Archive - Jul 17, 2011 - Story

And we thought we were harsh on the EBA's second farce of so-called 'stress tests'. Enter SocGen's Hank Calenti and team: "The test does not reflect current reality, in our view; even if GIIPS sovereign are further stressed within this test, a €22bn shortfall and a relatively healthy average 6.2% core Tier 1 appear. The European banking sector is captive to politics at the moment. A political error can trigger a freeze in money markets, and a liquidity crisis could quickly turn into a solvency crisis. Only improved governance would avoid such a nasty scenario." We wonder what Calenti would say about the US in this case...

Next week is light on data, thus developments in the European and US fiscal tensions are likely to remain high on the agenda. The Eurogroup heads of state will meet on Thursday to discuss European financial stability and further aid for Greece. Expectations are for an increase in the Greek financial rescue package, alongside some form of voluntary ‘bail in’ for holders of Greek debt. More comprehensive solutions to stem contagion risk, such as secondary market purchases of EMU government bonds by the EFSF, are said to be also on the cards, but uncertainty is very large. Ahead of the statement resulting from the summit, the market may remain caught in the headlights of headline risk. Discussions over raising the debt ceiling in the US will continue. On the data front, the business surveys will be key to watch. Towards the end of the week the HSBC flash PMI for China, the Euroland flash PMIs and the Philadelphia Fed Survey will all be published. The Euroland surveys are expected to decline slightly, but the Philadelphia Fed survey is expected to rise although our forecast is for a notably smaller rise than that of the consensus.

With the market's attention over the past year exclusively focused on bank holdings of insolvent European sovereign debt, which as is now well known had been declining for months, many if not all forgot that banks also have credit exposure via far simpler conduits: retail and commercial debt. And as an analysis of the full disclosure in the EBA's second stress test exposes, banks are on the hook for literally trillions in various plain-vanilla commercial and retail loans to individuals and businesses. WSJ's David Enrich summarizes it best: "Friday's test results shed light on another potential problem for Europe's banks: huge piles of residential mortgages, small-business loans, corporate debt and commercial real-estate loans to institutions and individuals from ailing countries. As those economies struggle, the odds of rising defaults grow." Oops.

From Friday: "The Treasury may be ceasing the incremental funding for its market
manipulative ESF.... but not quite yet. Presenting the E-mini surge on absolutely no
volume. According to Chicago floor traders, at least one bank bought
150 S&P contracts at very the close with one obvious purpose: ramp
the stock market into the weekend. Luckily, for the observant ones this
is merely another free money opportunity: the ES-RISK spread just soared
and presents the latest compression opportunity." As of a few minutes ago, the free money opportunity, courtesy of Brian Sack and the now legendary stupidity of momentum chasers (yes, we'll gladly take their money) has just been cashed in, and brings us to n out of n profitable ES-Spread compressions.

Over time many have wondered why the ECB, in order to "extend and pretend", does not simply do an episode of QE and monetize bonds outright? Well, in addition to Germany's flashbacks to hyperinflation which have so far kept Trichet from pursuing an all too aggressive bond buyback program in the primary market, the ECB does have the Securities Market Programme (SMP) which however since inception has bought only €74 billion (this week the number is expected to rise, or, if it doesn't, it confirms that now China is directly buying European bonds in the secondary market). The problem with the SMP is that it was conceived as a modest marginal debt buying program, never intended to surpass much more than a few dozen billion in debt. Alas, by now it is becoming all too clear that the ECB will need to monetize hundreds of billions of insolvent PIIGS debt in order to extend and pretend forcefully enough so that a new bailout is not needed every other week. But how to do it without monetizing debt on the ECB's books? Enter the EFSF, or the off-balance sheet CDO "at the heart of the eurozone" which according to the latest iteration of the European rescue package (Remember that most recent DOA plan to rollover debt? Yep - that's dead) is precisely the mechanism by which Europe's own open market QE is about to take place. "European Central Bank Executive Board member Lorenzo Bini Smaghi suggested the EFSF be allowed to provide funds for a buy-back of bonds from the market, where prices have in some cases fallen 50 percent from levels at which the debt was issued. "This would allow the private sector to sell bonds at market prices, which are currently below nominal value. At the same time, the public sector could benefit monetarily," Bini Smaghi told Sunday's To Vima newspaper in an interview." Translated: another market clearing perversion courtesy of the same structured finance abominations that brought us here. The problem, unfortunately, is that Moody's announced nearly two and a half years ago that the whole distressed debt buyback approach is... a dead end, and will lead to the same "event of default" outcome that all the prior bailout plans would have achieved as well (we correctly surmised that Bailout #2 was DOA, about a month before the "efficient" market did). Here is why.

