Archive - Dec 5, 2011 - Story

While there is no arguing with the strength in Italian bond prices, yield (now less than 6% again), and spreads (cash and CDS) over the last week or so, there is a rather ugly and similar-looking precedent from only five months ago that is making managers nervous. It seems that the hope is this time is different as we remember the three-step reaction to the summer's efforts to bailout the eurozone as fear gave way to hope which inevitably became reality. BTP prices are trading at levels which were viewed as precipitous in the summer and warranted massive intervention (the ECB announcements) and obviously spreads and yields reflect similarly the market reaction to any and every stick-save.

In yet another piece of news that somehow will be seen as largely bullish for risk, if not so bullish for the USPS's 600,000 thousand workers, we learn that the United States Postal Service, long on the verge of insolvency, has decided to take its already snail-pace speed... and make it even slower.

Expectations for ISM Services (services as in the sector that accounts for 70% of US GDP) were for expansion to keep the decoupling dream alive. Unfortunately, those dreams are dashed for now as the data prints its worst level in 23 months. The biggest driver of this drop was the employment sub-index which cliff-dived from 53.3 to 48.9 (a contracting print). The composite manufacturing and services PMI also dropped notably.

In a less than surprising turn of events, last week the ECB "only" bought €3.7 billion in peripheral bonds, which was to be expected considering the Fed announced the global FX liquidity swap rate cut on Wednesday morning providing a quite visible hand to push yields lower at least briefly, so in essence the ECB only had to keep the market up for half the required amount of time. Far more importantly, the total amount of bonds now carried on the ECB's books is €207 billion. This is important, because as readers will recall the ECB failed to sterilize an amount lower than this, or €203.5 billion, last week, with just €194.2 billion in bids submitted. Naturally, with the total cumulative amount increasing every single week, the likelihood of future sterilization failures only gets bigger and bigger. We will find out if the European banks parking a near record amount of cash with the ECB as of today, will result in a second failed sterilization in a row tomorrow and just how favorable the market will approaching this particular latest flashing red light around 7 am Eastern tomorrow.

A week ago, BTIG upgraded MBIA on the same thesis we had noted two months prior. Today, it is AGO's turn, on virtually the same assumptions and the same thesis as MBIA. To wit: "We view Assured Guaranty?s equity as deeply undervalued at current trading levels and anticipate that as the fears that have depressed its share price abate and the viability of its business model becomes more apparent, it will gravitate toward its intrinsic value. Consequently, we believe investors who can appreciate that Assured?s risk profile is overstated, and that its ability to generate profitable new business is understated, could realize outsized returns. We are initiating coverage of Assured Guaranty with a BUY and a $35 price target which is based on a 0.75x multiple of the company?s 2012E year-end stand-alone adjusted per share book value of $48.56. We believe some discount to adjusted book value is appropriate, for while we view the AGO?s portfolio exposures as manageable, they nevertheless present the potential for some loss of value. AGO trades at 0.23x the company?s 3Q11 adjusted per share book value. We believe the market reacted appropriately in providing AGO?s stock with a boost last week after Standard & Poor?s announced that the company would maintain its vital „AA? rating, particularly when the company?s ongoing efforts to boost capital appear to have given the rating staying power. However, we also believe that the stock price does not come close to reflecting what the removal of the rating overhang could mean for AGO as the only currently functioning monoline, and that last week?s price action may presage much larger gains ahead." And while AGO does not have the massive short overhang which could lead to an explosive short squeeze when unleashed, the underlying thesis is quite credible.

We can’t help but feel that we are watching a performance this week.  It feels like the actions, the meetings, and the statements are all very scripted.  It seems reasonably clear which ending they are going for, but many of their actions also fit the “alternative” ending so it remains imperative to be cautious. We will go through the motions of the planned scripts.  Many will shake their heads as the markets respond, but sooner or later (probably sooner), even those who fell for the media blitz will realize nothing is resolved.  The problems are bigger than ever, and we will have to revert to a new plan.  A plan that will have far less ability to contain the problem than it would now, because too many resources will have been wasted again. Any sense that the photo op scene at the end of the week is going to be cut, then get ready for a huge sell-off.  If they cannot create the photo op at the end of this week, we will hit new lows.

