Archive - Dec 29, 2011 - Story

It seems that it is not just the Europeans that are USD cash starved heading into year-end as the Swiss and Japanese gorged themselves on two-week maturity FX swap lines during the last week. The total outstanding under the Federal Reserve's USDollar Liquidity Swap Operations jumped from $62.599bn to $99.823bn - or more than 59% during the week ending 12/28. Admittedly, the size of the additional Swiss draw-down, $320mm more compared to $75mm the previous week, is a drop in the bucket compared to the ECB's additional $33bn this week. However, the more-than-$9bn additional draw-down by the Bank of Japan perhaps helps explain why USD-JPY cross-currency basis swaps eased so much this week (as the desperate need for USD through this counterparty-risk-exposed form of funding reduced by around 12bps or more than 25%). Perhaps it is time to take a closer look at some of the Japanese banks as while the stigma of borrowing from these lines is talked down, clearly there are funding/liquidity needs that are rising dramatically.

The volatility of today is nothing more than a fight between the active perceptions of participants trying to maximize self-interest within the classical, traditional concept of a free economy, and the opposing forces of overlordship of the landed economic elite, trying to get the uninitiated to simply follow orders.  The elite really believes that if everyone would gladly pile on even more debt and spend with reckless abandon, the Great Moderation would once again be within reach.  Consumers should only stop thinking for and of themselves since common sense is dangerous to the controlled economic system.  To get more debt “flowing” requires active price manipulation to make the world seem like it will be better in the near future so that people will start acting like it... That is both the opportunity and danger of a system reaching its logical end.  Put another way, there is a growing realization that while free markets are messy and somewhat unstable, central planning is not really a cure for those symptoms.  In fact, it has created more harm ($13 trillion in debt is only US households) than good, more illusion than solid results.  Volatility means that the free market is at least attempting to impose itself at the expense of central planning’s soft financial repression and control.  By no means is such a beneficial outcome assured; rather the other half of all this volatility (the risk-on days) is the status quo desperately trying to hang on through any and all means (even those less than legal, like bailing out Europe through cheapened dollar swaps). 

If one had to summarize 2011 in one sentence, it probably would be: "a year in which the market ended unchanged, in which the world got within seconds of global coordinated bankruptcy, and in which central planning finally took over everything." Simple. On the other hand, conveying a comparably concise message full of hope and despair at the same time, using charts would actually be slightly more problematic. But not for the Economist, which has managed to do just that, however not in one but nine discrete charts. Here is what they did.

As headline-makers from every mainstream media outlet attempt to fit today's spectacle to their cognitive biases, we note the massive surge in volume at the close in ES (the e-mini S&P futures contract). Financials closed at the highs of the day and stocks managed to retrace almost all of yesterday's drop (with seemingly everyone waiting for the ETF-moment at the end to transact?). We noted the disconnect earlier (and potential QE chatter) and while the break between TSYs and the synced USD-down-ES-up was incredible, the 5.5% rally in Silver off its earlier lows was none too shabby as Gold also managed to get back to $1550 (as the Gold/Silver ratio reverted to its 55x 'stable' ratio of the last two weeks). Investment Grade credit outperformed high yield and stocks today (not exactly a bullish risk-hungry indication) managing to close tighter than Tuesday's close even as HYG (our trusty high yield bond ETF) shrugged off a little more of its NAV premium and underperformed all afternoon as the equity ebullience struck.

At this point the weekly ICI fund flow update, showing the barrage of redemption requests no matter what the market does, is a moot point, but we will do it anyway: in the week ended December 21, when the market was doing its usual Santa rally antigravitational acrobatics and rising on the now denied hope that the European LTRO would be the Hail Mary pass of 2011, investors in domestic equity mutual funds pulled another $2.7 billion, leaving funds with even less dry powder, with even less ability to lever up, and with an even lower margin of error to any sharp pull backs in stocks. To date, and with just one week left in, investors have withdrawn a whopping $135 billion from equity mutual funds, which we are 100% certain is an all time record for any year in which the S&P closed even nominally positive for the year, proving that nobody believes this farce known as a market any longer. But we all know that... In further detail, investors withdrew funds for 34 of 35 consecutive weeks, have withdrawn $19 billion in the past month alone, and their flows show no indication of any sort of market correlation any longer, indicating that no matter how high the "powers that be" push stocks, retail no longer cares, and will not chase "performance" especially when said performance is 100% fraud and manipulation.

