Archive - May 2012 - Story

About two years ago the Norwegian sovereign wealth fund did something truly remarkable: it invested for infinity: "Norway, which has amassed the world’s second-biggest sovereign wealth fund, says Greece won’t default on its debts. The Nordic nation’s $450 billion Government Pension Fund Global has stocked up on Greek debt, as well as bonds of Spain, Italy and Portugal. Finance Minister Sigbjoern Johnsen says he backs the strategy, which contributed to a 3.4 percent loss on European fixed income in the second quarter, compared with gains on bonds in Asia and the Americas. Norway says its long-term perspective will protect it from losses. “One could say we are investing for infinity,” Johnsen said." Well, we all know how the experiment ended: "Norway Sovereign Wealth Fund Purges All Insolvent Eurozone Debt Holdings." So much for infinity. But that has not stopped others to boldly catch falling knives where so many other have tried to catch falling knives before, and failed. Enter Greylock Capital and various other hedge funds who are positive they have rediscovered the wheel.

What are the classic signs of an asset bubble? People piling into an asset class to such an extent that it becomes unprofitable to do so. Treasury bonds are so overbought that they are now producing negative real yields (yield minus inflation). And so America’s creditors are now getting slapped quite heavily in the mouth by the Fed’s easy money inflationist policies. John Aziz proposes (much to the consternation of the monetarist-Keynesian “print money and watch your problems evaporate” establishment) that this is a very, very, very dangerous position. And that those economists who are calling for even greater inflation are playing with dynamite. See, while the establishment seems to largely believe that the negative return on treasuries will juice up the American economy — in other words that “hoarders” will stop hoarding and start spending — we believe that negative side-effects from these policies may cause severe harm. Do we really want to risk the inflationary impact of continuing to print money to monetise debt (and hiding the money in excess reserves, thereby temporarily hiding the inflation). As John wrote recently - "So, does the accumulation of excess reserves lead to inflation? Only so much as the frequentation of brothels leads to chlamydia and syphilis." We’d call that playing dice with the devil.

Back in March India did a quick flipflop on its then announced Cotton export ban following complaints by China and domestic trade groups, which created quite a stir in the cotton market, first sending it soaring then plunging on supply concerns. This was promptly followed by another misguided attempt to control and benefit from the price of a key commodity, in this case gold, when the country announced it would impose an excise tax on gold jewelry, sending its gold merchants into a nationwide strike. This did not last long either and a few days later, merchants cancelled their strike following promises form the government that too would be promptly overturned. Sure enough, the excise tax has been officially withdrawn, and the biggest source of gold demand is set to see gold imports unleashed once again.

We have been warning of the pending fiscal cliff in the US and the somewhat inevitable debt ceiling debacle, election uncertainty, and the question of Fed independence in an election year as potential catalysts for risk flares in the US and abroad. For now, US equities are happy to ignore these events, still drawn in their Pavlovian-educated manner to US equities for their nominal enrichment. The trouble is - there are clear warning signs from some particularly noteworthy markets that all is not well (that appear more capable of comprehending fundamentals). Forget for a moment the overnight plunge and recovery in futures as this will bring only anchoring bias; a step back to 30,000 feet and we note that the spread on USA Sovereign CDS has risen by over 30% in the last month (now back at 40bps or 3-month wides) flashing a worrying warning signal for US equities if the past is any guide. Remember that US CDS are denominated in EUR and do not simply reflect the 'default' risk of the fiat-issuing USA but the devaluation or restructuring risks - and it appears market participants are getting nervous once again of the profligacy of the US government and the ineptitude of the central banks with their one-trick-pony experimentation. At the same time, central banks' broad repression has crushed volatility in every asset class - except, as Morgan Stanley notes - credit which is inferring considerably higher chance of a risk flare in the short-term. So while this week will bring cheers of growthiness and cooperation and decoupling, the all-seeing eye of credit markets remain far less sanguine.

