Archive - 2011 - Story

On a day when data confirms Spanish bad loans creeping up to recent highs and deposits continuing to stream out of the periphery, Boston Consulting Group has released an excellent treatise on the "What Next? Where Next?" perspective of the impact of collateral damage in and out of the Eurozone. The critical questions for most market watchers and prognosticators remain, how likely is an exit, and what would be the implications for 'leaver' and 'left behind'? BCG offers an at-a-glance chart of the economic, social, and market expectations for the ins-and-outs and notes, in less-than-Deutsche-Bank-like mutually assured destruction language, the cost of leaving the Euro varying from EUR3,500 to 11,500 depending on weak or strong exiting country per person per year. No matter what, an exit would impact the world economy considerably and BCG strongly suggests corporate management consider a Euro-zone breakup as a possible scenario for next year, along with a muddle-through, a Japanese deflation-like evolution, or a significant inflation possibility.

Just out on Yonhap:

• North Korea says its leader Kim Jong-il has died.
• N. Korean leader died of fatigue at 8:30 a.m. Dec. 17 during train ride: KCNA

And Reuters confirms:

• NORTH KOREA STATE TELEVISION SAYS KIM JONG IL HAS DIED

Great. More geopolitical uncertainty. Because as the Arab Spring has shown us there is nothing quite as stable as a transitory military government to fill a power vacuum (also see Thermidorian reaction during the French Revolution).

As expected the South Korean response is immediate.

• S. Korean gov't shifts to emergency footing on news of N.K. leader's death

While certainly humorous, entertaining and very, very childish, the recent war of words between France and Britain has the potential to become the worst thing to ever happen to Europe. Actually, make that the world and modern civilization. Why? Because while we sympathize with England, and are stunned by the immature petulant response from France and its head banker Christian Noyer to the threat of an imminent S&P downgrade of its overblown AAA rating, the truth is that France is actually 100% correct in telling the world to shift its attention from France and to Britain. So why is this bad. Because as the chart below shows, if there is anything the global financial system needs, is for the rating agencies, bond vigilantes, and lastly, general public itself, to realize that the UK's consolidated debt (non-financial, financial, government and household) to GDP is... just under 1000%. That's right: the UK debt, when one adds to its more tenable sovereign debt tranche all the other debt carried on UK books (and thus making the transfer of private debt to the public balance sheet impossible), is nearly ten times greater than the country's GDP. To call that "game over" is an insult to game overs everywhere. So here's the bottom line: France should quietly and happily accept a downgrade, because the worst that could happen would be a few big French banks collapsing, and that's it. If, on the other hand, the UK becomes the center of attention (recall this is the same UK that allows unlimited rehypothecation of worthless assets, and the same UK that unleashed the juggernaut known as AIG-FP's Joe Cassano - after all there is a reason why the UK has 600% its GDP in financial liabilities - financial innovation always goes there where it is least regulated), then this island, which far more so than the US is the true center of the global banking ponzi scheme, will suddenly find itself at the mercy of the market. At that point the only question is whether the vigilantes will dare to take down the UK, as said take down will result in an implosion in the very fabric of modern finance, much more so than what even a full collapse of France could ever achieve, or if due to the certain Mutual Assured Destruction that would follow a coordinated UK onslaught, the market will simply very quietly proceed to ignore the elephant in the room.

As first reported here, two weeks ago European banks saw the amount of USD-loans from the Fed, via the ECB's revised swap line, surge to over $50 billion - a total first hit in the aftermath of the Bear Stearns failure prompting us to ask "When is Lehman coming?" However, according to little noted prepared remarks by Anthony Sanders in his Friday testimony to the Congress Oversight Committee, "What the Euro Crisis Means for Taxpayers and the U.S. Economy, Pt. 1", we may have been optimistic, because the end result will be not when is Lehman coming, but when are the next two Lehmans coming, as according to Sanders, the relaunch of the Fed's swaps program may "get to the $1 trillion level, or perhaps even higher." As a reference, FX swap line usage peaked at $583 billion in the Lehman aftermath (see chart). Needless to say, this estimate is rather ironic because as Bloomberg's Bradely Keoun reports, "Fed Chairman Ben S. Bernanke yesterday told a closed-door gathering of Republican senators that the Fed won’t provide more aid to European banks beyond the swap lines and the discount window -- another Fed program that provides emergency funds to U.S. banks, including U.S. branches of foreign banks." Well, between a trillion plus in FX swap lines, and a surge in discount window usage which only Zero Hedge has noted so far, there really is nothing else that the Fed can possibly do, as these actions along amount to a QE equivalent liquidity injection, only denominated in US Dollars. Aside of course to shower Europe with dollars from the ChairsatanCopter. Then again, before this is all over, we are certain that paradollardop will be part of the vernacular.

