Archive - Jul 2011 - Story

As news comes fast and furious out of Europe, here is Goldman's take on the so far unconfirmed details of the latest Marshall Plan in Europe, which unlike last time comes before the war. Incidentally, Europe just approved debt monetization, only unlike in the US, it will do it off balance sheet, via the EFSF "CDO" SPV. "EFSF empowered to buy in secondary markets with input from ECB; BETTER THAN EXPECTED, PENDING clarification on SIZE and ACCOUNTABILITY; EFSF able to recapitalize banks in non-program countries through loans to governments; BETTER THAN EXPECTED, ditto. IF ALL OF THIS IS CONFIRMED, VERY positive relative to expectations. Particularly the systemic stuff is a big step forward to unconditional mutual help. If sovereign cross-correlation of default is low, ex ante risk sharing helps everyone participating"

So far all the news out of Europe is based on changes to EFSF. Greece will be able to borrow for 15 years at 3.5%. French bonds with a 15 year maturity trade at 3.8%. So the EFSF will have to pay more on its debt than it receives? Interesting. Have the rating agencies signed up to rate the new EFSF as AAA? From deals I've worked on, things that always hurt ratings were i) extending maturity, ii) including banks in addition to sovereigns, iii) allowing trading, iv) vague rules as opposed to written rules. The headlines all indicate the new EFSF has all of these components. I am sure the agencies have been involved in these discussions, but I remain dubious how happy the market will be to finance the EFSF at rates that are remotely in line with the rates the EFSF plans to provide financing at. Lots more details likely to come out during the day, but watch for the details. The headlines sound great, but can they be executed. I also noticed somewhere that new lending would be collateralized. If that is true, has anyone asked the borrowers if that makes sense for them?

A rather sobering report out from S&P, which has no other function than to tighten the screws even more on those who prudently are holding out against extending the debt ceiling. As for S&P: please explain to US how 120% debt/GDP is better than 100% debt/GDP, and thus more worthy of a AAA rating? Please. Because we must be bloody stupid: "In our view, the need for an agreement to raise the debt ceiling before it is breached--which the government has said would occur on or around Aug. 2--remains a major risk to the U.S. economy, in our view. Because we see a real risk that efforts to reduce future deficits may meaningfully miss the targets that Congressional leaders and the White House have discussed, we put the likelihood that we would lower the long-term rating on the U.S. within the next three months and potentially as soon as early August--by one or more notches, into the 'AA' category--at about 50-50."

The economic disaster continues with the next target of Europe's reverse Marshall Plan likely being the US itself. Initial claims just prolapsed to 418K, the 16th week over 400K, a 10K increase from the upward revised 408K last week (naturally before it was 405K), and a miss to expectations of 410K. Keep in mind this number will be further revised higher next week. Continuing claims was slighly better than expectations of 3,705K, printing at 3,698K, down from 3,748K. The ongoing 99 week cliff problem is hitting more and more people as 132K dropped off EUC and Extended benefit rolls for the week ended July 2. And while 9,681 of the claims were associated with Minnesota shutdown, nothing explains why there was a surge in 20,599 new claims out of New York of all places.

Headlines out of Reuters:

• Draft EU summit conclusions call for "Marshall plan" of investment, growth stimulation for Greek economy
• Collateral will be part of new Greek aid deal according to Eurozone draft
• Draft EU summit conclusions says three options for private sector role in second Greek bailout remain on the table; debt buyback, rollover and swap
• Draft EU summit conclusions says EFSF will be able to recapitalise financial institutions through loans to governments,including non-programme nations
• Cost of recapitalising Greek banks estimated to be total of EUR 25bln according to Eurozone document
• Draft EU summit conclusions see rate of around 3.5% on new EFSF loan for Greece
• Draft EU summit conclusions says EFSF will be able to intervene in a precautionary basis
• Draft EU summit conclusions see extension of EFSF loans from 7.5 years to at least 15 years, according to a Eurozone document

The Rubicon has now been crossed: Europe goes all or nothing on Greece. When this latest bluff fails it is all over.

Strength was observed in European equities, led by financials, in early trade on the back of news that France and Germany had agreed on an accord ahead of the Eurozone leaders' summit on Greece and PSI. However, later in the session it became increasing apparent that EU leaders may opt for a selective default on the Greek debt, which resulted in equities moving back in negative territory, and weighed on the EUR. Weakness in equities supported Bunds and also observed some widening in the Italian/German and Spanish/German 10-year government bond yield spreads, after EU's Juncker said that selective default for Greece is a possibility. Elsewhere, EUR/USD came under further pressure on the back of weaker than expected manufacturing and services PMI figures from core Eurozone countries such as Germany and France, and as the USD-Index gained strength as the session progressed. Also, GBP/USD moved up around 30 pips following higher than expected retail sales data from the UK. Moving forward, markets look ahead to key economic data from the US in the form of jobless claims figures, house price index, leading indicators, and Philadelphia Fed. In fixed income, 2-, 5-, and 7-year Note refunding announcements, together with USD 13bln 10-year TIPS auction are scheduled for later in the session. US corporate earnings from the likes of Microsoft, and AT&T will also be keenly watched, whereas markets will keep a close eye on the outcome of the Eurozone leaders' summit.

