Archive - Jan 2012 - Story

Almost six months ago we discussed the dramatic shifts that were about to occur (and indeed did occur) the last time the New York Fed tried to unwind the toxic AIG sludge that is more prosaically known as Maiden Lane II. At the time, the failure of a previous auction as dealers were unwilling to take up even modest sizes of the morose mortgage portfolio was the green light for a realization that even a small unwind of the Fed's bloated balance sheet would not be tolerated by a deleveraging and unwilling-to-bear-risk-at-anything-like-a-supposed-market-rate trading community. Today, we saw the first glimmerings of the same concerns as chatter of Goldman's (and others) interest in some of the lurid loans sent credit reeling. As the WSJ reports, this meant the Fed had to quietly seek confirming bids (BWICs) from other market participants to judge whether Goldman's bid offered value. The discreteness of the enquiries sent ABX and CMBX (the credit derivative indices used to hedge many of these mortgage-backed securities) tumbling with ABX having its first down day since before Christmas and its largest drop in almost two months. The knock-on effect of the potential off-market (or perhaps more reality-based) pricing that Goldman is bidding this time can have (just as it did last time when the Fed halted the auction process as the market could not stand the supply) dramatic impacts as dealers seek efficient (and critically liquid) hedges for their worrisome inventories of junk. The underperformance (and heavy volume) in HYG (the high-yield bond ETF we spend so much time discussing) since the new-year suggests one such hedging program (well timed and hidden by record start-of-year fund inflows from a clueless public which one would have thought would raise prices of the increasingly important bond ETF) as the market's ramp of late is very reminiscent of the pre-auction-fail-and-crash we saw in late June, early July last year as credit markets awoke to the reality of their own balance sheet holes once again.

As volumes this year in stock markets remain significantly below last year's but high yield bond ETF inflows reach record highs, TrimTabs offers some context for the massive relative flows of real cash into checking and savings accounts versus stock and bond mutual fund and ETFs. Not-Charles-Biderman, otherwise known as David Santschi of the now-infamous Bay Area backdrop, explains the incredible statistic that in the first 11 months of last year investors poured more than eight times more money into checking and savings accounts than into Fed-inspired risk assets in general. Even with rates ultra-low, the Fed's efforts to drive speculative flows is dwarfed by investors' aggregate sense of the reality of our tenuous situation as a massive $889bn was poured carefully into mattresses while a measly $109bn went into risk-worthy assets (including bonds). As Santschi concludes, as long as most investors keep hiding most of their money away, the economy is unlikely to get off to the races anytime soon and while we agree from a consumptive demand perspective, any recovery will only be truly sustainable via savings which are being desperately drawn-down by a need to maintain standards of living that are perhaps too much to expect.

Are the markets already front running a potential announcement of a third round of Quantitative Easing (QE 3)?   Maybe so.  We had expected QE3 at the end of last summer as the economy weakened substantially from the impact of the Japanese earthquake/debt ceiling debate/Eurozone crisis trifecta.  However, with political pressures running high due to the raging battle in Congress raising the debt ceiling there was little support from the public for further intervention.  Furthermore, with inflation, as measured by CPI, already outside of the Fed's comfort zone, the Fed opted to institute "Operation Twist" (O.T.) instead. With the Euro-Crisis on the broiler, another debt ceiling debate approaching, the U.S. economy struggling along as Europe slips into a recession and corporate earnings being revised down there are plenty of reasons for stocks to decline in price.  Yet, they have continued to inch up.  With short interest on stocks having plunged in recent weeks it certainly sounds like the markets are betting on something happening and soon.