Two weeks ago in "Has The Imploding European Shadow Banking System Forced The Bundesbank To Prepare For Plan B?" we suggested that according to recent fund flow data, "the Bundesbank wants slowly and quietly out." Out of what? Why the European intertwined monetary mechanism of course, where surplus nations' central bank continue to fund deficit countries' accounts via an ECB intermediary. We speculated that according to the recent ECB proposal, the primary beneficiary of direct ECB intermediation in fund flows, as Draghi has been pushing for past month, would be to disentangle solvent entities like the Bundesbank, allowing it to prepare for D-Day without the shackles of trillions of Euros in deficit capital by virtually all of its counterparties. Today it is the turn of Goldman's Dirk Schumacher to pick up where our argument left off, and to suggest that it is indeed a possibility that the Buba would suffer irreparable consequences as a result of Eurozone implosion, and thus, implicitly, it is Jens Wiedmann's role to accelerate the plan of extracting the Buba from the continent's rapidly unwinding monetary (and fiscal) system. Needless to say, the possibility that a European country can leave at will, as the European Nash Equilibrium finally fails, is something the Bundesbank not only knows all too well, but is actively preparing for: here is what we said on December 6: "we may be experiencing the attempt by the last safe European central bank - Buba - to disintermediate itself from the slow motion trainwreck that is the European shadow banking (first) and then traditional banking collapse (second and last). Because as Lehman showed, it took the lock up of money markets - that stalwart of shadow liabilities - to push the system over the edge, and require a multi-trillion bailout from the true lender of last resort. The same thing is happening now in Europe. And the Bundesbank increasingly appears to want none of it." After all, Germany has been sending the periphery enough messages to where only the most vacuous is not preparing to exit. The question is just how self-serving is Germany being, and whether once Buba is fully disintermediated, Germany will finally push the domino, letting the chips fall where they may?

As Bob Janjuah, of Nomura, notes in his final dissertation of the year, our in-boxes are stuffed with all the good cheer of sell-side research outlooks. However, the bearded bear manages to cut through all the nuance to get to the six questions that need to be addressed in order to see your way successfully in 2012. With the US two-thirds of the way through the post-crisis workout phase while Europe remains only half-way through, and China a mere one-third through the necessary adjustments to less global imbalance, he is not a global uber-bear on every asset class as the net effect is modest global underlying demand and plenty of savings sloshing around looking for a home. The market, though, will have to adjust further to an extended period of weakness in Europe, which will impact EM growth expectations and so the existential ursine strategist is skewing his macro expectations to the downside and with the market pricing a 'softish' global landing, there remains a considerable gap between downside risk potential and current expectations. Furthermore, Janjuah believes the upside is relatively self-limiting on the basis of commodity price pressures and the potential for property or asset bubble bursts - leaving upside limited and downside substantial.

As is by now well known, it was the British refusal to budge and thus agree to the fiscal compact from the December 9th summit, that led to the realization that the European bailout is now further away than ever before. And as reported earlier, tomorrow European finance ministers will sit down to finalize the terms of a €200 billion IMF injection, funded by various European governments, which is the last ditch rescue effort now that the EFSF and ESM have both failed to convince the market of a long-term solution. Enter Britain. Again. Because as the Telegraph reports, it will be up to Britain to fund not just any portion of the upcoming €200 billion payment, but the second largest one, a commitment which David Cameron and the majority of Britain will likely balk at. "Figures suggest European Union officials expect British taxpayers to be the second largest contributor. The Prime Minister has repeatedly promised not to provide any extra funding for the IMF for the specific purpose of saving the euro and Britain is already liable for £12 billion of loans and guarantees to Ireland, Greece and Portugal...An EU official said Britain was still expected to contribute €30.9 billion (£25.9 billion), leaving the country as the second biggest contributor to the new IMF fund behind Germany and equal with France." So ten days after British obstinacy to "on the fly" European bailout plans led to the EURUSD dropping to 2011 lows, will it be the Albion that once again leads to another step down in the European currency, as it now becomes clear that the last ditch Plan Z "IMF Bailout" plan is now worthless? We will find out shortly, although we are confident that anyone hoping that Britain will do an about face and revert on its controversial position, will be disappointed.

