Archive - Jul 2011 - Story

Risk-aversion remained the dominant theme during the European session, as lack-lustre economic data from the US last week, and China, during the weekend, weighed on market sentiment. Allied to that, the ongoing contagion fears in the Eurozone dented the appetite for risk-among investors. European equities traded lower throughout the session, with particular weakness seen in financials, which was also reflected in the Italian FTSE MIB and Spanish IBEX 35 indices underperforming their European peers. Weak equities provided support to Bunds, whereas general widening was observed in the Eurozone peripheral 10-year government bond yield spreads. European sovereign concerns together with strength in the USD-Index weighed upon EUR/USD and GBP/USD, whereas safe-haven currencies including JPY and CHF received a boost. Elsewhere, WTI and Brent crude futures traded under pressure weighed upon by a strong USD as well as diminishing hopes of a sustainable economic recovery.

• Merkel's Migraine: The Man Who Wants Greece to Give Up the Euro (Spiegel)
• Up to 15 years needed to fix Greece: German president (Reuters)
• Taxes still a stumbling block in debt talks (Reuters)
• EU stance shifts on Greece default (FT, first in the WSJ)
• EU calls emergency meeting as crisis stalks Italy (Reuters)
• China Boosts Lead in Global Exports (WSJ)
• Italy's Market Regulator Imposes Measures To Curb Speculation (WSJ)
• NOTW reporters tried to access 9/11 phone data (Reuters)
• Trichet says debt is global, not European problem (Reuters)

The farce is now complete, as the Chinese rating agency Dagong, which was the first one to downgrade the US, reminds the world it is there to lend its weight in destabilizing the ponzi house of cards. From Dow Jones: "Chinese ratings agency Dagong Global Credit Rating Co. said Monday it is putting Italy's sovereign debt on negative watch for a possible downgrade. The Italian government's debt accounts for 119% of gross domestic product, with most of the debt coming due in the next five years, Dagong said in a statement. Dagong has often issued controversial ratings. In November last year, it cut its rating on the U.S. to A+ from AA, with a negative outlook. It ranks the U.S. as a riskier borrower than China. Italian debt is in focus at the moment, as spreads between 10-year Italian and German bond yields reached a record 2.47 percentage points on Friday. Dagong said in its statement that it will downgrade Italian debt if the government's debt-financing costs continue to rise. "(Italy's) financing needs are huge each year, and the debt burden of the government will be seriously constrained by financing costs," Dagong said. Dagong gave Italy an A- rating with a negative outlook in June 2010." Who could have possibly thought that Italy's surging issuance load over the short term could be an issue. Oh wait... And yes, the irony that China, which as of this morning has telegraphed it is just as helpless in controlling the global liquidity implosion as everyone else, is downgrading another insolvent country is not lost on us. But yes, earlier Dagong did announce that that Moody's report on local government debt is "unfounded" and "vicious." Perhaps the most ironic thing is that the rating agencies got us here... And they will be those who get us out (courtesy of the escalating downgrades to the global reset ushering bottom).

This morning's Greek deposit flight (which recently dropped by €5 billion or 2.5% of total, in the month of May) appears to be enjoined by other countries, who are now actively converting their currencies into CHF and stuffing it into bank vaults deep under the Swiss Alps. As of minutes ago the critical EURCHF just took out the 1.18 stops, which sent the pair tumbling to an all time record lows of 1.1789. And, like clockwork, the triggering of the Swissy stops, send gold surging to a new record high in euros, and to just under $1,550 in USD. And elsewhere, confirming that Italy is merely the gateway drug, is the Belgium-Bund spread, which just hit all time wides. And this is as the S&P long overdue threat to downgrade the world's longest governmentless country hangs like a sword of Damocles which will send the Euro-crisis into overdrive.

Europe is now openly burning once again (Italy-Bund spreads just hit a new record), the US is 9 days away from being bankrupt, and completing the trifecta is China, which just failed to sell half of the proposed 50 billion in CNY of local government debt at an auction, courtesy of the SHIBOR supernova which oddly only Zero Hedge has been covering. From Bloomberg: "China’s finance ministry failed to sell all of the three-year debt offered at an auction on behalf of local governments as a cash crunch curbed demand. The ministry sold 23.9 billion yuan ($3.7 billion) of bonds at a yield of 3.93 percent on behalf of 11 provinces and municipalities, falling short of its 25 billion yuan target, said a trader at a finance company required to bid at the auction. The Shanghai interbank offered rate, or Shibor, for three-month yuan loans, was fixed at 6.24 percent today, near a record high of 6.46 percent reached on June 28. “While the interbank borrowing cost is so high, investors won’t spend money on local government debt,” said Huang Yanhong, a bond analyst at Bank of Nanjing Co. in Nanjing. “Demand is low also because the debt’s secondary-market trading isn’t active. After you buy it, you can only hold it till maturity." Who would have possibly thought that 7 week money costing 7% and more could have implications and stuff...

