Archive - Jul 26, 2011 - Story

When we looked at the notional change in net outstanding CDS on the top 25 reference entities tracked by DTCC last week, we first made the discovery that the US has for the first time surpassed Greece in number of net speculative default bets outstanding. It was, also, the most rerisked name in total monthly notional, outpacing China and Japan in second and third place. Following tonight's weekly update from DTCC we get an even starker picture of where America lies on the risk spectrum: just to the left of UniCredit and Italy (left being bad). As the chart below indicates, the monthly percentage change in the number of net CDS contracts outstanding on the US increased by a whopping 10%, beating such insolvent entities as Italy's top bank and Italy itself (with mega black swan China, and 200% debt/GDP Japan coming in 4th and 5th place). And completing the bad news for the US from the perspective of a CDS trader, is that for the first time ever, US 1/5 year CDS inverted. Why? Because with American recovery rates well in the 80s based on trading prices of the cheapest to deliver bonds, unlike other sovereigns such as Greece which may need recovery calcs in the 20s or 30s, this is virtually equivalent to trading points up front and convexity is massive. It also means that with the 52 week Bill pricing at 0.2% earlier today, anyone who wishes to transact in a 1 year basis trade, can make a lot of money by putting on the negative basis courtesy of the blow out in 1 Year CDS compared to cash... assuming the US does not default of course. But in that case one will be bigger problems than paying their counterparty the require variation margin.

When describing the Boehner's plan as perceived by the CBO we used one key word: "laughable" in that i) it cut far less than many had expected it would cut, particularly during its "first stage" and ii) it had a pathetic $4 billion of actual discretionary cuts in its first projected year. It seems even the GOP has realized that its plan is nothing but a red herring, and as a result has declared that it is delaying its previously scheduled vote on the debt ceiling which was supposed to take place tomorrow, has now been delayed until Thursday after republicans "scrambled Tuesday night to rewrite the measure to ensure that accompanying spending cuts were large enough." Which means that with far too much action expected int he aftermath, most of which includes the expected voting down in the Senate following just after the House vote, and another vote on a plan proposed by Reid, as well as possibly a vote on Obama's still non-existent grand compromise, this is no longer an 11th hour affair. The budget farce just became a 12th hour and 1 minute affair. Alas, the money runs out at midnight. What happens next nobody knows, but perhaps Ben Bernanke can tell us: after all it is him everyone looks up to in order to justify never selling on any news, good, bard or otherwise. And he better have a damn good explanation.

Even as the Congressional Budget Office has just released its score of the proposed Boehner plan, the president's spokesman Jay Carney was out earlier hemming and hewing for about 9 minutes in front of reports before it was made clear that Obama does not even have an actual plan to paper which the CBO can score. Yet surprisingly enough, as the National Review Online presents, even without actually having any plan, Obama is still happy to announce he will veto Boehner's plan. It is one thing to veto one plan over another, if one believe the "another" is better. But vetoing something on purely ideological grounds, in the complete absence of "another"... well that we have no idea how it can possible be spun aside from pure ideological demagoguery.

Morgan Stanley has released its comprehensive quarterly metals outlook update for Q3, which while traditionally furiously wrong in its price targets for the assorted metals under consideration, represents one of the best reference materials for the underlying fundamentals behind each hard asset including base and precious metals, steel and bulk commodities, mined energy, rare earths, even such arcania as zircon and titanium dioxide. We suggest readers avoid the conclusion by Morgan Stanley which ultimately will be based on the firm's prop trading bias, and instead focus on the key supply/demand mechanics in any given product. For the sake of reference, we break down MS' outlook on gold, silver due to the special place these hold in the modern geo-political and voodoo economic discussions.