Someone is very, very nervous in Europe as it took precisely zero time for the various CHF crosses to plunge to all time lows. The chart below shows the EURCHF which just opened about 140 pips lower than the Friday close. And while there is little if any movement in the crap currencies, i.e. the USD and the EUR, the flight to fiat safety has never been as profound. Since the CHF is a direct proxy of gold in the commodities space, look for gold to take out $1,600 as early as a few hours from now when the market reopens. Also, expect a possible SNB intervention any minute as the Reuters IFR article below speculates.

One look at the most recent naval update maps shows that in addition to global insolvency (courtesy of the broke European dominoes and a potentially technically broke US), a UK on the verge of a parliamentary scandal courtesy of a media baron whose empire is crumbling, and not to mention yet another downward inflection point in the global economic slowdown courtesy of the end of QE2 and no replacement yet, market watchers may have to start factoring in geopolitical risk yet again. While the fact that Syria, Yemen, Egypt, Tunisia, and now Turkey, are ever more increasingly on edge is apparently something Mr. Market has managed to internalize, when it comes to geopolitics everyone stops to listen when renewed Iran-Israel rumblings reappear. Which may just be the case. As the most recently updated naval map from Stratfor demonstrates, the CVN 77 G.H.W. Bush has just entered the Persian Gulf, the first time a US aircraft carrier has passed through the Straits of Hormuz in months. What is also notable is that the LHD 5 Bataan amphibious warfare ship has just weighed anchor right next to Libya: this is odd since the coast of Tripoli had been left unattended for many weeks by US attack ships. And topping it all off is that a third aircraft carrier, the CVN 73, is sailing west from the South China seas, potentially with a target next to CVN 76 Ronald Reagan which is the second carrier in the Straits of Hormuz area. Three carriers in proximity to Iran would be extremely troubling, yet fit perfectly with the story of CIA veteran Robert Baer, the man played by George Clooney in Syriana, who as Al Jazeera reports, appeared on KPFK Los Angeles, warning that Israeli PM Netanyahu is "likely to ignite a war with Iran in the very near future." It gets worse: "Masters asked Baer why the US military is not mobilising to stop this war from happening. Baer responded that the military is opposed, as is former Secretary of Defense Robert Gates, who used his influence to thwart an Israeli attack during the Bush and Obama administrations. But he's gone now and "there is a warning order inside the Pentagon" to prepare for war." The punchline: "There is almost "near certainty" that Netanyahu is "planning an attack [on Iran] ... and it will probably be in September before the vote on a Palestinian state. And he's also hoping to draw the United States into the conflict", Baer explained." For the betting public out there, an September CL call may not be the dumbest trade possible...

A complete summary of what is happening (or not, as the case may be) in the third and final act of the debt talks tragicomedy courtesy of Reuters.

Alabama's Jefferson Country, which has been teetering on the verge of bankruptcy for years courtesy of $3.2 billion in bonds related to its sewer system (a deal which has not made JP Morgan many friends south of the Mason Dixon line over the years), may soon decide to unleash the spring-loaded municipal bankruptcy dominoes. Reuters reports that "bankruptcy is still a "very strong possibility" for Alabama's Jefferson County, Governor Robert Bentley said on Saturday -- a move that could make for the largest municipal bankruptcy in U.S. history. "It is still on the table, and it's a very strong possibility," Bentley told Reuters during the National Governors Association meeting in Utah's Salt Lake City. The county is observing a "standstill period" to allow settlement talks with creditors, and this week it finalized a plan aimed at settling the debt to present to creditors." And while the municipal insolvency tsunami is merely a matter of time (it would be amusing to watch the army of Whitney bashers retract), the greatest irony would be if the Federal government were to file first, a move which as Moody's already noted would immediately send 7000 munis down the Chapter 9 rabbit hole as well, effectively bankrupting the entire $2.9 trillion municipal bond market overnight.

And another chart that needs additional exposure...

We previously presented the following chart from Citi in our report on America's brief flirt with income statement austerity, although we feel we may not have emphasized it enough. So, in an attempt to remedy that situation, here is the chart that casually explains most if not everything that is wrong with the US healthcare system, currently the cause of so much political bickering and consternation... not to mention future spending.

You don't need a degree in macro economics to understand an economy. Just because an economy is complex, the analysis need not be. I've been studying the change in GDP from Q4 2010 to Q1 2011 to get a sense of where the economy is regarding contraction or expansion. I have a sense the economy stands today where it stood in December 2007 the very month the great recession began. I've shared various technical charts showing striking similarities with the 10 year treasury market and equity markets comparing the price action between May 2011 to present and October 2007 through December. The big component though was the macro picture. You could easily argue it is far closer to recession now than it was in 2007 when Q4 07 GDP was 2.9% only to print (.72)% the very next quarter. With Q1 2011 GDP at 1.9% the margin for error is far less than in 07. But that is not enough to base an investment decision upon.