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

Technically the title of this post is wrong: the truth is that nobody could possibly know or predict what a bank run would looks like in details suffice to say that it would have terminal and devastating results on the global economy. One needs only remember what happened when the Reserve Fund broke the buck and the $3 billion money market industry was at risk of unwinding (for those who do not, Paul Kanjorski does a good summary here). What we do, however, wish to demonstrate is the tenuous balance between physical money - yes, just like precious metals, there is actual "physical money", better known as currency in circulation - and more abstract, confidence-based, "electronic money." Now when it comes to talking about systemic instability, pundits often enjoy bringing up the case of the $600+ trillion (recently discussed here in a different capacity) in synthetic derivatives, whose implosion would "wipe out the world." While that may indeed be the case (the memory of the CDS-precipitated AIG implosion is still all too fresh), since nobody really can comprehend the side effects of the collapse of global derivative system, which by some estimates is over $1 quadrillion when combining exchange and OTC based derivatives, it is largely based on pure conjecture. And, as we demonstrate below, one doesn't even need to do get that high up in the pyramid of credit money. The truth is that should there be an American bank run, what would happen is the conversion of all electronic dollars into physical dollars, as retail Americans rush to empty their checking and savings accounts, exit their money markets, while institutional America converts all "shadow" liabilities into hard dollar assets (Zero Hedge has a specific methodology of defining what liabilities make up the shadow banking system). The truth is that should there be a D-Day in the American banking system and there is a global scramble for physical paper (ignore gold) the conversion ratio for binary dollars into hard ones could be as high as 30 to 1. Which begs the question: should one apply a 90% discount when evaluating their electronic dollar exposure? That, and many other questions too...

Remember when the dollar reigned supreme, and nobody cared about that joke of a currency, the Chinese Renminbi? Neither do we. And neither does the CME, which just announced it is launching USD/CNY futures, which will be available in standard and E-micro sizes beginning August 22. Put otherwise, with one fell swoop the CME will now allow one to transform liability risk, credit and maturity of underlying assets from one currency to another, while on margin (granted, exposed to the same margin shenanigans that make silver bulls scream blood murder every time the CME's name is mentioned). And the CME is just the beginning of what soon will allow everyone to denominate their liability exposure into the Chinese currency. In the process, the dollar lost yet another battle, as it continues to lose the war.

In 1938 the citizens of the major European powers, Germany, France and the UK, along with isolationist America, having suffered grievously during WW1 were willing to believe almost any lie that supported the prevailing sentiment. Sentiment exemplified by the aforementioned timeless speech from Neville Chamberlain. Today I see a European political and economic elite clinging desperately to the notion that any action that calls into question the current construct of pan-European “unity” must be quashed to preserve the peace. The reality from the available evidence suggests that what these elites are more fearful of is broad realization that this current construct is as fatally flawed as the one in existence in 1938.

After meeting for exactly 75 minutes, the president and members of congress achieved absolutely nothing except for what ZH readers already knew: that a debt deal has to be reached by July 22 or else. "President Barack Obama said Sunday that "we need to" work out a debt deal within the next 10 days as he convened a meeting with congressional leaders, aiming to fashion a deficit reduction package for the next 10 years. As the meeting opened, Obama and the leaders sat around the table in Sunday casual dress. Asked whether the White House and Congress could "work it out in 10 days," Obama replied, "We need to." Despite Boehner's preference for a smaller, $2 trillion plan for deficit reduction, White House aides said Sunday that Obama would press the lawmakers to accept the larger deal. Republicans object to its substantial tax increases and Democrats dislike its cuts to programs for seniors and the poor. The aides, however, left room for negotiations on a more modest approach." And just like on Friday when the president's appearance was heralded as a harbinger of a massive NFP beat only to be the biggest let down since Geithner's TV appearances in February which sent the market down by 10 S&P points each time, so the president will address the nation tomorrow. From Reuters: "U.S. President Barack Obama will hold a news conference at 11 a.m. EDT (1500 GMT) on Monday about the status of negotiations to cut the deficit and raise the debt ceiling, the White House said on Sunday. Obama met with congressional leaders for about 75 minutes Sunday evening and will meet again with them on Monday "to discuss the ongoing efforts to find a balanced approach to deficit reduction," the White House said, without giving a time for that session."

