Archive - Jul 6, 2011 - Story

A snapshot of the European Morning Briefing covering Stocks, Bonds, FX, etc.
Market Recaps to help improve your Trading and Global knowledge

Not like it matters much, because any bank that is found to be insolvent following the second consecutive European stress test will merely receive more taxpayer funds concealed as an SPV or a CDO or some other "complex" instrument, but for what it's worth Moody's has released a list of banks that it believes will either fail the farce, pardon, test outright, or will be "candidates for additional support going forward." As a reminder, the European Banking Authority (EBA) is about to publish the results of an EU-wide stress test involving 91 banks from 21 countries. The purpose of this exercise was to assess banks’ resilience to adverse external circumstances and to identify vulnerable banks, defined by EBA as banks whose Core Tier 1 (CT1) ratio falls below 5% under at least one of the scenarios included in the stress test. Moody's splits the sample into 4 Groups as follows: Group 1 : investment grade banks (at or above D+/Baa3 ) : 54 banks, Group 2 : non investment grade banks from peripheral countries (Ireland, Greece, Portugal, Spain) : 17 banks, Group 3 : non investment grade banks from other countries (Germany, Slovenia, Hungary, Austria, Cyprus) : 9 banks, and Group 4 : unrated: 11 banks. It is Groups 2 and 3 that are the focus of the analysis and which will be benchmarked against the test to determine credibility. As for the fact that all European banks are insolvent if just one is, just as all of Europe is bankrupt if Greece were to go under, that's a completely separate point.

I haven't found any firm estimates of the unfunded liabilities due in the next 20 years, but since 25% of the entire population (the Baby Boomers) will be retired and drawing on Social Security and Medicare within 15 years, I think we can reckon that about half that $106 trillion will come due in the next 20 years--and that is probably absurdly conservative. $15 trillion down, $35 trillion to go. Do you see how utterly hopeless this exercise is when Federal spending rises by 6.5% every year even as the underlying economy muddles along at 2% in good years and -5% in poor years, if we subtract borrow-and-spend deficit financing? In other words, $100 trillion in unfunded liabilities is the number now, but if spending continues rising at triple the rate of the real economy, then that number will only grow. If we're honest about our accounting, then the U.S. economy hasn't grown at all since 2008; it's shrunk by $6 trillion, a sum we have masked by borrowing and spending $6 trillion in Federal debt, money that replaced the decline of private borrowing and spending. Please look at the charts of healthcare and local government pension and healthcare costs again. Those rocket-launch lines shooting higher cannot be funded by a national income that is flat or declining. We need a national conversation about reality, not wishful thinking. We need to grasp the nettle and talk about triage, about conserving Social Security for those with no other sources of income, and about devoting our scarce resources for palliative and preventive care. The Status Quo is completely, utterly unsustainable, but that needn't bring the nation to its knees--unless we actively insist that it does so.

While without much direct implication for ponzi market navigation strategy and tactics, the attached videos of Phoenix disappearing under a 5,000 foot tall dust storm, which at time was as tall as 10,000 feet, is stunning in its own right. As the Huffington Post reports "the massive dust cloud, also known as a "haboob," was around 5,000 feet when it arrived in Phoenix, but radar data reveals that it reached heights anywhere from 8,000 to 10,000 feet high prior. The storm appeared to be around 50 miles wide in some areas, KSAZ-TV reported. The dust storm originated in Tucson, and was a part of Arizona's monsoon season. According to CNN, the dust storm prompted the Federal Aviation Administration to issue a ground stop on flights at Phoenix's Sky Harbor Airport for about an hour and 15 minutes. At it's peak, the storm left 10,000 customers without power, Jenna Shaver of the Arizona Public Service told CNN."

As expected, last week's manufacturing ISM was a contrived, one time surge. June's Services ISM just printed at 53.3, down from 54.6 in May, and missing expectations of 53.7. As a reminder for the US, which is a 70% service economy, this number is far more indicative of the true direction of the economy. Among the components, there was a decline in the New Orders, Prices, Backlogs, Imports and, huh, Inventories? Yes, the same inventories that accounted for 66% of the Manufacturing ISM surge are dropping here. Of the 17 non-manufacturing industries reporting all reported growth, except for the all too critical Financial & Insurance and the completely irrelevant Health Care & Social Assistance. Oh yes, all commodities except for diesel and gasoline were reported up in price. And now that WTI is almost back to $100, that's about to end shortly. Some deflation. And now, talk of a triple dip recession may resume.

