October 6th, 2011
Wake up as many people as you can.
"A rock and a hard place" is a long-running theme of Casey Research publications. It refers to the dilemma the US government has wandered into with its continued policy of rescue inflation. The "rock" is what will happen if the Fed pauses for long in printing still more money – the collapse of an economy burdened by an accumulation of mistakes that rescue inflation has been keeping at bay. The "hard place" is the disruptive price inflation that becomes more likely (and likely more severe) with every new dollar the Fed prints to keep the effects of those mistakes suppressed.
When the dollar was cut loose from the gold standard in 1971, the Federal Reserve was freed to create as much new money as it saw fit, whenever it saw fit. Enabled, it turned with enthusiasm to doing what central bankers imagine they are supposed to do – eliminate downturns in the economy. The Fed fancied itself as being on the answering end of a 911 system: whenever the financial markets signaled distress, whenever the economy came down with the flutters, the Federal Reserve would dispatch a van, an ambulance, a fire engine or even an assault vehicle, whatever seemed right but in every case full of cash.
Even a traditionally optimistic Michael Darda, of MKM Partners, is having trouble discovering the silver lining among the flotsam and jetsam that is the global macro-economic ocean currently. The Japanification theme continues with five charts offering too-correlated-to-be-ignored perspectives on equities, money supply/velocity, valuations/multiples, and demographics.
No, Obama is NOT the answer ...
Geithner frets that the crisis in Europe could undermine confidence. But if confidence isn't based on facts and transparency, it's a con game.
VIX expiration day often coincides with particularly heavy trading activity in underlying SPX options. VIX settlement value, or VRO rarely matches either the Tuesday close or Wednesday open prices on the "cash" index, prompting pundits to blame VIX settlment for being manipulated. A popular theory is that VIX settlement value is being pushed up or down with huge SPX trades, referred to as "carpet-bombing". Some say that the manipulative trades are concentrated around high-vega strikes, others concerned specifically about puts. In this post I explain why large trades are not likely an explanation for VIX manipulation, and instead how VIX settlement value can be artificially increased for less than one hundred dollars, how VSTOXX futures and options are not subject to such manipulation, and propose a simple modification that makes VIX manipulation too expensive to be profitable.
Euro Rumormill Disintegration Begins As Reality Returns: France, Germany Fail To Reach Agreement On EFSFSubmitted by Tyler Durden on 10/06/2011 17:52 -0400
In our previous post we warned, indirectly through the IMF, that the biggest risk for Europe is the inability to reach consensus over anything from the most complicated, to the simplest matter. As noted previously, one of the main initial drivers of the market surge which has since translated into yet another short covering rally of epic proportions was the belief that Europe can actually come together in agreement over the simplest thing - like its own survival. Alas, it appears even that is not the case. As Bloomberg reports, "Germany and France are at odds over whether the European Financial Stability Facility should have limits on government bond purchases, Handelsblatt reported, citing an unidentified high-ranking European Union diplomat. France doesn’t want to restrict the EFSF on how much of its funds it can use for such purchases, the newspaper said in a preview of an article to appear in tomorrow’s edition. Germany wants to limit the amount EFSF can spend for bonds per country and is also considering whether there should be a time limit for bond purchases, Handelsblatt said." Said otherwise, here comes the latest cause of discord within Europe. Unfortunately, it also means that any rumor, innuendo and speculation that Europe has finally reached a coherent union over its own bailout can be promptly discarded. As if there was ever any doubt in the first place.
Squeeze has taken us to new reistance levels, now what....?
Another day, another 12 swings of greater than 0.75% in S&P futures as volume slid to the lowest in a week and second lowest in two weeks. Credit and equity markets stayed largely in sync (as they have for the last few days - with slight beta-adjusted underperformance of credit) until around lunchtime and then a funny thing happened to investment grade credit. At around 12:30ET, the most liquid credit index, IG17, gapped tighter as ES and HY reversed briefly off the highs and then IG did not stop - compressing 3-4bps more into the close - notably outperforming HY and ES (its far higher beta cousins). At the same time, the less liquid but hugely levered (and exposed to correlation traders, tail-, and jump-risks), IG9, cracked very notably tighter (from our runs around 15bps) to 147bps. IG9 had held up as markets rallied but this move's magnitude and velocity suggest more than just some hedge adjustments and while the rest of the risk assets we cover were all levitating, this 'capitulation' stands out among them. Dollar weakness of course helped fuel the equity strength and commodities and PMs pushed on all day with gold the most subdued.
BBC Does It Again: "In The Absence Of A Credible Plan We Will Have A Global Financial Meltdown In Two To Three Weeks" - IMF AdvisorSubmitted by Tyler Durden on 10/06/2011 16:40 -0400
A week after the BBC exploded Alessio Rastani to the stage, it has just done it all over again. In an interview with IMF advisor Robert Shapiro, the bailout expert has pretty much said what, once again, is on everyone's mind: "If they can not address [the financial crisis] in a credible way I believe within perhaps 2 to 3 weeks we will have a meltdown in sovereign debt which will produce a meltdown across the European banking system. We are not just talking about a relatively small Belgian bank, we are talking about the largest banks in the world, the largest banks in Germany, the largest banks in France, that will spread to the United Kingdom, it will spread everywhere because the global financial system is so interconnected. All those banks are counterparties to every significant bank in the United States, and in Britain, and in Japan, and around the world. This would be a crisis that would be in my view more serrious than the crisis in 2008.... What we don't know the state of credit default swaps held by banks against sovereign debt and against European banks, nor do we know the state of CDS held by British banks, nor are we certain of how certain the exposure of British banks is to the Ireland sovereign debt problems."
Do not be fooled. This move is short-covering and a snapback and nothing else. We’ve seen several of these in the last two months alone. Every time the market rolled over quickly and collapsed. So let the traders play their games. Based on retracement levels this move could go to 1,182 or 1,200 on the S&P 500. But this rally should be used to get even more defensive than before.
We have highlighted this before but given the incessant rumblings that everything is fixed and that nationalizations, recaps, and EFSF votes are 'positive', we thought a reflection on what is really going on would be useful. The mother of all short squeezes as we mentioned recently continues - catalyzed by the since refuted FT Rumor of a pan-European bank recap 'plan'. The fact that Short Interest is at its highest since the "generational lows" only helps.
On Monday, Goldman was the first bank to go ahead and hike its recession odds for the US from 30% to 40% (needless to say assigning probabilities to a non-linear outcome is utterly ridiculous but we'll play along), additionally saying that both France and Germany will enter a recession shortly. Promptly, Wall Street followed. Yet despite the glaringly obvious, still nobody dares to assign a majority probability to a recession in America. Until today. French bank SocGen is once again the trailblazer in telling the truth, with its economics team being the first to make the bold (for a bank) claim that America now has not only a majority, but a two thirds chance of recession. To wit: "the recent financial shock, if it continues, is already large enough to derail the cycle prematurely. Our financial conditions index is at a tipping point and, all else equal, suggest 65% probability that the economy will enter recession in the next 12 months" (and to all those who point to record corporate profitability as the strawman which will never allow the US to enter a recession, SocGen has this response: "the recession that began in December of 2007 occurred in the face of very strong corporate profitability.").