Archive - Jul 2011 - Story

Sooner or later it was inevitable. Next up: the "tea party" lives up to its true name.

Those who had read our prediction that the Paris Air Show was a harbinger of weaker durable goods will not be surprised to read that June durable goods just came at a very disappointing -2.1% on expectations of an increase to 0.3%, from 1.9% in May. But it wasn't just Boeing's fault: ex-transportation the number was a subpar +0.1% on consensus of a 0.5% beat, with the May reading revised up to 0.7%. The driver according to Bloomberg's Joseph Brusuelas: "decline in transportation bookings, incl. 28.9% drop in non-defense aircraft orders." And that's not all: "Non-defense ex-aircraft, proxy for capex, points to slower growth in coming qtr." This means that as expected not only is Q2 GDP trending now much lower, possibly below 1%, but the weakness is starting to spill over into Q2 data. As AP reports, "Manufacturing has been the stellar performer in the two-year-old recovery. But activity slowed in the spring, reflecting in part supply disruptions following the March earthquake and tsunami in Japan. Manufacturing was also hurt by the hit the overall economy took from higher energy prices which dampened consumer demand." Ah, still blaming it all on Japan. And to think in Joe LaVorgna's world it was supposed to be a boost to GDP. Kneejerk reaction: USD plunges, futures down, gold surges to new record over $1,626. On so forth.

Markets remained apprehensive as the impasse over the issue of raising US's debt ceiling prevailed, and further risk-aversion materialised after German finance minister expressed his reluctance in the use of EFSF/ESM to purchase government bonds in the secondary market. This resulted in weakness in European equities, led by financials, which provided support to Bunds, and also weighed upon the EUR across the board. In other news, AUD received strength following higher than expected inflation data from Australia overnight, whereas a downtick was observed in GBP/USD after a sharp decline in CBI trends total orders figures from the UK.  Moving into the North American open, markets look ahead to key economic data from the US in the form of durable goods report, DOE inventories figures, as well as the release of Fed's Beige Book. In terms of fixed income, USD 35bln 5-year Note auction is scheduled for later in the session. Markets will also watch keenly US corporate earnings from the likes of Boeing, ConocoPhillips, and Visa.

• IMF Chief Raises Idea of Seeking More Cash (WSJ)
• US Money Market Funds Build Liquidity (FT)
• Interbank Loan Probe Focuses on Yen Rates (FT)
• Watchdog Sees Financial Weak Spots (WSJ)
• China’s 29% Jump in Industrial Profit to Spur Growth by Fueling Investment (Bloomberg)
• Shanghai to Step Up Probes of Home Prices (Bloomberg)
• Lessons From the Malaise (NYT)
• Hurtling toward economic chaos (LA Times)
• Who Elected the Rating Agencies? (WSJ)

Today's economic docket consists of Durable Goods numbers (if the Paris Air Show was indeed as bad as we expect, Boeing, i.e., aircraft, orders may slip substantially), the Beige Book, and $35 billion in 5 Year Notes (+$20.065 net). All of it irrelevant: the double whammy of major headline risk out of both Europe and the US (Europe bailout 2 unwinding, no deal 24 hours ahead of the Thursday congressional deadline) will be the key driver of the market once again.

Gold is trading at USD 1,620.40, EUR 1,120.50 and GBP 989.08 and CHF 1,298.50 per ounce. Both the dollar and the euro are under pressure again today and gold has reached another new record nominal high of $1,625.70/oz in early European trading. Economists in the U.S. believe that the U.S. will lose its vanguard AAA credit rating according to a recent poll conducted by Reuters. A survey of 53 economists showed 30 believed that one of the three leading credit rating agencies will downgrade US debt. The economists do not believe that the U.S. will default. A downgrading of the U.S. is inevitable given its very poor fiscal position – the question is by how much the U.S. is downgraded and AA looks possible in the coming months. The widening in U.S. CDS has so far been modest but the bond vigilantes may be awakening from their slumber as net notional CDS on US debt has risen above that of Greece and Italy. They either believe that the U.S. government will default on its debt or are taking out insurance against of this happening. Investors internationally -- including everyone from individual consumers in their pension funds, to hedge funds, to the Chinese government -- currently hold $9.3 trillion (with a T!) in Treasury bonds, and they're counting on Uncle Sam paying up when those contracts mature. The U.S. government will have a three-business-day grace period to make good on any default before credit default swaps are triggered, the International Swaps and Derivatives Association said Tuesday.

When we first summarized our take on the second European bailout package we completely ignored the specifics of the rollover mechanism and the private investor participation scheme because they were entirely irrelevant. We said: "This is merely a red herring that attempts to confuse the issues associated with the first, and far more important concept: the nuances of the EFSF and its imminent expansion. And expand it will have to, because in reality what is happening is that the net debt of the countries will end up growing even more over time for one simple reason: this is not a restructuring of existing debt from the perspective of the host country! Simply said Greek debt will continue growing as a percentage of its GDP, meaning it, and Ireland, and Portugal, and soon thereafter Italy and Spain will be forced to borrow exclusively from the EFSF. Therein lies the rub... The bottom line is that for an enlarged EFSF (which is what its blank check expansion today provided) to be effective, it will need to cover Italy and Belgium." We further said that "by not monetizing European debt on its books, the ECB has effectively left Germany holding the bag to the entire European bailout via the blank check SPV." We concluded with the rhetorical: "what happens tomorrow when every German (in a population of 82 very efficient million) wakes up to newspaper headlines screaming that their country is now on the hook to 32% of its GDP in order to keep insolvent Greece, with its 50-some year old retirement age, not to mention Ireland, Portugal, and soon Italy and Spain, as part of the Eurozone?" Well, German Finance Minister just gave us an answer, and it is the reason why various European banks are once locked limit down, and the entire banking industry in Europe is bleeding: "German Finance Minister Wolfgang Schaeuble said the euro zone's rescue fund should only purchase bonds on the secondary market in exceptional circumstances, according to a letter obtained by Reuters on Wednesday. "The government rejects a 'carte blanche' for widespread purchases on the secondary market." Translation: Germany finally realized the horrors of the fine print and just said no. This means that the entire second bailout package has now been unilaterally unwound courtesy of German which has realized it was the patsy, and will not agree to the clause giving the EFSF unlimited PPT powers. Time to start planning bailout #3.

A snapshot of the European Morning Briefing covering Stocks, Bonds, FX, etc.
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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