It was only yesterday when we observed that the story of GM's relentless channel stuffing has now gone mainstream. Sure enough, a few hours later, here is Morgan Stanley with a stick save so pathetic it does not even deserve commentary.

The much ridiculed "MLEC-type" bailout proposal of Greece, which contemplates the rolling of existing debt into a guaranteed SPV, and which was the European rescue deux ex machina for exactly two weeks, appears to have been pulled off the table, following the announcement by German Deputy Finance Minister Joerg Asmussen to Reuters Insider TV that "Germany has put a Greek bond swap back on the table as a model for private sector involvement in fresh aid for Athens." More: "The model put forward by some French banks is still a good base for discussions and we are currently working on this. But since rating agencies have signalled that they will consider modalities (such as) the French proposal as a selective default -- that means a rating event -- we can also put other options like a bond exchange on the table." he said, adding discussions would take place over the summer break. Translation: back to square minus one. And actually it is much worse, because if Asmussen is aware of rating agency policy, a debt exchange would most certainly qualify for an event of default. Which confirms our initial expectation from a month ago that there is nothing absent a complete loss of ECB credibility that can possibly transpire next, as the ECB realizes there is no way around accepting defaulted Greek bonds as collateral. The only question is what happens then: will the market, head currently deep in the sand, scramble upon the confirmation that the ECB emperor is naked, or will it continue acting as if nothing has changed yet again.

A few days ago, Erste Bank shared the following spot on description of gold's function in the modern monetary system: "The possession of gold is tantamount to pure ownership without liabilities. This also explains why it does not pay any ongoing interest: it does not contain any counterpart risk. Along with the International Exchange and the Chicago Mercantile Exchange, JPMorgan now also accepts gold as collateral. The European Commission for Economic and Monetary Affairs has also decided to accept the gold reserves of its member states as additionally lodged collateral. We also regard the most recent initiatives in Utah and in numerous other States as well as in Malaysia, and the planned remonaterisation of silver in Mexico as a clear sign of the times. The foundation of a return to “sound money” seems to have been laid." Today, we get a quick reminder of this all too often forgotten truth, after gold has surged by one percent in the span of an hour as the world once again realizes that the best the ECB Titanic (and shortly thereafter, the Fed) can hope for is merely to delay, not prevent, the sinking of the broken monetary system. Furthermore, that this is happening even as China hiked rates for the 3rd time this year may indicate the inflection point in gold has now come and the take out of nominal highs, just $30 higher, is next.

In today's edition of Bloomberg Brief, the firm's economist Richard Yamarone looks at one of the more unpleasant consequences of Federal monetary policy: the increasing schism in wealth distribution between the wealthiest percentile and everyone else. While the Fed's third mandate is by now all too clear: push the Russell 2000 to the highest possible level, one can now suggest that the 4th mandate is one that would make Robin Hood spin in his grave: "To the extent that Federal Reserve policy is driving equity prices higher, it is also likely widening the gap between the haves and the have-nots....The disparity between the net worth of those on the top rung of the income ladder and those on lower rungs has been growing. According to the latest data from the Federal Reserve’s Survey of Consumer Finances, the total wealth of the top 10 percent income bracket is larger in 2009 than it was in 1995. Those further down have on average barely made any gains. It is likely that data for 2010 and 2011 will reveal an even higher percentage going to the top earners, given recent increases in stocks." Alas, this is nothing new, and merely confirms speculation that the Fed is arguably the most efficient wealth redistibution, or rather focusing, mechanism available to the status quo. This is best summarized in the chart below comparing net worth by income distribution for various percentiles among the population, based on the Fed's own data. In short: the richest 20% have gotten richer in the past 14 years, entirely at the expense of everyone else.

