Archive - Sep 2013 - Story

As further explained (confounded) by Bill Dudley as part of his speech earlier today, the Fed is pushing on with its Fixed-Rate Reverse Repo test, which while supposedly is meant to assist the Fed in extracting liquidity from the market once the mythical balance sheet unwind begins, what it really does is set a level the playing field for banks and non-banks, by disintermediating their collateral eligibility, and in the process collapsing the spread between the IOER and General Collateral rates. It will likely have many more side effects, now that non-banks can compete with banks for the Fed's IOER, all of which will be largely unexpected and as the impact on collateral bifurcation moves from the purely theoretical to the real world.

Following Friday's stunner of a stock halting press release, moments ago BBRY was halted again, this time however for some "good" (relatively speaking) news. The firm reported that it has entered into a Letter of Intent (so nothing definitive yet) with Fairfax Financial, according to which BBRY shareholders would receive U.S. $9 per share in cash - Transaction valued at approximately U.S. $4.7 billion - Consortium permitted 6 weeks to conduct due diligence - BlackBerry entitled to go-shop during due diligence period, subject to payment of a termination fee in the event alternative offer accepted. In other words an LBO, one which however has not only but many outs: "There can be no assurance that due diligence will be satisfactory, that financing will be obtained, that a definitive agreement will be entered into or that the transaction will be consummated." Which means that once the buyers figure out the potential disaster on the books, expect the final price (if any) to be revised lower as one after another MAC clause is triggered. 

We have heard from the doves, now the hawks. Dallas Fed's Fisher (a non-voting member) pulls no punches in his speech this morning. Confirming Esther George's comments last week, and our views on the same:

• *FISHER SAYS HE TRIED LAST WEEK TO PERSUADE FOMC TO TAPER QE
• *FISHER SAYS DECISION NOT TO TAPER QE UNDERMINED FED CREDIBILITY

But that was not it. The well-known hawk went to warn that:

• *FISHER: BIGGEST BANKS ARE `DAGGER POINTED' AT ECONOMY'S HEART
• *FISHER SAYS NO QE TAPER ADDS TO `UNCERTAINTY' ABOUT FED POLICY

None of this should come as a surprise as Fisher told Santelli earlier in the year that "this cannot go on forever!"

If Obama's intention with the fast and furious series of geopolitical and domestic distractions over the past three months was to sideline Edward Snowden's revelations of the biggest spying scandal since Nixon, he appears to have largely succeeded: not only has America become largely numb to every successive iteration of shockers emerging from the most important whistleblowing episode in recent US history (and in fact can't wait to get even more in debt to purchase shiny, faux-gold fingerprint scanners), but the person behind these revelations, the 30 year old Snowden himself, has largely faded into the collective subconscious. So what is the Russian asylum-seeker doing now that the fruits of his labor has been largely exposed and the US public is already eager for the next big watercooler scandal, popcorn in hand? As AFP reports, it is all but life as usual for the whistleblower: "US intelligence leaker Edward Snowden is living under guard at a secret address in Russia and sometimes emerges in disguise, although he remains in such danger that even a family visit could endanger his security, his lawyer said Monday."

A funny thing happens when the free-money liquidity-train stops calling... it seems the post-euphoric realization that a taper is inevitable (or at the least lower growth than anyone expects is likely) is wearing on those that could do no wrong until just last week... Last week's dramatic short-squeeze appears to have flushed the (forced) sellers from the market and left the market to auction down to levels at which there is a bargain to be struck... Of course, now that the "most shorted" is underperforming so strongly, there is ammo for yet another squeeze higher.

Following the crisis in October 2008, Iceland's government declared all deposits in domestic financial institutions were 'blanket' guaranteed - an Emergency Act that was reafrmed twice since. However, according to RUV, the finance minister is proposing to restrict this guarantee to only deposits less-than-EUR100,000. While some might see the removal of an 'emergency' measure as a positive, it is of course sadly reminiscent of the European Union "template" to haircut large depositors. This is coincidental (threatening) timing given the current stagnation of talks between Iceland bank creditors and the government over haircuts and lifting capital controls - which have restricted the outflows of around $8 billion.

The process the Fed is wrestling with is no different than that of the drug addict. After a certain point, dependency develops. Then the withdrawal process is so painful it is not willingly accepted. The drug analogy is appropriate up to a point. Here is a major problem with the analogy. The drug addict brings the outcome on himself. Those who will suffer the most for the Fed’s actions are not responsible for the pain they will endure. Regardless, the pusher has made most of us junkies. We have been forced into an economic haze that seems real but is not. Whether we know it or not, we are hooked. A great “drying-out” period lies in front of us. Few have understanding of what “economic cold turkey” means, but we will all learn.