On Friday, as the Eurobond market was briefly soaring, we attributed the move to sentiment that was best captured by a note out of Morgan Stanley's govvie desk: "The carry trade is happening, there is no doubt about it. In SPGBs (45bps tighter t0) we estimate 15-20bn (incl 6bn auction) of buying from domestic mid sized banks and cajas THIS WEEK (500mm is usual 2way trading volume per day). We are seeing the same starting with Italian mid tier banks in BTPs today (35bps tighter t0). Also Ireland seems to be very well bid up to 2016 maturities (75bps tighter on day). While Huw and Laurence anticipated this in their research piece on the LTRO from yesterday, we certainly did not expect it to be this intense and front loaded, this is the strongest buying we have seen all year, it feels a lot like QE." In simple summary, what MS was hoping and praying (because if clients are buying, MS is selling) its clients would believe, is that European banks would promptly forget that Europe has trillions of rolling over financial corporate debt, and instead of focusing on generating the cash needed to pay down maturities if no buyer stepped up, banks would somehow re-lever, by buying up even more sovereign debt in hopes of catching a few bps of carry, and completely ignoring the "#1 issue at the heart of the Eurozone crisis"^TM - the fundamental supply/demand paper maturity mismatch. Not to mention that any statement which needs the redundant "there is no doubt about it" is a 100% lie. It took the market about 3 hours to wake up from its zombified state and to do a 180, proceeding to rapidly sell off European debt following the realization that the Morgan Stanely thesis is nothing but a purely self-serving lie. The folks at Reuters IFR explain why MS completely botched this one up, and why Eurobanks are finally starting to wake up to the realization that the MF Global trade just may not be coming to town.

Five months ago, Zero Hedge first boiled down the math of the European bailout as follows: "The Fatal Flaw In Europe's Second "Bazooka" Bailout: 82 Million Soon To Be Very Angry Germans, Or How Euro Bailout #2 Could Cost Up To 56% Of German GDP." And while everyone was assuming Germany would be delighted to go down for the proverbial insolvency "ride" one more time, we strongly urged not to make that assumption, as we posited the fundamental equation running through the mind of every German: is the opportunity cost of keeping the euro high enough to threaten either a complete German economic meltdown (fiscal support), or hyperinflation (massive ECB intervention), and that the outcome would not be the one the Eurocrats wanted. While at the time our speculation was seen as preposterous, it has since become mainstream (just look at the Eurostoxx). The latest observation on just this comes from Grant Williams' latest "Things that make you go hmmm" where he says: "France and Germany need to be prepared to foot the bills that are coming due and, by ‘France and Germany’, I mean Germany because, with a budget deficit of 7.1%, and debts of 83% of GDP, France WILL be downgraded shortly and will be in no position to chip in to the EFSF as their own ship begins to take on a serious amount of water in the shape of rising borrowing costs. That leaves the intransigent Germans. With a budget deficit of 4.3%, a record of having exceeded the mandated deficit limit in seven of the past eleven years a debt-to-GDP level of 85% and climbing, not to mention an economy that is on the verge of a recession (I told you not to MENTION that), Germany may soon have to go  and sit somewhere quiet in order to reflect on what to do next." And so on.

Julius Caesar undoubtedly was showing off with his Veni-Vidi-Vici (I came, I saw, I conquered) when referencing to his short war outside Zela (Zile) in Turkey over two millennia ago.  Similarly, if we were to use a short catchy-comment for the almost nine years America has invested in its “Iraq Mission,” we would be on target by condensing the US experience in also three Latin words, although not as melodic this time: Invasi-Eradicavi-Turbavi which sadly stand for, I invaded, I destroyed and I threw-into-chaos. No matter what the Pentagon and White House tell us, the fiasco in Iraq likely stands as the most costly mistake in America’s history, a true Keystone Kops type of political dark comedy.  And it wasn’t a bad or flawed decision by a singular moron or group of morons – Bush the Younger, Sadist Cheney and Loquacious Rumsfeld composing the original warpath triumvirate, together with two dozen equally deranged staff of their inner circles.  Unfortunately, this time Congress, together with a brainwashed public, closed rank with an evil and criminal White House.  So, whether the American citizenry likes it or not… the Iraq conflict wasn’t just Bush’s war, but “the peoples’ war,” a war with a dangerous aftermath yet to come, one we’ll likely be paying for in the future with additional blood and treasure.

Buried deep in the 137 pages of Fixed Income 2012 Outlook, Deutsche's bond group looks at the implications of an extremely flat US Treasury Curve and implicitly low bond risk premium. Based on 5Y5Y rates relative to long-term growth and inflation expectations, tail inflation risks, and estimates of supply/demand shocks, the current bond risk premium are at levels that were witnessed ahead of the bond market sell-off of 1994, at the peak of the bond market conundrum of 2004-2006 and around QE announcements. This 100bps or so of 2s10s 'flatness' relative to real short rates and expected deficits also corroborates this risk premium. So what does this tell us? The extremely low risk premium fully captures QE expectations. Empirically, they find USD19bn of new QE tends to reduce real rates by 1bps and based on this and a model of fundamentals and risk aversion parameters, they find that Twist was fully priced in last September and since then the current dislocation suggests another full QE2-style package of about $800bn is already priced into the market (ex MBS reinvestment). We just hope the market is not disappointed.