• BofA's Mortgage-Bond Pact Draws Challenge (WSJ)
• Greek Rescue Snarled by Sales (WSJ)
• Portuguese downgrade darkens euro zone rescue hopes (Reuters)
• Rare-Earth Prices Decline in China (WSJ)
• Geithner has not told Obama he wants to go (Reuters)
• Bless this mess: AGs, banks near $60B deal on foreclosures (NY Post)
• Orszag: Why We Care About Price of Water in China (Bloomberg)
• How America Ceded Capitalism’s Bastion to German Boerse (Bloomberg)

Last year's Eyjafjoell and the recent Grimsvotn eruptions will have been a walk in the pyroclastic park if, as AFP reports, the most feared of all Iceland volcanoes, Hekla, is indeed about to blow. "Experts say one of Iceland's most feared volcanoes looks ready to erupt, with measurements indicating magma movement, raising fears of a new ash cloud halting flights over Europe. The Iceland Civil Protection Authority says it is closely monitoring the situation. "The movements around Hekla have been unusual in the last two to three days," University of Iceland geophysicist Pall Einarsson said." Hekla's eruption would certainly have far more dire consequences on European airspace than Grimsvotn, which merely succeeded in getting Obama to vacate Ireland sooner than expected: "The volcano, dubbed by Icelanders in the Middle Ages as the "Gateway to Hell," is one of Iceland's most active, having erupted some 20 times over the past millennium, most recently on February 26, 2000. Over the past 50 years, Hekla has gone off about once a decade." And so Europe, once again caught in the maelstrom of a sovereign debt crunch, will be sensitive to headline risk, as the last thing the continent which is now doing all it can to ostracize rating agencies, as if its insolvency is their fault, is a continent-wide grounding of all flights.

Moody's downgraded Portugal's sovereign rating to "junk" status yesterday (Ba2 from Baa1; outlook negative), which promoted risk-aversion during the European session, and weighed on EUR and equities. Bunds traded higher and record widening was observed in the Portuguese/German 10-year government bond yield spread. Meanwhile, the German deputy finance minister said that Germany will put the idea of a bond swap in Greek debt deal back on the table, adding that all options should be considered as rating agencies have signalled that the French model will lead to a selective default. Risk-appetite was further dented after the PBOC raised its one-year benchmark lending and deposit rates by 25 basis points each, effective from July 7th. Moving into the North American open, markets look ahead to Challenger job cuts data from the US, and building permits figures from Canada. In fixed income, Fed's Outright Treasury Coupon Purchase operation in the maturity range of Jan'14-Jun'15, with a purchase target of USD 2.5-3.5bln, is scheduled for later in the session. Markets will keep a close eye on any development with respect to Greek or Portuguese economies.

Forget new job formation. According to the just released Challenger jobs report, job destruction is starting to be an issue again, after the June report disclosed that "the number of planned job cuts announced by U.S.-based employers increased by 4,297 or 11.6 percent to 41,432 in June. The June increase is the second in as many months. Announced layoffs in May were up 2.0 percent to 37,135, after falling to a four-month low of 36,490 in April. The two consecutive months of increased job cuts did little to impact the overall slow pace of downsizing. For the quarter ending on June 30, a total of 115,057 job cuts were announced, down 12 percent from 130,749 in the first quarter and 1.2 percent lower than the second quarter in 2010 (116,494)." The worry is that after troughing in April we are now back to March levels, and just off from 2011 highs reached in February. The states with the biggest YTD layoffs by location are California: 35,114; District of Columbia: 15,771; New Jersey: 13,182; Florida: 13,006 and Texas: 12,165. The largest job cuts in June were not surprisingly in the government sector at 10,176, followed by health care, food, aerospace/defense and entertainment/leisure. Only 7 people were said to be expected to be fired in Real Estate. Overall, an ominous sign ahead of the ADP and the NFP later in the week.

The Moody’s downgrade of Portugal has led to a brutal sell off in Portuguese debt in morning trade which has seen Portuguese 10 year bond yields surge from 11.02% to 12.23%. Yields on Portuguese two-year notes soared 212 basis points to over 15.14 percent. There is increasing speculation that another downgrading of Ireland is imminent and Ireland’s 10 year yield has surged to over 12%. Portugal received a $112 billion loan package only two months ago. It was due to sell 1 billion euros of treasury bills today but the Portuguese government debt agency IGCP said it sold 848 million euros of bills due in October. Portugal is a reminder that Greece is just the tip of the iceberg and Portugal, Ireland, Spain, Italy, Belgium, Hungary in Europe and the U.S. itself face similar challenges, of greater and lesser degrees.

Quiet day today, with just Challenger layoffs data and the non-manufacturing ISM, which incidentally may be a tad more important as services account fof about 70% of the US economy.