The Greek elections culminated with the worst possible outcome: 2 votes short of a majority for the pro-bailout New Democracy and Pasok parties. So what happens next? Well - two things: expect to see random stop hunting ramps in the EURUSD and ES on false rumors that despite the math, a pro-bailout coalition government is being formed. It isn't, but it will take out all FX and ES stops to the upside first as skittish shorts get burned as usual on planted fake headlines. More importantly, and as predicted last week, we will likely see yet another Greek election as the political vacuum in Athens is likely too big to be circumvented in a few days. Below we present a summary of immediate next steps as summarized by the WSJ. Yet one thing we want to bring attention to is that as we pointed out first on Saturday, a key even over the next two weeks, during a time when Greece will most likely not have an active government in place is the May 15th maturity of €430 million in international-law bonds whose holders have not agreed to the terms of the PSI and thus demand full payment... of money that Greece does not have. Finally we already know that Norway is the biggest non-PSI compliant entity out there. So will we finally see the first Greek PSI-related lawsuit on May 16 if and when Greece fails to make a payment? We will know in 9 days whether the European soap opera gets even more exciting than usual as various European countries start suing each other in international court, especially when one of the countries will have no government for the foreseeable future.

Just like Rome wasn’t built in a day, the Eurozone won’t be destroyed in a day, but it is on a path that leads to eventual dismantling. This week we will see everyone play nice. Conciliatory words will be spoken.  Growth will become the topic de jour.  The markets will fall all over themselves once again on news of bank bailouts.  The headlines we get in the early part of this week will once again be overwhelmingly designed to encourage people and the markets.  Europe will have a new spirit of co-operation and will welcome fresh insights into the process.  Growth, growth pacts, plans to grow, infrastructure growth, etc., will be talked about.  There will be talk, and maybe even action on the bank recapitalization efforts.  Good banks and bad banks will abound.  Governments will promise money to banks at rates so low no sane investor would even consider. Ultimately these plans will fail, and we will see fresh lows on the year for stocks, with the U.S. and Germany hit hardest as justifying further bailouts for the core will be nigh on impossible, growth is not easy to achieve, and the good-bank-bad-bank model is a loser from the start.

We have been pounding the table that 2012 will be a replica of 2011 since before January 1: after all the central planners' script book has only so many pages. Sure enough, here is yet another indicator. Job gains remain anchored in the low cost labor sectors of the economy - retail, temporary, leisure, and hospitality - a pattern, as Bloomberg Brief points out, that has characterized growth during the current expansion. While this growth in jobs may optically appeal to many, it leaves a 2.9% spending growth pace unsustainable especially as we see, in the three charts below, a growing sense of deja vu in the labor market overall. Between a Spring-time swoon in non-farm payrolls, a cyclical crunch in service sector hirings, and a mirror-image trough and deterioration in initial claims, 2012 appears to be heading towards the same pattern of central-bank disappointment as the last three years of this nominal recovery. Same Deja Vu... Different year.

While events over the weekend have had a dramatic impact on the political landscape of Europe, that's just what they are: political events. Yet for all the rhetoric, promises, and bluster, only one thing matters in the end: cold, hard math. The same math which last weekend indicated that Europe is still facing trillions and trillions in bank deleveraging. That has not changed one cents between then and now, regardless who is the puppet (muppet?) head of this country or that. But since that won't become evident for at least a few more years, it can be safely forgotten, until the time comes to recall it that is, at which point there will be a full blown crisis even though there were years of advance warning to prepare for the crunch. So here is some more math: in a downside case forecast looking at funding capacity of Spanish and Italian banks - the same banks that would have been long insolvent had it not been for a $1.3 trillion injection by the ECB - Deutsche Bank predicts that the two groups may have as vast a funding shortfall as €210 billion in 2012 (€114.4 billion in Spain, €96.1 billion in Italy). Which to DB means one thing of course: more LTROs coming because once the market has habituated to the now periodic infusion of monetary heroin it will not let go until it is convulsing in its death rattle, something the status quo will never allow, or until it gets just one more hit.

Now that France has a Socialist President the story is not over, not even close to over as the next French elections, for Parliament, will roust the nation once more into the spotlight as Ms. Le Pen and her allies assume a new role, a higher ground, and as the financial situation in France deteriorates they may get an even bigger slice of the pie than thought at present. It is not just that Europe is going to be governed in a different fashion but that France will be run differently and with more difficulties I predict than currently thought. The recession and the anger directed at Germany are rousing the spirits once thought dead; France for the French, the Netherlands for the Dutch, Greece for the Greeks and soon we may find the same dreaded tale in Germany as Nationalism rings in the death knell for European unity and for the political parties that flaunted it. It is a rolling thunder all across Europe, that much is known, and the implications of it all will be felt by the people of each separate country. The dream is fading into the reality of a different sun and daylight will mask that which was dared to be dreamed years before.