Our earlier discussion of the relationship between ECB and Fed balance sheets as the driver of risk correlations this year seems particularly timely as we are seeing quite notable divergences among US asset classes and FX flows today. EUR is now up relative to the USD on the day (DXY is down and tracking stocks higher), Treasury yields are falling fast and the curve flattening (2s10s30s dropping rapidly) and Silver is rallying hard off its lows (Gold perhaps being held back for now by collateral/cash/redemption calls for now). Oil is back green for the week also. Is the market starting to comprehend that the non-QE of the ECB's LTRO and SMP is in fact QE and implies the currency wars just went to 11 - forcing the Fed's hand?

While the language, so far, of the new fiscal compact for the European Union remains wishy-washy at best and outright useless from an enforceability perspective at worst, we thought it instructive to take a look at just where we stand within the existing 'old' fiscal compact. The Wall Street Journal's interactive charts has an excellent example of the disappointing state of the union and the likelihood that anything new will change anything at all. Presented with little comment -12 of the 17 member nations currently have annual budget deficits that exceed the existing (and new) fiscal compact's 3% of GDP rule (including FrAAAnce) and the data is not all in yet obnviously!

European markets are thin this week, thinner even that in the US from what we see in credit runs and equity volumes, but today saw a notable divergence between credit (sovereign, financial, and corporate) and equity markets continue. The broad BE500 equity index (of European stocks) rose majestically in the European afternoon (after US day session began), ending the day nicely positive, while spreads were wider in every category. Financials were the worst performers in European credit as they didn't see any bid into the close even as investment grade and crossover credit rallied modestly. There are a lot of divergences (and breakdowns in correlation) occurring in and across asset-classes as we see EURUSD weaken - unch now on the day (weak auctions, macro data, or market recognition of ECB QE that is not QE occurring), Gold down (because the dollar is up? liquidation/collateral/cash needs?), Stocks up (QE that is not QE again?), Corp and financial credit wider (nothing is solved and QE does not help a spread-based not currency-based numeraire), Sovereigns wider (nothing is solved and even ECB buying is not working now). Its always tricky to read too much into Christmas week trading - low volumes, high marginal impact, and year-end rotations and window-dressing (cash management), but the trend in risk assets overall seems to be lower not higher, no matter how you squint at it (even though last year's opening-day rampfest is fresh in most people's memories).

Taiwan imports 99 percent of its energy, which is vital to its rapidly industrializing economy. The island nation's electricity demand was recently growing at almost 5 percent per year, but this is slowing to about 3.3 percent per annum to 2013. Nuclear power has been a significant part of the electricity supply for two decades and now provides 17 percent of the country's overall energy needs. But this has come at a potential cost. The country's three nuclear power plants (NPPs) comprise four General Electric boiling water reactors and two Westinghouse pressurized water reactors. Taiwan's three existing nuclear plants and a fourth, the one now under construction, are located in earthquake-prone regions near the sea. Encumbent and opposition party politicians are outdoing one another in their energy supply goals, promising to shut down all of these nuclear sites by 2025. Therefore, the only remaining question is whether the South China Sea's notorious weather patterns will remain benign over the next 14 years. If not, according to Wang To-far, economics professor at National Taipei University, "if a level-seven nuclear crisis were to happen in Taiwan, it would destroy the nation."

