Archive - Jun 8, 2012 - Story

The significant rise in global systemic risk that occurred in 2008 remained until mid 2010 when it began to subside a little as Jackson Hole and QE2 seemed to allay fears somewhat. However, in the last year or so, BofA's market fragility index has soared higher alarmingly signaling higher systemic risks than in the peak pre-Lehman era. This confirms the massively elevated signal for global systemic risk that credit markets are also sending.

Just as predicted earlier, the GDP downgrades begin.

We revised down our Q2 GDP tracking estimate by two tenths to +1.8% (quarter-over-quarter, annualized) from +2.0% previously. The downward revision primarily reflects weaker-than-expected real export growth in April. This was partly offset by stronger than expected wholesale inventories, which increased by 0.6% (month-over-month) in April.

Surely this explains why the market is about to turn green.

Actually, we are not sure just what the president will discuss in his 10:15 am address on the economy, but our suggestion that the president will suggest more spending as the cause solution to all of America's problems seems like a fair guess. That or blaming Merkel for the epic NFP miss last Friday. We are not sure what the shot keyword is today (aside for thingamajig of course), but we know what isn't: $15,734,596,578,458.59. That's was US Federal debt as of close on Wednesday: another fair guess is that it will receive exactly zero prominence in Obama's latest sermon.

The biggest news this morning is the talk that Spain's Rajoy will discuss 'how to shore up' his banking system with the EU officials this weekend. As SocGen noted earlier, EURUSD managed a 30 pip bounce and then promptly sold off - 'That says it all really'. A  'bailout' of Spanish banks poses a lot more questions than it answers.  Specifically that this crisis began with Greece and now has spread to Spain. Will the focus move on again?  The market believes that European officials have yet to put in place contingencies that will stem contagion and stress on other European countries. Hence the anemic response from currencies. What is clear is that Greece, and now Spain, have set the dismal example for their peers: 'Crush the banks, then get bailed out' which leaves only one course of action it seems, banks will be shorting themselves to force action from their overlords in Berlin and Brussels. If we get a risk-on bounce in Italian banks, on any weekend 'interim' resolution for Spanish banks, then shorting into that strength seems more than appropriate (or long credit, short equity as burdens are shared).

Dear German readers: please avert your eyes.

While the ever-present analogs to the last few years of crisis-response-improvement-complacency (CRIC), as Morgan Stanley so clearly described, have provided a clear picture of what to expect, the treja vu is now starting to fade in one very important market indicator. As BofA notes, the forward expectations of Fed Funds rates have finally started to shift from an endless string of 'hope' for growth and reflation just around the corner and rate hikes any quarter now (despite the Fed's 'exceptional' chatter) to a much less sanguine pit of despair that rates will indeed stay low for 'ever' reflecting a stagnating deleveraging economic reality. At some point they will be right as the Japanization of rates around the fiat world becomes the new normal and 'smart/fast-money' traders appear hope-less.

Perhaps some novel solution is found but this is not the muddling along kind of thing at all. This is the changing of charters kind of thing, the changing of national banking regulations kind of thing; the ceding of power to Europe kind of thing and anyone who thinks that this can all be accomplished in a matter of days is out having tea with Cinderella’ fairy godmother. Yet equities have rallied and bond spreads stopped widening on just this kind of hope but I predict that this will all be short-lived because, on its face, it is irrational. There is nothing wrong with having hopes and prayers but to base investment decisions on irrational interventions of some Divine power where there is not even a door for the Divinity to enter is just poor judgment by this name or any other you may concoct. It is no longer a case of “Risk on/Risk off” but of “Reality on/Reality off” and I advise you to keep pressing the “Reality on” button!

Just as we expected earlier, when we suggested that Spain is waiting to see Germany's preliminary response to its (re)newed push for a bailout, Spain has seen the outcome, and does not like it.

• SAENZ SAYS KNOWS OF NO `TECHNICAL' MEETING ON SPAIN

And another just brilliant headline:

• Consultants, IMF to Determine Spain Banks’ Needs

Yup. Consultants

This should explain it all.

That economic data out of Europe was disappointing overnight should come as no surprise to anyone. That Spain is broke, and there is no money to bail it out under the existing framework (and that Germany is unwilling to come up with a new bailout scheme), should also be no surprise. And yet they somehow manage to stun the market... each and every day. Which is why overnight action has now boiled down to a simple algorithmic exercise: is there a short covering squeeze: if yes, then rip, aka Risk On. If not, then Risk Off. So far, the squeeze has not been initiated which is also to be expected, following the biggest short covering squeeze in up to two years. This too may change if repo desks decide to pull borrow as they tend to do during regular hours, to give the impression that the latest and greatest bailout plan is "working." And in other news, which is completely irrelevant, here is the actual news.

• Obama Seeking Ally on Europe Finds Merkel a Tough Sell (Bloomberg) - but he has an election to win
• China rate cut sparks fears of grim May data (Reuters)
• China faces stimulus dilemma  (FT)
• Papademos warns of Grexit vortex (FT)
• China’s Shipyards Fail to Win Orders as Greek Owners Shun Loans (Bloomberg)
• Rajoy Holds Bank Talks With EU Leaders as Fitch Downgrades Spain (Bloomberg)
• Capital Rule Is One Size Fits All (WSJ)... now the modest question of where to get the $3.9 trillion in capital
• Merkel Pokes at Cameron With Backing for Two-Speed Europe (Bloomberg)
• City safeguards set Britain at odds with EU (FT)
• Bernanke says Fed to act if Europe crisis deepens (Reuters)