Archive - Jul 2012 - Story

UPDATE: AXP (down AH) and IBM (up AH) miss top-line; QCOM misses everything and guides down (up AH - AAPL staggered a little but unch now), EBAY beat (small up AH); KMI miss (down AH)

Far be it from us to say but once again equity markets spurted far and away beyond credit, interest rates, FX carry, commodities, and reality would have expected with only good-old VIX crashing to breathe that levered life into them. Ending the day with a 15 handle, VIX closed at its lowest in over three-and-a-half months and notably beyond where equity and credit relationships would expect as the front-end of the curve remains under huge pressure. Gold, the USD, and Treasury yields all played along on the day - trading with a decent correlation in a relatively narrow range but the open of the US day-session saw the appearance of the infamous equity rally-monkey who lifted us 1% in 30 mins then extended 10 more points into the European close. EUR roundtripped on the day leaving USD practically unch but -0.35% on the week. Credit markets were quiet (cash busier than synthetic) as IG, HY, and HYG all underperformed for the second day. Gold and Silver limped lower on the day as WTI surged back above $90 to two month highs. Treasuries traded in a very narrow range ending the day -2bps across the curve. Financials underperformed as Tech and Industrials reached for the skies with a 1.75% boost today (makes perfect sense after the earnings?). Decent average trade size on the day which was more prevalent up above 1365 suggests more unwinds of blocks into strength but something has to give with VIX for this train to stop running.

We thought it was coming (as we wrote yesterday); we heard the rumors; but now the 'temporary liquidity problem' that faced Sicily has been resolved by... yes, you guessed it - the transfer of EUR400 million from the Italian government. Do not worry though. As one official noted "there's no default risk for Sicily, whose budget was in surplus in 2010 and 2011". Unbelievable.

"The developments in Sicily are very serious," said Prof Giuseppe Ragusa from Luiss University in Rome. "It is just the sort of negative shock we don’t want right now. Everything has to go perfectly for Italy to pull through."

Hedging basic equity positions with options is nothing new. Buying Puts or selling calls to protect or enhance your position is not uncommon. The relative price that is paid (or received) for that protection is the implied volatility - it is the lever with which supply and demand for protection is turned. Strategies to hedge large equity positions have become more and more complex (as more and more complex instruments have become available). A more advanced strategy is to buy risk-reversals (long out-of-the-money VIX calls against short out-of-the-money VIX puts) which creates a 'synthetic long volatility position' to hedge the long equity underlying position. This strategy has been very successful in hedging downside in the S&P 500 since the crisis began. The last few weeks has seen the return from the hedged strategy converge to the S&P 500's performance and we suspect this has been the trigger for exits. This unwind of a very popular risk-reversal hedge in VIX options is implicitly like selling volatility - hence the dramatic outperformance of front-month vol even as stocks and credit are not soaring to such highs. Watching the skew between VIX calls and puts may give us some sign that this exuberant compression is over.

As we discussed recently, the idea of retirement - given ZIRP (or even NIRP) - remains further and further away for many middle-aged men and women in America. But Michael Cembalest has some sage advice for those who are passing 50 years old with whimsical views of Viagra-commercial-like retirement settings any time soon. Based on recent research from the Munich center for the economics of aging, one should keep working as long as possible (the precipitous drop in cognitive function once retirement is hit is enormous) - which also offers some insight into why the long-term unemployed suffer so much more in ever getting back into the work-force. More importantly, it seems as we pass that magic 50 year-old barrier, so men's cognitive function plunges far quicker than women's - especially in immediate and delayed recall (where did I leave my keys?). The bottom line is, if you want to succeed later in age: get a job; keep a job; work that job longer; and become a woman!

From UBS: "We think that a creditor nation is less at risk of hyperinflation than a debtor nation, as a debtor nation relies not only on the confidence of domestic creditors, but also of foreign creditors. We therefore think that the hyperinflation risk to global investors is largest in the US and the UK. The more the fiscal situation deteriorates and the more central banks debase their currencies, the higher the risk of a loss of confidence in the future purchasing power of money. Indicators to watch in order to determine the risk of hyperinflation therefore pertain to the fiscal situation and monetary policy stance in high-deficit countries. Note that current government deficits and the current size of central bank balance sheets are not sufficient to indicate the sustainability of the fiscal or monetary policy stance and thus, the risk of hyperinflation. The fiscal situation can worsen without affecting the current fiscal deficit, for example when governments assume contingent liabilities of the banking system or when the economic outlook worsens unexpectedly. Similarly, the monetary policy stance can expand without affecting the size of the central bank balance sheet. This happens for example when central banks lower collateral requirements or monetary policy rates, in particular the interest rate paid on reserves deposited with the central bank. A significant deterioration of the fiscal situation or a significant expansion of the monetary policy stance in the large-deficit countries could lead us to increase the probability we assign to the risk of hyperinflation."

The Fed's Beige Book was just released and for those looking for cliff-dropping and panic-driven views of the plunge in the economy, we are sorry. The Beige Book was, well, beige. Some headlines, via Bloomberg:

• *FED SAW WEAKER U.S. MANUFACTURING, RETAIL SPENDING LAST MONTH
• *FED SAYS LOAN DEMAND `GREW MODESTLY' IN MOST DISTRICTS
• *FED SAYS MANUFACTURING EXPANDED `SLOWLY' IN MOST DISTRICTS
• *FED: HOUSING MARKET REPORTS `LARGELY POSITIVE'
• *FED SAYS DISTRICTS' BUSINESS CONTACTS `CAUTIOUSLY OPTIMISTIC'

The word-cloud highlights the 'continued activity' though does note 'demand pressures', 'slowed markets' and 'sales conditions'. Maybe we will just muddle through with our lower earnings and weaker outlooks but never quite bad enough to get Ben off the bench.