Last week, when we pointed out what was then a record $77 billion in Treasury sales from the Fed's custody account, in addition to noting the patently obvious, namely that contrary to what one hears in the media, foreigners are offloading US paper hand over first, there was this little tidbit: "The question is what they are converting the USD into, and how much longer will the go on for: the last thing the US can afford is a wholesale dumping of its Treasurys. Because as the chart below vividly demonstrates, the traditional diagonal rise in foreign holdings of US paper has not only pleateaued, but it is in fact declining: a first in the history of the post-globalization world." Well as of today's H.4.1 update, the outflow has increased by yet another $8 billion to a new all time record of $85 billion, in 6 consecutive weeks, which is also tied for the longest consecutive period of outflows from the Fed's Custody account ever. This week's sale brings the total notional of Treasurys in the Custody account to just $2.66 trillion (down from a record $2.75 trillion) and the same as April of last year. And since the sellers are countries who have traditionally constantly recycled their trade surplus into US paper, this is quite a distrubing development. So while the elephant in the room could have been ignored 4, 3 and 2 weeks ago, it is getting increasingly more difficult to do so at this point, especially with US bond auctions mysteriously pricing at record low yields month after month. But at least the mass dump in Treasurys explains the $100 swing higher in gold in the past month.

2011 was a merry-go-round of more bailouts, more deferrals and more denial. Everyone is tired of the Eurozone. It’s not fixable. There’s too much debt. The politicians don’t know what’s going on. Nothing has structurally changed. We’re still on the wrong path. There’s more global debt than there was a year ago, and it’s the same old song: extend and pretend, extend and pretend,… around and around we go,… and it isn’t fun anymore. Just as we wrote back in October 2007, and again in September 2008, we feel compelled to state the obvious: that the financial system is a farce. It’s a complete, cyclical farce that defies all efforts to right itself. This past year continued the farcical tradition with some notable scandals, deferrals and interventions that underscored the system’s continuing addiction to government interference. With the glaring exception of US Treasuries and the US dollar (which are admittedly two of our least favourite asset classes), it was not a year that rewarded stock picking or safe-haven assets. Many developments during the year bordered on the ridiculous, and despite some positive news out of the US, we saw little to test our bearish view. If anything, our view was continually re-affirmed.

Yesterday, in a must read post, Gluskin Sheff's David Rosenberg played the devil's advocate and presented a much needed experiment in contrarianism, attempting to unravel what it is that bulls may be seeing in the economy and the market (an analysis which may have to be revised after today's pro forma 400K in initial claims and deplorable retail sales update). While we don't know if anyone was converted into the permabullish fold as a result, it certainly was useful to have a view of what "sliding down the wall of satisfaction" means currently . Today, Rosie is back to his traditional skeptical self with today's publication of the "Laments of a Bear", which is yet another must read inverse view of everything that yesterday was not. Our advise to readers: be aware of both sides of the argument and make up your own mind. Plus at the end of the day the only thing that really matters is what side of the bed Bernanke wakes up on...

Thanks to disappointing macro data early on and better-than-expected European auctions (and ECB not cutting), the EUR went bid early on, accelerate after the Europe close, and stayed that way for most of the day (EURUSD squeeze? or ES-EUR convergence?) ending a one-week highs. Credit markets gapped tighter around their open (thanks to Europe's early strength) but leaked back as the morning wore on. Stocks underperformed credit overall as IG and HY credit rallied into the European close and held gains - while HYG (the high yield bond ETF) significantly underperformed on the day (compressing its NAV premium further despite a modest late day pullback) which should be mildly concerning for bulls (given the size of flows and momentum behind it recently). ES (the e-mini S&P futures contract) converged with VWAP and CONTEXT around lunch then pulled higher into the close managing to tag the day-session open but broad risk-drivers did not participate so much (and we saw higher average trade size volume come in covering at the close). Oil is down 2.6% on the week (sub $99) seeing its biggest 2-day drop in a month and while Gold and Silver leaked lower from midday highs, Copper managed to hold onto its gains (now up over 6% on the week). Volume ended about average for the year in NYSE stocks and ES (though still well down from December).

Wonder why all bank earnings over the past 3 years are fake? Wonder why few if any banks ever dare to take major write offs and represent the true nature of their financials? Wonder no longer: Bloomberg's Jonathan Weil explains.