You have seen it before in action, first in nat gas, then in crude (with some caveats), now see it morphing to plain vanilla products... like stocks. Observe the stock chart below: it shows the trading in the stock of one of the most insolvent companies in the world: the National Bank of Greece. The pattern should be familiar. It is the very comparable "fractal" algo pattern that we have grown to love and miss. Granted, as Nanex points out to Zero Hedge, the underlying dynamics are different from those observed before, although the end game is obvious: hunt for loss triggers on both the up and the downside, and hope to precipitate a stop loss collapse or surge. How the underlying engine generating the trading pattern is positioned in parallel to the underlying, certainly via options, is unclear, although it is obvious that the ulterior motive is to generate some very dramatic short-term liquidity. Not surprisingly, after it completed two quick cycles, the algo disappeared and was not  seen from again. Expect to see it migrating through other less liquid stocks as it continues its prowl for stop loss triggers.

Complexity works beautifully as self-preservation, because it actually expands the bureaucratic power of fiefdoms and widens the moat protecting cartels. Once the fiefdom expands to manage all those new rules, only a handful of corporations can possibly afford the regulatory reporting burdens. They are thus free to exploit the populace as an informal cartel. Put another way: in the competition with the private sector for scarce capital, the State and corruption always win. That's why kleptocracies and banana republics are characterized by bloated, unaccountable State bureaucracies and systemic corruption: sweetheart deals, no-bid contracts, shadow banking, shadow governance by Elites, inefficient workforces that cannot be fired or held accountable, and so on...The single goal is preserving the revenue and reach of concentrated power centers: State fiefdoms with large constituencies and headcounts, and cartels with no competition and stupendous profits. The two are hand in glove. But complexity does have an eventual cost: collapse. Keep adding decks to the ship and eventually it capsizes and sinks. One the ship is sufficiently top-heavy, all it takes is a small wave.

RANsquawk Market Wrap Up - Stocks, Bonds, FX etc. – 26/07/11

While it is unclear if something said in the Paul-Hoenig hearing is what spooked the market, one thing is clear: something spooked the market. As of a few minutes ago, with an increasing average block size, the ES has just slid to fresh lows after levitating almost in the green earlier. Oddly enough the sell off in stocks is not being replicated anywhere else, as both the DXY, the 10 Year and Crude are all at levels last seen at the start of the sell off. Are stocks, with just 2 days to go until Thursday, finally starting to get tired of pretending that all is well with America? And while the dump accelerates we are awaiting the inevitable headline from Boehner in which he will make it all too clear that he refuses to compromise with a president who has threatened a preemptive veto on his "debt ceiling" plan. The soap opera is once again up front and center.

Watch Kansas Fed's (non-voting) Hoenig, long the only sane and dissenting voice at the Fed, discuss Fed monetary policy live at the House Financial Services subcommittee chaired by Ron Paul (and this time the audio actually works).

Just because we needed some fireworks, here is Obama, providing the catalyst. Watch for a very indignant Boehner TV appearance in T minus 5...4...3... And yes, this will not help the consensus-building effort.

Earlier today, while discussing the implications of a US debt downgrade on a SIFMA call, JPM head of fixed-income Terry Belton told listeners that a US downgrade could cost the US an additional 60-70 bps in incremental interest. That's per year. He also added that US asset managers are unlikely to sell Treasurys on a downgrade, but that's irrelevant. Nobody can predict what all the knock off events from a US downgrade would be, as the Citi presentation from yesterday indicated. Should there be a downgrade, investors may not sell Treasurys, but they sure will be forced to sell other lower rated instruments to keep the overall rating distribution of their portfolio in line with mandated rating requirements. Which in turn, following margin calls, will result in, you guessed it, selling of Treasurys. Yet this debate is the topic of another post. What is more important is that on the same call, Belton said that a 70 bps increase in interest would result in an incremental $100 billion in interest expense each year. As a reminder, this is roughly the amount that the NPV of a realistic deficit reduction plan over 10 years would chop off from the US deficit on a yearly basis. Simply said: the US downgrade alone, now virtually taken for granted by everyone, will offset any beneficial impact from any deficit reduction that will have to happen for the debt ceiling to be increased. And that, ladies and gentlemen, is why cash flows matters.