Here come the latest headlines from the Sarkozy-Merkel press conference:

• SARKOZY CITES COMPLETE AGREEMENT WITH GERMANY REACHED
• FRANCE, GERMANY SEEK TO PREVENT REPEAT OF CURRENT CRISIS
• FRANCE, GERMANY WANT `NEW TREATY' FOR EU
• AUTOMATIC PENALTIES BACKED FOR BUDGET VIOLATORS, SARKOZY SAYS
• SARKOZY SAYS PREFERENCE IS FOR TREATY AMONG 27 EU COUNTRIES
• PEAN MONETARY FUND BACKED, SARKOZY SA
• EURO BONDS ARE `IN NO CASE' A CRISIS SOLUTION, SARKOZY SAYS

Vice President Joe Biden, now best known for being the man who relies primarily on Jon Corzine for financial advice, continued his recent roll of epic linguistic blunders this morning. As Reuters reports, the VP, "joked during a visit to debt-choked Athens on Monday about bringing money to help Greece out of its deepest financial crisis in decades. Introducing a member of his delegation during a meeting with Greek President Karolos Papoulias, Biden said: "This man represents the Treasury department. He's brought hundreds of millions of dollars." His comments drew laughs from both the Greek and U.S. delegations." It is unclear if the Greeks laughed because the noted number was orders of magnitude less than what would be needed to actually put a dent in the Greek fast-motion train wreck, or because everyone was waiting to see what the American taxpayer's response would be to learn that while America is hopelessly locked in gridlock of releasing more cash to that country's middle class, the US Treasury is quite happy to disburse taxpayer funding to Greece. We are holding out breath to find out.

Just as Europe seems destined to tip into recession and the US growth miracle decouples its reality from perceived global slowdowns, the oil market steps in to balance the equation. With WTI breaking $102 and Brent over $111 this morning, driven by Iran and Syria tensions, it would seem tough for a nation exporting its way to success, that is so dependent on both domestic consumer and energy to grow 'as expected' with energy premia so high - or perhaps the justification is the energy sector will carry the S&P through the next quarter as earnings expectations are cut. Nevertheless, as Reuters points out, the risk of supply disruptions remains high.

While the short answer is "nothing", for those who wish to sound sophisticated in high society or while being interviewed on TV, here is the full breakdown of what to expect from Europe as we head into the latest European "end all, be all....forget all" summit this Friday, as well as the ECB's announcement on Thursday where consensus is for the adoption of dramatic monetary slash and burn practices. In summary from Bank of America: "Overall, because these meetings could fall short of making more concrete steps towards closer integration, they are unlikely to deliver more than a short term rally for markets, in our view, assuming communication is focused on delivering points for integration. Against this backdrop, we are concerned that markets may be somewhat disappointed though expectations may not be very high." Then again, disappointing is the new black, which also happens to be the new Christmas rally.

ISM non-manufacturing index and factory orders.

Even as Italian bonds surged on hopes that the $40 billion Italian austerity plan (putting this to scale, $400 billion in Italian debt has to be refinanced in the next 12 months) proposed by Monti which is supposed to lower the nation's debt load (putting this to scale, Italy has €1.9 trillion in debt), coupled with expectations that this time (we lost track of which one this actually is) the European summit on December 9 will actually achieve something, the liquidity situation, and not just any liquidity but EUR-funded liquidity (the one that the Fed can do nothing to help by lowering the OIS swap rate) deteriorated massively overnight, as European banks deposited a whopping €20 billion in additional cash with the ECB despite the coordinate central bank intervention yesterday. Total deposits are now at €333 billion, just €50 billion short of the all time high hit in June 2010 when Greece failed for the first time and there was no clarity that the Bernanke Put had gone global, implying the need for an eventual Mars bail out. And confirming that the liquidity crunch is now shifting to the local currency, another €7 billion was borrowed from the punitive Marginal Lending Facility. So now what we have is a liquidity crisis that has been confirmed to not be only USD-based but also EUR. Congratulations Fed. Yet since the market is slow in understanding complex things it is surging, as it looks at Italian bonds which as noted earlier are soaring on nothing but hope, it will take a little before this filters to all the right places.

Gold and the dollar are Bank of America Merrill Lynch’s top currency trades for 2012. The second-biggest U.S. bank by assets after JPMorgan Chase & Co. said that investors should buy gold versus the euro as the ECB engages in quantitative easing to contain debt turmoil. David Woo, global head of rates and currencies in New York at the Bank of America Corp. unit, told clients in research note that “the ECB will be buying more government debt and doing QE, so buy gold against the euro.” “The second major theme is U.S. fiscal tightening is about to come and the U.S. economy will slow, and this will be very good for the U.S. dollar.” “The general theme for the year ahead is pretty negative for the risk environment,” Woo said.

• Monti cabinet agrees Italy austerity plans (FT)
• Sarkozy, Merkel kick off week of crisis talks in Paris (Reuters)
• China to prepare for social unrest (FT)
• China to stabilize exports, expand imports amid lackluster global demand (China Daily)
• U.K. banks face higher financing costs (FT)
• Reid Seeks to Break Impasse on Payroll Tax Cuts, Unemployment (BusinessWeek)
• U.K. Economic Growth Forecasts Cut by EEF as Manufacturers See Stagnation (Bloomberg)
• Germans Remain Unflappable During Euro Crisis (Spiegel)
• Wolfgang Munchau: France and Germany look set to fudge it yet again (FT)