A few hours ago the Des Moines Register threw its support behind the Bain Capital founder, and the man now known to have actively destroyed any trace of his public "service" before his 2007 Massachusettes office handover (with a pending response to a Reuters FOIA, which will disclose just what it was that Romney was so tenuously shredding). Because according to the Iowan newspaper, Mitt Romney "is the best to lead" America, although into what, is not quite clear - perhaps the biggest Fed funded LBO (with a Bain Capital $1 mezz piece) of all time, that of America? We don't know. And neither does the Register's editorial board. What they do know are hollow adjectives, such as "sobriety", "wisdom" and "judgment" which somehow are applicable to Romney, if not so much "betting" and "shredding." Those looking for a late night laugh can read the OpEd below (link to tomorrow's front page here). And ironically, while likely set to provide a very short-term boost to Romney's chances, it is the baseless ongoing accusations against Ron Paul that will likely solidify the groundswell behind the Texan, with such desperate platitudes as "Ron Paul's libertarian ideology would lead to economic chaos and isolationism, neither of which this nation can afford." Because what America certainly needs is more of that old ideology of doing everything just the same and hoping for the best, because if there is anything Romney's would be predecessors have taught us is that hope apparently is a credible strategy. But perhaps most relevant is the reminder that the Des Moines Register is a Gannett company whose Chairman just happens to be one Marjorie Magner, whose bio reads: 'Ms. Magner, 61, is Managing Partner of Brysam Global Partners, a private equity firm investing in financial services firms with a focus on consumer opportunities in emerging markets founded in January 2007. She was Chairman and CEO of Citigroup's Global Consumer Group from 2003 to 2005. She served in various roles at Citigroup, and a predecessor company, CitiFinancial (previously Commercial Credit), since 1987. Ms. Magner currently serves as a director of Accenture Ltd. and Ally Financial Inc. and served as a director of The Charles Schwab Corporation from February 2006 to May 2008. Ms. Magner has broad business experience and financial expertise from the various senior management roles she held with Citigroup."

As we wind down 2011, the time for predictions for what is to come as nigh. Having posted what UBS believes their biggest list of surprises for 2012 will be earlier, we next proceed with out long-term favorite - Saxobank's list of "Outrageous Predictions" for what the bank has dubbed "2012: the Perfect Storm." Mostly proposed tongue in cheek (unlike predictions by other pundits who actually believe their own delusions), the list of 10 suggestions represents nothing less than an attempt to force people "out of the box" and look at the world with a set of "what if" eyes. Because if there is anything 2011 taught is, it is not to discount any one event from happening. As Saxo says: "Should one, two or three of our Outrageous Predictions come to pass, it would make 2012 a year of tremendous change. This may not necessarily be a negative thing either - and given the  structure and uncertainties in the marketplace here at the end of 2011, we would suggest that even if none of our predictions come to pass, equally important and totally unanticipated events will. Sometimes we need to get to a new starting point before we can gain the right perspective. We hope 2012 will be the year where we start on the long march towards re-establishing jobs, growth and confidence." Naturally, the best outcome for 2012 would be the end of the broken status quo model, and a global fresh reset... but not even we are that deluded to believe that the quadrillions in credit money (real or synthetic) will allow such a revolutionary event to occur in such a brief period of time. At least not before everything is thrown at the intractable problem unfortunately has just one possible long-term outcome. In the meantime, here, to help readers expand their minds, is Saxo Bank's list of "Outrageous Predictions" for 2012.

Traders in the market (what little is left of them) always seek out the investment thesis with the highest upside/downside ratio to a delta in any fundamental forecast. In other words, what derivative play to a secular trend generates the higher IRR? A good example is the ABX which allowed contrarians in 2006 and early 2007 to bet on a collapse in subprime and put on a "short" at next to now cost of carry, with practically no downside if the thesis ended up being wrong, and unlimited upside (just ask Paolo Pellegrini and Kyle Bass). Well, as we just learned, one of UBS "surprises" for 2012 is that oil could drop below $70/barrell. Is this possible? Absolutely - should the Eurozone collapse, and/or China experience the long-overdue hard landing, a deflationary shock (which will naturally only precipitate the central banks into an even more rapid devaluation of legacy paper currencies) can and likely will send crude tumbling (Iran geopolitical concerns aside) as happened back in early 2009 when crude collapsed to around $30/barrel however briefly. So is there a better option to play crude downside than merely shorting CL? Perhaps one idea with better "upside" in case of a deflationary collapse in crude is to get bearish on Boeing instead. As the following chart from Goldman shows, 3 of the 4 biggest widebody (and thus most profitable) aircraft orders are from Gulf airline companies - Emirates, Qatar and Etihad. Together, they amount to about 450 profitable future orders... which could well be cancelled if Gulf states revert to their panicked state last seen so vividly in the spring of 2009 when they were cancelling orders left and right.