Update:

• HOUSE TO VOTE JAN. 18 ON OBAMA'S DEBT-LIMIT INCREASE REQUEST

Two days ago we wondered how long it would take for Obama to restart the debt ceiling theater. Not that long it turns out.

• OBAMA SENDS CONGRESS REQUEST TO RAISE DEBT CEILING
• OBAMA NOTIFICATION STARTS 15-DAY CLOCK FOR CONGRESS TO VOTE

So with Congress in recess, will Obama succeed in passing another automatic vote using base trickery? The same Obama, who as recently as 3 hours ago warned Congress that any attempts to pass approval on the Keystone Pipeline without his involvement are "counterproductive"... In other news, America' new debt ceiling of $16.3 trillion, or 107% of GDP is now just a formality, about to be interrupted by a little circus clowning.

UPDATE: Oil Sub $100.

And so the escalation ends, if only for the time being, as Iran chalks a (Pyrrhic?) victory.

• EU IRAN OIL EMBARGO SAID TO BE LIKELY DELAYED BY SIX MONTHS

Why? Because the world slowly realized that the potential surge in oil prices would tip a world already on the verge of a recession even deeper into economic contraction. Not rocket science, but certainly something the US president apparently has been unable to comprehend, especially if hoping that he would merely transfer exports from Iran to his close ally Saudi Arabia which would cement its European market monopoly even further. Or, perhaps, someone just explained to Obama that Embargo in January + QE3 in March = No Reelection...

In other news, crude is now dumping.

Dear U.S.A.--your overdraft protection is about to be pulled.

Dear United States of America: We regret to inform you that your withdrawals exceeded your deposits last year by $1,600,000,000,000 ($1.6 trillion), including your "supplemental appropriations" spending.

Your account does have an overdraft protection, and so bonds were sold to cover your $1.6 trillion overdraft. While we value your business, we feel obligated to remind you that this is the third year that your overdraft protection exceeded 10% of your gross national product (GDP), and it seems your account is on course to register yet another $1.6 trillion overdraft in fiscal year 2012.

Currently, your overdraft account exceeds your GDP of $15 trillion.

Just like in yesterday's weakish 10 Year auction, the thunder from Tuesday's strong 3 Year has all but gone. In today's issuance of $13 billion in 30 year reopening, the results were anything but strong, with the bond pricing at 2.985%, a a 3 bps tail compared to the 2.955% When Issued. Furthermore, the BTC was a big drop compared to last auction's record 2.98, coming at 2.60, compared to 2.68 in the last 12 auctions. And with Indirects taking down just 31.9%, and Directs sliding to a one year low of 7.2%, it means that it was the Fed, via the Primary Dealer repo mechanism that once again took down a whopping 60.9% of the entire auction. Needless to say, the bond market response was not pleasant, but was to be expected as the Fed continues to artificially massage the curve in any and every way possible. Most hilarious, however, was the tweet sent out by Bill Gross in the minutes after the auction which we present below: it speaks for itself.

On the day when Greek 1Y yields broke above 400% for the first time, a consideration of just what Greece would look like post-exit is perhaps fruitful. Looking at hypothetical forward rates (generated from covered interest rate parity between EURUSD FX and EMU sovereign interest rates), MSCI has an interesting analysis of what a decoupled Drachma (and for that matter Lira, Escudo, and Irish Pound) would look like. Given the Greeks entered the EMU in January 2001 at 340.75 Drachma to the Euro, the current market is pricing in a massive devaluation to around 1530 Drachma to the Euro. Perhaps as further evidence of the market's perspective that a devaluation is likely, from extremely high correlations just over a year ago, the implied new Greek Drachma vs Euro has dropped to almost negligible correlation against an implicit Deutschmark vs Euro. As the PSI discussions go from bad to worse (as we expected and discussed yesterday), it seems the market is increasingly expecting at best a coercive agreement (if not outright exit).