In an interesting history, today's WSJ points to a closed-door meeting in Washington on April 14th of this year as the moment that the attempts to 'save' Europe began to unravel. The player at the center of the debacle - one Dominique Strauss-Kahn - was pressing for more 'help' from Europe or else the IMF would not deliver more magic-money to the Greeks. The ultimatum drove a wedge between many competing camps over who should be on the hook for more or less of the money required to save this tiny sovereign. Critically, as we have pointed out again and again, it is not (in this case) size that matters, but the precedent that a nation leaving the socialist construct of the Euro 'breaks' the union and the WSJ weaves a torrid tale of this increasing tension and DSK's catalytic impact and timely 'dismissal' from the process. Furthermore, the clear 'dithering' they describe among these so-called leaders offers insights into what we can expect going forward as a new fiscal compact (same as the old one) begins to emerge with mid-March hard Greek deadlines looming fast.

If there is one stance that can gather non-partisan support, it's "tax the rich." If we look at tax revenues and income in a practical way, we find "tax the rich" will not close the widening $1.5 trillion gap between Federal revenues and spending. Clearly, $1.5 trillion annual Federal deficits to fund the Status Quo--fully 10% of the nation's GDP--is unsustainable. Eventually, the ad hoc "solutions" currently being pushed by the Federal Reserve--zero interest rates to keep borrowing costs artificially low and money-printing operations that buy Treasury debt--will encounter political and/or market pressures which will limit the marginal effectiveness of these interventions, and the real cost of these historically unprecedented deficits will trigger a host of unintended consequences--all negative.  How about those soaring corporate profits? If we taxed 100% of the $1.5 trillion corporate profits, then we could close the $1.5 trillion budget deficit. But then Wall Street would have nothing to support those sky-high stock valuations.

Yet another set of macro data that will keep 'em guessing as Oil inventories rose more than expected and the Kansas City Fed's Manufacturing index dropped to 28 month lows and went negative for the first time in two years. Oil inventories rose significantly (and WTI drops below $99) bucking the notable seasonal trend (and missed expectations dramatically). These two combined to be enough to take the edge off the rally in stocks and pull ES (the e-mini S&P futures contract) back to its VWAP.

The primarily sovereign credit crunch in Europe, which has resulted in part due to the ECB's disastrous, and since reversed decision just like in 2008, to hike rates early in the year, only to go ahead and not only cut but expand its balance sheet by a record EUR 800 billion in the past six months, has finally started trickling down to the corporate, and more importantly financial levels, where as was just reported today, the broadest monetary aggregate, the M3, rose by a only 2.0% in November, dropping by a whopping 60 bps from October (keep in mind this is a huge amount on a number that is in the tens of trillions), which happened to be the biggest annualized contraction change since 2009. What is worse, and what confirms that the daily "near default" state Europe finds itself in every single day has sent shockwaves of uncertainty around the continent, is that the loans to private businesses grew at just a 1.7% rate in November, a plunge from October's 2.7% and missing expectations of 2.6% by a wide margin. Said otherwise, corporate credit (far more important than its sovereign equivalent) is being turned off. And as has been widely discussed without credit flowing, there is not only no growth, but the threat of imminent economic depression. Lastly, that this has happened even as the ECB's balance sheet has risen from EUR 1.9 trillion to $2.7 trillion in 6 months is truly humiliating from Trichet as none of the money he injected into the banks has made it to the broader public, and instead all has been used to prop up Europe's failing banks, something we know all too well here in the US.

Now that we have had a day to digest the move from yesterday, we go to the only voice in the market worth listening to, that of Art Cashin. Not surprisingly, he doesn' tell us anything we did not already report or know, but good to hear the confirmation nonetheless.

"Not many market participants will lament the passing of 2011" is how Goldman starts a brief note today looking back at a year full of adverse shocks in order to judge the year-ahead's potential to destroy forecaster's perspectives. The 'shocks' as well as the known unknowns are summarized effectively as the experience of 2011 suggests that the global economy remains at a delicate juncture as we head into 2012. They note that by definition, shocks are unpredictable. But slowing growth (and in places outright contraction), public sector cuts, and a renegotiation of the social compact between state and society in different parts of the world is an environment ripe for political turmoil, and this may well be a source of more shocks as the year progresses.