Today's "Breakfast with Dave" from David Rosenberg is a veritable chartapalooza, the inspiration for which appears to have been the "reversion to the mean" theme presented in yesterday's IMF chartpack, presented here. There is, however, one section that is unique: that dealing with gold, and more specifically, why in Rosenberg's opinion gold is still quite cheap and why it is trading at about 50% of what the Gluskin Sheff strategist would consider bubble value. As Rosie says: "we have liked gold for a long time and we remain very constructive. It is more than just a hedge against recurring bouts of global financial volatility. The growth rate of gold production is roughly stagnant while the growth rate of fiat currency in most parts of the world continues to accelerate. It's all about relative supply curves - the supply curve for bullion is far more inelastic than is the case for paper money. It really is that simple." Indeed it is: when one strips out all the fancy talk, mumbo jumbo, and syllogistic gibberish out of modern economic theories, be they neoclassical Keynesianism (or, god forbid, just classical), chartalism (sorry, infinite debt-money issuance won't work: in two years we will all see why), or any other attempts to reduce a broken imbalance in supply and demand propped up by the "invisible hand", it is all about supply and demand. Sure enough, one thing we have an infinite supply of is fiat money, and the resulting debt necessary to "back it up." As for demand, well that's another matter. With gold: it is just a little inverted.

As anyone who follows the restructuring process (and religiously reads debtwire) will tell you, the first sign of smoke is when a creditor retain legal bankruptcy counsel, promptly followed by financial, which in turn, or at least 95% of the time, leads to a dropping off of bankruptcy docs at the local bankruptcy court, or Southern New York. And where there's smoke, there's Alabama fire. According to blog al.com, the Jefferson County Commission has just retained the services (at $975/hour) of Ken Klee, of LA-based Klee Tuchin, best known for advising Orange County on its Chapter 9 filing back in 1994. And with this the probability that Jefferson County will conclude that the time to file its own Chapter 9 in two days, is virtually a certainty (and sorry, no bankruptcy lawyer will advise his clients not to file for bankruptcy. Hourly retainer, remember?). And with the US debt situation still unlikely to be resolved within 48 hours, the last thing the market needs is to worry not only what known on effects this mega-municipal bankruptcy case will end up generating, but who else will file after. That said, we are confident the market will surge even more as it digests these news. Why? Two words: Bernanke Put.

Just like in previous auctions post the end of QE2, so today's just concluded $35 billion 2 Year auction closed off with Direct Bidders once again surging to take down nearly as much as the Indirects. Foreign institutions (Indirects) were responsible for 27.67% of the total allocation, while Directs rose from 13.53% to 20.03%: Chinese proxies, Fed, who knows. It wasn't dealers, who supposedly took down just over half or 52.30% of the auction. Otherwise, the bond priced at a 0.417% high yield, modestly higher than June's 0.395% same with the Bid To Cover, which came at 3.14, just higher than the 3.08 previously. With the When Issued trading at 0.42% there were no major surprises into the pricing. Overall, nothing notable except for the increasing role that Direct Bidders continue to play in each and every issuance now that the Fed is briefly not monetizing treasury debt. We expect more of the same in the remaining 5 and 7 auctions in the balance of the week.And an amsuing comment from TD's Richard Gilhooly: "Given the bid in the Treasury market today as spreads widen in Agency paper and mortgages, belatedly in swap spreads, it would suggest that we are seeing an ironic flight to quality into the asset class that is at risk of downgrade." Yeah, who cares though.

I first started coming regularly to Daet, in the Bicol region of the Philippines, more than 13-years ago. Wages for unskilled workers are about $4.65 per DAY. If you buy food from the local markets or vendors and prepare it yourself, you can have quite a decent meal of fresh local fish, rice, and vegetables for less than $1 per person. If you have a place to stay, even adding in a few luxuries (beer is about 50c a bottle, for example), you could live well here on $10 a day. Down the road from my wife’s small hotel is a vacant beach lot for sale. It’s priced at about $35,000, and the owners have spent a considerable amount of money improving it with access ramps and other structures leading down to the water. The land is already planted with some crops, and there are ponds suitable for fish farming. Of course, construction costs here are quite cheap by western standards, and you could build a nice three-bedroom home for around $60,000. In total, that’s less than $100,000 for a spacious beachfront home in a quiet, clean, pristinely beautiful place where living costs will only run $10/day.