In case there was any concern that the umbilical cord between US corporations and government has never been thicker (especially in light of recent revelations that the NSA views the AAPL Borg Collective as useful "zombies", abusing their credit cards just so they can be spied upon in new and improved ways) the New York Police Department is here to remind everyone of just that.

It was fun while it lasted but it seems a recognition that the Fed will have to Taper at some point sooner rather than later (for these four reasons) combined with the Washington anxiety hotting up seems to have sparked a "sell the news" event on the back of good news (China PMI, EU PMI, Merkel, AAPL). Perhaps, just perhaps, the final short overhang was wrung out inlast week's epic spike courtesy of a Fed that didn't like how consensus was in line with them. Notably, bonds are rallying in a very old-normal rotation to weak growth/safety manner and are near post-FOMC low yields. Gold remains well above its pre-FOMC lows and the USD remains well below pre-FOMC levels. In other words, US stocks have given back the most of all assets impacted by the un-Taper.

Once upon a time, US thrift institutions were the primary provider of credit to keep the American housing market humming along. Then the great Savings and Loan crisis happened, and by and large thrifts disappeared from the housing credit landscape. The result was the advent of Fannie and Freddie (i.e., the GSEs) as the "rug" that tied the US housing market room together. The chart below shows the dramatic increase in the role that the GSEs started playing following the S&L crisis, and which culminated with the great financial crisis, or rather the failure of the GSEs a month ahead of the Lehman bankruptcy.

Much attention has fallen on the Fed's recent announcement that a new fixed-rate, full-allotment overnight reverse repo facility is in the works (so much so that both shadow banking experts Singh and Stella have opined on the issue). It appears that despite the Fed's "best efforts" at communication, not enough clarity has been shed on the topic. So here is Bill Dudley's explanation.

Last week we destroyed in detail the fallacy that the plunging participation rate in the US was related to demographics. Despite Ben Bernanke's comments during his press conference last week that demographics play a role, it seems Fed's Dudley and Lockhart have a different view - in line with ours.

• *DUDLEY SAYS UNEMPLOYMENT RATE DECLINE `OVERSTATES' PROGRESS
• *LOCKHART SAYS A NUMBER OF EXPLANATIONS FOR PARTICIPATION RATE (as we covered here)
• *U.S. FED'S DUDLEY SEES 'HOLLOWING OUT' IN LABOR MARKET INCLUDING FACTORY WORKERS
• *LOCKHART: LOWER PARTICIPATION MAY MEAN LOWER ECONOMIC POTENTIAL, WHICH IS A CONCERN

What now? Instead of demographics (the aging of America fallacy), it is a 'hollowing out' of our manufacturing base and this leads to lower economic growth potential. It seems Stockman's 'born-again jobs scam' is very real.

As expected, here come the first two doves "explaining" the reasons behind Bernanke's taper surprise last week:

• DUDLEY SAYS FED MUST ACT ‘FORCEFULLY’ TO PUSH AGAINST HEADWINDS
• DUDLEY: MAY TAKE CONSIDERABLE TIME TO REACH 6.5% JOBLESS LEVEL
• DUDLEY SAYS ECONOMY STILL NEEDS `VERY ACCOMMODATIVE' POLICY

And Lockhart adds to the chorus:

• LOCKHART SAYS FED FOCUS SHOULD BE FASTER U.S. ECONOMIC GROWTH
• LOCKHART HAS BACKED FED'S ASSET PURCHASE PROGRAM
• LOCKHART SEES `SOME SLOWING' IN U.S. PAYROLL GROWTH

Translation: much more "high-quality collateral" to be extracted from the system.

If the Fed was worried about 'froth' in the markets earlier in the year, then this chart should have them panicking. Of course, as Jim Bullard noted Friday, there is no bubble because everyone knows there is no bubble but judging by the massive surge in covenant-lite loan issuance, there is a bubble in forced demand for leveraged loans. At $188.7 billion, the 2013 issuance of these highly unsafe loans (which have seen huge inflows since the Fed started talking taper back in May) is almost double that of the peak of the last credit bubble in 2007 and is five times the size of 2012 YTD issuance at this time. As Reuters notes, Covenant-lite loans used to be reserved for stronger companies and credits, but are now so common in the U.S. leveraged loan market that investors are becoming wary of some credits with a full covenant package. With corporate leverage at all-time highs, what could go wrong?

Despite exuberance at European and Chinese PMIs, the US clean shirt just skidded with a miss. Against expectatins of a high YTD 54.0 print, PMI posted 52.8 - its lowest in 3 months and falling for the second month in a row. New orders fell at the slowest pace since April (boding ill for durable goods) and the employment sub-index grew at the slowest pace in 3 months (suggesting payrolls will not hold up well). Of course, as Markit notes, bad news is good news "as far as policymakers are concerned there are some worrying signals in relation to the sector’s growth momentum, which vindicate the Fed’s decision to hold off on tapering its asset purchases."