +0.6% - source
• US PPI ex-Food & Energy (Oct) M/M 0.0% vs. Exp. 0.1% (Prev. 0.2%) - source
• US PPI (Oct) M/M -0.3% vs. Exp. -0.1% (Prev. 0.8%)  - source

Europe entering recession, China stagflating, and the US soaring. Rrrrright. And now, back to the European meltdown.

Remember how prohibiting the use of naked sovereign CDS was supposed to make the CDS market tame as a docile lamb? Well, as it turns out, the bulk of the marginal moves were not CDS driven, but simply basis traders putting on, and taking off hedges. Ignoring the fact that many desks have experienced "Boaz Weinstein" like events in the past month (perhaps even Mr. Basis "$4.7 billion AUM" Trade himself), it seems that CDS is now simply tracking moves in cash. And those moves, if you are France, are not pretty. As the chart below shows, French CDS have just hit 88 MPH and are about to go back to a calmer, more peacful time, when everyone could buy and sell stuff using the French Franc...

Paulson & Co. sold a third of the their SPDR holding which is quite a large liquidation. However, Paulson remains bullish on gold as was seen in positive comments he made recently so it would seem likely that this sale may have been an effort to raise cash after his fund suffered sharp losses in the last quarter. Some hedge funds sold the ETF to cover losses during a rout that erased $7.8 trillion from the value of global equities since May. Soros Fund Management LLC held 48,350 in the SPDR Gold Trust as of Sept. 30, compared with 42,800 shares at the end of the second quarter. The increase in Soros gold holdings are meager at some $10 million worth but suggest that Soros is not as bearish on gold as the multitude of news headlines, regarding his comments regarding gold being “the ultimate asset bubble”, would suggest. Soros added 145,000 call options and 120,000 puts in SPDR Gold in the third quarter. This confirms that Soros is not as bearish on gold as some would have us believe. There is also the real possibility that Soros’ fund, like other hedge funds, may have opted to own allocated bullion rather than a gold trust. Some hedge funds have opted for allocated gold bullion due to it being more discreet with a lack of disclosure (no quarterly filings), due to the lower long term costs and due to allocated accounts having less counter party risk than a trust with many indemnifications. Steven Cohen’s SAC Capital Advisors LP and New York- based Touradji Capital Management LP established gold positions in the third quarter. SAC Capital, which manages $14 billion and is based in Stamford, Connecticut, held 184,601 shares in the SPDR Gold Trust as of Sept. 30. Paul Touradji had 45,000 shares compared with none on June 30, the filings show.

• Debt turmoil and political uncertainty in Spain and Italy witnessed widening of the Spanish/German and Italian/German 10-year government bond yield spreads, despite decent T-Bill auctions from Spain. Also, yield on the Italian 10-year government bond breached the key 7% level to the upside
• According to the ZEW, there will be at least one negative quarter in Germany, most likely in Q1 2012
• BoE's King said he expects inflation to fall back sharply in the next 6 months, and will reach around the BoE’s target by the end of 2012
• SNB’s Jordan said that the SNB would act if the economic outlook and deflation trends demand

In addition to the usual headline barrage from a broke continent, the first of many, we have a very busy data schedule, highlighted by October retail sales.

• Monti faces resistance on cabinet as market honeymoon turns sour (Bloomberg)
• Papademos urges Greece to commit to bail-out terms (FT)
• New York police evict anti-Wall Street protesters (Reuters)
• Power price hike looms in China amid plants' whopping losses (Xinhua)
• Scalia and Thomas dine with healthcare law challengers as court takes case (LA Times)
• Loan Backer's Cash Runs Low (WSJ)
• UBS names Ermotti CEO to reassure investors (Reuters)
• IMF warns on Chinese financial system (FT)
• Risks may blunt tough U.S. talk on China (Reuters)

ECB is back to playing Whack-a-mole. Just as BTPs seemed poised to collapse to new all time records, and yields reenter the stratosphere, the ECB stepped in aggressively bringing the yield to just under 7%, at 6.996% last, however briefly. The problem, as pointed out previously, is that now the vigilantes will simply focus on those bonds where the ECB can not spoil the party. Such as France. French OATs just hit a fresh all record yield, and low price as technocratic NWO is scrambling to find a third Mario, who just so happens to be is a Goldman and Fed alum, to take over Sarko and head France.

It took Europe two days to go from fixed to fully broken all over again. Those curious why they are waking up to a see of red, Italian 10 Year yields back over 7%, stock futures tumbling, the EUR/$ sliding, Italian, French and Belgian CDS at fresh records, and a record scramble for Bund short-dated bonds (2 Year under 0.030%) is due to two main things: a failed Spanish auction now that contagion is back to sleepy Iberia, which sold €3.2 billion of bills, below the €3.5 billion target, with the yield soaring to 5.02% from 3.61% at Oct. auction leading to Spanish 2-, 10-yr yield spreads to Germany both significantly wider to records.  The second main factor is the realization that Mario Monti is not the second coming and will in fact face major resistance to form a government. Bloomberg reports: "Monti, a former European Union competition commissioner, struggled to get political parties to agree to participate in his so-called technical Cabinet during talks in Rome yesterday. A government lacking political representation will find it harder to muster support from the parties in parliament to pass unpopular laws. Monti said he’ll conclude his talks today." And if Monti can't do it, nobody can. Which explains why the fulcrum European security, the Italian 10 year BTPs, just fell off a cliff, and is now yielding back over 7% at a euro price of under 85 cents. This could well be crunch time: there are no more magic rabbits in the hat, or deus ex prime minister resignations in the hat for Italy.