After plunging by 19 points in the overnight session, and just touching the 100 DMA, ES has managed to score a recovery, one which has so far clutched at straws, namely stronger than expected German factory orders (+2.2% vs Exp. 0.5%) despite German GDP due in a week which may well push the core European country into the same double dip tsunami which has swept the resto of Europe, if it prints even a slightly negative GDP print. News from Spain that the "bad bank" bailout has started, with Bankia as the first casualty is also lifting spirits as it means that more taxpayer cash will be used to support risk assets. How long this micro euphoria of "bad news is good news" lasts is anyone's guess, but mostly that of the BIS which after failing to defend the 1.3000 EURUSD, has again managed to get the all important pair over the critical support area. 

European cash equities opened sharply lower this morning following electoral uncertainties arising from various corners of Europe, notably Greece and France. Volumes also remain light as the market closure across the UK reduces the number of participants today. The mainstream political parties from Greece, PASOK and the New Democracy, failed to establish a majority this weekend as voters firmly expressed their discontent with the political establishment, evident in the rise of fringe parties. As such, the leaders of New Democracy and PASOK will now attempt to establish a coalition party with the splinter group Independent Greeks (a party notable for its anti-EU/IMF stance), due to begin as soon as today. The uncertainty in Greece’s future has taken its toll across the markets today, with EUR/USD beginning the session sub-1.3000 and all European equities trading markedly lower throughout most of the morning session. Elsewhere on the political front, Francois Hollande has won the French Presidency and is to be inaugurated on May 15th, as such; participants now look out for any comments regarding the relationship between the new French leader and German Chancellor Merkel. The Spanish government are set to make an announcement on Friday concerning the continuing troubles over the Spanish banking sector, with a government source commenting that the plans will include the creation of a 10- and 15-year ‘bad bank’. Recent trade has seen a recovery across forex and stocks as EUR/USD grinds higher and stock futures move closer to unchanged. Strong German factory orders data has helped the moves off the lowest levels, as demand from outside the Eurozone helps lift the figure above expectations of +0.5% to +2.2% for March.

• Greek pro-bailout parties lack majority, final poll results (Reuters)
• Greek Election Gridlock Raises Risk for Bailout, Euro Future (Bloomberg)
• Socialist Hollande ousts Sarkozy as French leader (Reuters)
• Merkozy End Means Franco-German Gulf; Greek Voters Rebel (Bloomberg)
• Election swing leaves Greece teetering (Kathimerini)
• Merkel's Coalition Appears to Suffer Loss in German State (WSJ)
• The Only Solution to the Eurozone Crisis (FT)
• Cameron Faces Clamour From Party Right (FT)
• Falcone’s LightSquared Said to Get Week Credit Extension (Bloomberg)
• Hungary plans three-year, 15 billion euro IMF deal: state sec (Reuters)
• Putin pledges unity on return to Kremlin (Reuters)

It was only a matter of time before the next bank bailout began despite all those promises to the contrary. Sure enough, as math always wins over rhetoric and policy, earlier this morning the shot across the Spanish bow was fired after PM Rajoy did a 180 on "no bank bailout" promises as recent as last week. From Dow Jones: "Spain may pump public funds into its banking system to revive lending and its recessionary economy, Prime Minister Mariano Rajoy said Monday, signalling a policy U-turn. The government had pledged to not give money to the banking industry that is struggling in the wake of a collapsed, decade-long, housing boom. "If it was necessary to reactivate credit, to save the Spanish financial system, I wouldn't rule out injecting public funds, like all European countries have done," Rajoy said in interview with Onda Cero radio stations. The weakness of Spain's banks is weighing on the economy that contracted 0.3% in the first and fourth quarters, meeting most economists' definition of a recession. The unemployment rate is at an 18-year high 24.4%, data showed April 27. Banks have sharply reined in credit in the face of rapidly growing bad debt and problems getting finance on international markets." And explicitly we learn that Spain will inject EU7 bln of public funds via contingent-capital securities to support BFA-Bankia, El Confidencial reports, citing Economy Ministry officials it doesn’t name. It actually sounds cooler in the native: "El Estado inyectará 7.000 millones de dinero público para salvar BFA-Bankia." So it begins. Which also means that the "Bad Bank" idea is about to be launched. So far so good... The only problem is that like the EFSF, like the ESM, like the IMF, all those "deus ex machina(e)" also had to find funding of their own... and failed: it is one thing to intend to rescue the system. It is another to find the cash to do it with.