Something curious happened with outstanding Treasury debt over the past few years: after plunging in average maturity to just 49 months during the Lehman crisis, when everyone scrambled to safety of Bills and the Treasury was forced to issue gobs of it, since then average maturity has been a one way street, and as of the end of Q1 as per the most recent quarterly refunding statement, is at 60 months. This is the "oldest" average Treasury age since 2003, and a substantial shift from the recent average of about 55 months. Incidentally, 60 months is what Stone McCarthy calculates is the average maturity of Fed SOMA holdings (as in debt purchased as part of the various QE programs). Keep in mind this chart is as of March 31: in the past three months due to the debt ceiling breach, Geithner has aggressively reduced Bill rollovers, which means the average Treasury age is likely about 65 months if not more. And while we have discussed the imminent surge of Bill issuance as soon as the debt ceiling is raised, this will be nowhere near enough to get the Treasury comfortable with average bond aging. Since Geithner will certainly do all in his power to reduce the average duration on marketable bonds to recent historic lows, the only way we can think of this happening on a "voluntary" basis is for a recreation of the same Lehman conditions that forced a 6 month change in maturity in the span of 60 days back in October 2008.

The European financial system, like the others, is efficient but is not robust. It makes the most of what it has and runs on a razor edge between efficiency gains for individual agents and horrendous systemic losses. It depends crucially on the performance of its sovereign assets. System survival depends on one hand whether or not counterparties can absorb the necessary haircuts and on the other, whether fundamentals of debtor nations are strong enough to stand on their own. Spain and Italy will have to stand on their own, because when Greece goes, Ireland will most likely go, which will in turn set off a critical mass such that the nation who dictates monetary policy (Germany) will be taking care of its own self.

China activity data: Following the June CPI print, which saw inflation rise to 6.4% yoy, in line with our above-consensus forecast, we will be looking for above-consensus activity readings for Q2 GDP and June industrial production. Eurogroup meeting and bank stress tests: This will be an important policy week for Europe. On Friday, the IMF approved its disbursement to Greece under the old EU/IMF program of EUR110 bn agreed in 2010. Discussions at the Eurogroup meeting will center on the financing of a new program, which is supposed to close the financing gap for Greece for 2012 and 2013. The role of private sector involvement remains a key issue. The week also brings a bond auction for Italy on Thursday, for an estimated EUR7 bn. The week ends with the publication of the EU-wide bank stress tests on Friday. Summary results will be published at 6 pm CEST, with bank-by-bank results following thereafter. Bernanke testimony: In his semiannual monetary policy testimony, Fed Chairman Bernanke is likely to repeat the basic message from his recent press conference—namely that labor market performance has been disappointing but that inflation remains too high to combat the weakness with additional monetary easing.

The earlier news that Italy's regulator may forbid naked short selling in a desperate attempt to preempt the bond vigilantes from taking down the country's financial system (how shorting stocks prevent evil speculators from selling bonds is somewhat confusing) has been confirmed. But that's just the beginning. The latest twist is that the Consob has also requiring shorts to immediately disclose their short positions "in an effort to increase market transparency." Odd how shorts are never required to be exposed when the markets are surging (or how silver margins have yet to be reduced despite the near 40% price drop in the metal from recent peaks). It gets worse: from Bloomberg: "The European Securities and Markets Authority, which co- ordinates the work of national regulators in the 27-nation EU, should be given emergency powers to temporarily ban short selling or trades in CDS on sovereign debt in the EU, the Parliament said. The Italian regulator said short sellers must disclose their net positions when they reach 0.2 percent or more of a company’s capital and then make additional filings for each additional 0.1 percent."

Once again the great diversionary scapegoating of speculators begins, after as Il Sole 24 Ora reported that the Consob, or Italy's regulator, may enact a naked short selling ban as early as tonight. The premise is that it is the shorters who are responsible for the ruinous state of the global ponzi. Not the fact that it is a, well, global ponzi. Distraction 101. And yes, it did not work back in 2010 when banning naked shorting was implemented in other European countries, it will not work this time either. But it won't stop bankrupt governments from trying. To wit: "Commissioners will assess the situation before markets open Monday, said a Consob spokesman, who declined to be named in line with the regulator's policy. Commissioners may decide to restrict "naked" short-selling in line with similar decisions taken in other European countries, he said.... The Consob meeting occurs after shares of Italy’s biggest banks fell to the lowest in more than two years on July 8, and government bonds dropped, driving 10-year yields to a nine-year high." 24 Ore adds: "Consob intervened several times in the past on short selling after the collapse of Lehman Brothers to protect stock markets."