The number of casualties in the Bulgarian bus explosion (reported earlier) is not even known yet, but Israel already knows just who is behind it:

• ISRAELI PRIME MINISTER SAYS SIGNS THAT IRAN BEHIND BURGAS BOMBING -RTRS
• Prime Minister Benjamin Netanyahu: "Iran is responsible for the terror attack in Bulgaria, we will have a strong response against Iranian terror." - Haaretz

Elsewhere:

• CARNEY SAYS OBAMA BRIEFED ON BULGARIA BLAST THAT HIT ISRAELIS
• CARNEY SAYS US NOT IN POSITION TO SAY WHO IS RESPONSIBLE FOR THE BUS ATTACK

And here we were wondering why crude spiked above $90 for the first time in months earlier today.

CNBC's Rick Santelli is goaded into responding to the easing-based hope that is driving stock prices and levitating every risk asset class. "Enough is enough", he notes, quoting Volcker's recent comments, "as we have to let the economy sink or swim on its own at this point." Liesman's responds by stepping away a little from his comments as he leaves Bernanke alone believing that QE will do some good at the margin (while the economic reporter remains less sure). Implicit in his downgrade of the economy is an increase in the probability of additional QE and retail sales sank the ship. A little later in this brief clip, Rick goes full-Santelli - feeling the need to add a third pillar to the Fed's mandate "if we see something wrong in the market, it's our job to do something about it" with Bernanke's response being "it's not my job". Critically, Rick notes, "if anybody listening or watching right now ever thinks that more regulators will ever stop anything, you have to watch Ben Bernanke - appears to be an honest guy and straightforward though I don't always agree with him - saying 'it's not my job. I don't regulate that.' unbelievable!" The CYA, not-my-problem, someone-else-did-it, keep-my-job mentality when it's front-and-center in the most powerful financial entity in the world is deplorable.

Some rather unexpected rational insight out of Bernanke responding to Patrick McHenry's question on whether and how much more QE the Fed can do:

• "I assume there is a theoretical limit on QE as the Fed can only buy TSYs and Agencies"
• "If the Fed owned too much TSYs and Agencies it would hurt the market"

But in closing:

• "We still have some capacity at this point."

Perhaps the market was expecting that the Fed would admit it can buy ETFs and REITs like the BOJ, or that it can sell vol into the single digits, as its New York Fed trading desk is rumored to be doing, but this is hardly the stamp of endorsement to buy any stock come hell or high water that the algos now expect out of the Fed.

Presented without commentary...

There is a strange delayed reaction between the initial exposure of weakness in the financial system and the public’s realization of the truth, sort of like Wile E. Coyote dashing off a cliff in the cartoons only to continue running in mid-air above the abyss below.  It is a testament to the fact that beyond the math, there is an undeniable power of psychology in our economy.  The investment world naively believes it can fly, even with the weight of endless debt around its ankles, and for a very short time, that pure delirious oblivious belief sustains the markets.  Eventually, though, gravity always triumphs over fantasy…

All throughout the epic surge in corn prices, the big Kahoona, Goldman Sachs, where buy means sell, and sell means Goldman's traders are buying everything its clients have to dump, was quiet. That is no longer the case: "we recommend a short May-13 CBOT wheat position vs. a long May-13 CBOT corn position." In other words, Goldman will now be selling May 13 corn. We all know how these recommendations end.

Update 2: Blame it on Iran: ISRAELI PRIME MINISTER SAYS SIGNS THAT IRAN BEHIND BURGAS BOMBING -RTRS

Update: According to BurgasInfo.com not one but two buses were blown up. Unclear if the second one was also carrying Israeli tourists.

According to Bulgarian press Sega.bg, and confirmed by other wire sources, a bus with 40 Israeli tourists was "blown up" at 5:30 pm local time at the local airport of the seaside town of Bourgas. Sega says that according to BTV "it is an assassination attempt." The bomb was located in the trunk of a white bus with Israel tourists from Israel who were en route to the seaside town of Sunny Beach according to an airport source. The mayor of the city, Dimitar Nikolov confirmed the news according to Sega. Furthermore, according to the airport's website, an Air Via flight from Tel Aviv landed at 4:50 pm local time. The shock wave was so large it also exploded two neighboringing buses located in the arrival area of the airport. The number of casualties is currently unknown, but at least three people are dead according to the local police, with dozens wounded. Sega adds "the flames are huge with three firetrucks on the scene and seven ambulances driving out charred people."

As Messers Frank and Paul take on the Bernank this morning, we reflect on the four easing options that the illustrious fed-head laid out in a statement-of-the-obvious that still managed to get the algos ripping. As Goldman notes, his prepared remarks were terse (and lacking in 'easing options' discussion) - cautious on his outlook, concerned at Europe, and fearful of the 'fiscal cliff' - but his response in the Q&A were a little more revealing as he laid out his choices: asset purchases, discount window lending programs, changes in communication about the likely path of rates or the Fed balance sheet, or a cut in the interest rate on excess reserves. We discuss each below but note, just as Goldman believes, that while we think that a modest easing step is a strong possibility at the August or September meeting, we suspect that a large move is more likely to come after the election or in early 2013 (and not before), barring a very rapid further deterioration in the already-cautious near term Fed economic outlook (which we assume implicitly brings the threat of deflation).