An interesting analysis article on gold by Reuters confirms massive and growing demand for physical gold in Asia and the risk of dislocations and rapidly rising prices in the gold market due to central bank demand. The giant middle class populations in Asia, especially China and India are buying physical gold bullion in volume due to concerns about global growth, in order to protect themselves from stubbornly high inflation and concerns about the declining value of their respective paper currencies. Gold demand in China alone is expected to rise about 20% to near 700 tonnes this year from 570 tonnes in 2010. The massive increase in demand from Asia is sustainable. Especially in China where gold ownership was banned from 1950 to 2003 and therefore per capital consumption of gold is increasing from a near zero base. Besides this Asian demand, there is also the continuing and growing central bank demand. Central banks were net sellers for most of the last 30 years and became net buyers in 2010 due to monetary and systemic concerns. The analysis piece reports something experts on the gold market have been saying for some time, which is that “central banks have to tread lightly, as sizable purchases could jolt the relatively small gold market.”

While the entire world is focused on political developments, namely the rescue of the Eurozone, and the extension of America's credit card borrowing limit, there are some economic updates to keep track of in the US, namely initial jobless claims and the July Philadelphia Fed Index. As Goldman observes below, a weaker than expected initial claims number will be lamed on the ongoing Minnesota shutdown, while it appears that as expected yesterday the surge in M2 has been completely ignored by the economists, and thus expect a massive beat in today's 10am LEI. That said, the only thing that will drive the market once again will be headlines from both sides of the Atlantic.

For what it's worth, and probably not much, here is Goldman's Francisco Garzarelli on why it is "Decision Time or bust" for Europe. With the just commenced summit, the market has very high expectations of a favorable outcome. Should the proposed resolution end up being disappointing, and it likely will upon a close read between the lines as it can not possibly be anything more than merely another can kicking exercise, look for the EUR to tumble after this final relief rally. From GS: "We said at the start of the week that Euro-zone bond markets would be volatile, caught between attractive valuations and expectations of a deal, and the uncertainties surrounding PSI. On light flows, some of the sell-off has reversed over the past 48 hours. If our baseline case above plays out, we would expect more upside and almost all of the widening in intra-EMU spreads seen since Moody’s downgrade of Portugal could be corrected. We doubt we will see more upside than that, at least for a while. It will take some time for the new policies to be articulated and implemented, and all decisions taken today will need to be put before national Parliaments, probably at the start of September. Moreover, concerns over the pace of global growth remain in the background weighing on weaker borrowers. Last but not least, investors have been heavily affected by recent events and thus may want to reduce risk in a recovering market."

When observing the latest "hope" based rally in the EUR last night we said that we "can't help but be extremely skeptical that this short-lived bounce will promptly reverse." Sure enough, 8 hours and 110 pips lower, this appears to have been the case driven primarily by remarks by Eurogroup president Jean-Claude Juncker and Dutch FinMin Jan Kees de Jager, both of whom said that a selective Greek default "cannot be excluded." Specifically, Dutch Finance Minister Jan Kees de Jager said on Thursday he had seen willingness at the European Central Bank (ECB) to discuss the possibility of a selective default on Greek debt. "The ECB is continuously involved in talks about private sector involvement... We have recently seen some room at the ECB to discuss this topic. This is something different than a credit event. I am talking about a selective default," De Jager told the Dutch parliament. Juncker said essentially the same thing earlier, which precipitated the EUR tumble, as this shows that with the summit starting (11 am GMT), once again nobody in Europe has any idea what they are doing. Furthermore, horrible PMI data out of Europe (following last night's Chinese contraction) overnight certainly did not help. And lastly, a Spanish auction of 10 and 15 Year bonds for which the country had to pay record prices even as the Bid To Cover barely moved (and in the case of the 10 Year declined) also took away from any risk on sentiment.

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

The rumors were true: after printing on the verge of a contraction back in June, July's HSBC Manufacturing PMI is now sub 50, or 48.9: the first sub-50 print in this particular series in a year. This confirms that the manufacturing sector is now in contraction mode. The immediate kneejerk response is a 20 pip slide in the EURUSD which has retraced half the surge on the earlier, and repeatedly priced in, news about the nth Greek bailout. Now if only China could slow down that inflation to go alongside its economic contraction, which unfortunately as the following chart from Bloomberg demonstrates, will be a difficult proposition.

A few weeks ago we first reported what, according to Bill Gross, the upcoming QE episode may look like: namely a version of Operation Twist from the 60's in which the short-end of the curve -arguably the 2 or 3rd year point- is locked, resulting in a record steep yield curve while allowing ongoing bond monetizations to proceed. While that is a useful frame of reference, a far more relevant observation is what the man in charge of the world's largest bond portfolio -none other than the FRBNY's Brian Sack- has to say about what the future of QE holds, which he conveniently has done in a speech to Money Marketeers today titled, "The SOMA Portfolio at $2.654 Trillion." In addition to the future of the Fed's SOMA, Sack shares some other much needed information such as the trading details of the QE program from the view of the Fed, his perspective on the QE2's strengths and weaknesses, and his overall assessment of the program's effectiveness. Not to mention his admission that the Fed now carries 200% more interest rate risk than it should...

The EURUSD is pushing higher in the low volume afterhours session after a Reuter report that the German and French delegations have reached an agreement over Greece. Since this is about the 6th "pricing in" of Greek bailout, we can't help but be extremely skeptical that this short-lived bounce will promptly reverse especially since the USD is about to pop on comparable good news to come out from the Obama meeting with Boehner.

Remember how ole' Ronnie bankrupted the Evil Empire by forcing them to build ever more and more nukes, leading to the collapse of the communist empire and unleashing a whole lot of upscale Wall Street prostitution rings in the process? Maybe the CIA can do the same back home, because if the Russian "post default" debt/GDP is any indication perhaps it is time Regan's ghost gave the order to bankrupt none other than the "good empire": the good old US of A. Here is Russian debt/GDP, based on CIA historical data and IMF projections. No "Kolhoz of 6" in Moscow any time soon.