The global crisis that began in 2007/8 has unmasked many unsustainable economic dispositions. Unfortunately, the proper conclusions have still not been arrived at, as evidenced by the fact that the same old Keynesian recipes that have failed over and over again are being implemented on an even grander scale. One must not be misled by the claims of 'austerity' being imposed, as this has evidently little bearing on government spending as such, but is rather an attempt to squeeze more blood out of an already shriveled turnip, namely what remains of the private sector. Puerto Rico seems – at least so far – not any different in that respect.
When it comes to complex systems and unintended consequences, the key phrase is "be careful what you wish for." A lot of people are remarkably certain that their understanding of how systems will respond in the future is correct. Alan Greenspan was certain there was no housing bubble in 2007, for example (or he did a great job acting certain). Some are certain the U.S. stock market is going to crash this year, while others are equally certain that stocks will continue lofting higher on central bank tailwinds. Being wrong about the way systems responded in the past doesn't seem to deter people from being certain about the future. Complex systems don't act in the linear way our minds tend to work.
Take your pick of which "confidence" measure you choose to watch to confirm your previous "common knowledge" meme. Unsurprisingly, the government's own Conference Board indicator provides the highest level of confidence relative to recent months but today's beat by UMich (81.2 flat from last month but above 80.2 expectations) is the highest overall level among the indices. It seems not even the weather can dampen the enthusiasm of the US consumer (who is retail spending at a dismally low level?) Hardly surprising is the fact that the tumble in the current conditions index was entirely dissolved by the hope for the economic outlook which stands at 6 month highs! Short-dated inflation expectations also ticked up. Of course what really matters is keeping the dream alive that multiple-expanding confidence will cover up any and all missed expectations in macro and micro data.
So far the overnight session has been a replica of yesterday, with the all important carry trade once again fizzling overnight during Japan trading hours, and dipping as low at 101.60 before staging a modest rebound to the 101.8 level. We expect the "invisible" 102.000 USDJPY tractor beam to be again engaged shortly and provide market support and/or levitate stocks higher as the now standard selling in Japan, buying in the US trade pattern repeats. On the other hand, US equity futures appear to have decoupled from the pure carry trade, and instead latched on to USD weakness and EUR strength following European Q4 GDP data, which came at 0.3% on expectations of 0.2%, up from 0.1%. Considering the constant adjustments to the European definition of GDP, at this point Mongolia would have been able to demonstrate growth if it was in Europe (but apparently not Greece which once again missed GDP expectations with Q4 GDP of -2.6% vs Exp. -2.0%). Expect ES and USDJPY to recouple shortly, as they always do - the only question if the recoupling will take place lower or higher.
Yields on United States 10-year bonds rose above 3% at the beginning of January. The yield on the 10-year had reached its lowest point in history in July 2012 at 1.43% as a result of the Fed’s policy of Quantitative Easing. Since then yields have doubled as markets have incorporated the impact of the Fed tapering their purchase of U.S. Government securities. This raises the question, how high could interest rates go from here? Could interest rates move up to 3% per quarter? U.S. interest rates were that high back in 1981 when the yield on US 10-year Treasuries hit 15.84% and 30-year mortgage rates hit 18.63%. What about 3% per month?
The US equity market took 16 hours to fall 15 points and 90 minutes this morning to recover amid an absolutely dismal retail sales print. The full bulltard farce of disastrous news being great news is writ large in stocks as they decouple from any FX carry or bond market sense of reality.
Having rallied yesterday and totally ignored the fact that Letta's 10-month-old government was about to collapse, Italian equity and sovereign bond markets are falling this morning by their most in two weeks. The main bone of contention for Renzi-Letta fight is jobs and growth - there is none of either - and while Prime Minister Letta assures that the Italian economy grew in Q4 (GDP data to be released tomorrow) for the first time in 10 quarters, as Bloomberg's Niraj Shah notes, real GDP is still smaller than it was in 2000. Letta has just canceled his UK visit (planned for 2/24) and did not take part in the Democratic Party meeting with a Renzi friend saying "[Letta] will resign." Italians are, of course, used to the farce that is politics - there have been 64 government since 1945.
With so much of the recent bad news roundly ignored or simply "priced in" and blamed on the snow, it is unknown just what it is that catalyzed the overnight round of risk-offness, but whatever the ultimate factor, it first dragged the Nikkei lower by 1.8%, as we noted previously, then sent the SHCOMP down by 0.55%, then ultimately dragged the USDJPY below the key 102 support area which in turn pulled US equity futures to set the scene for a red open (with no POMO and no Yellen testimony today which also was canceled due to snow), and, putting it all together, suddenly Europe too is back on the scene, with a blow out in Italian yields driven by the realization that the Letta government is on the edge of collapse, in a deja vu moment to those hot summers of 2011 and 2012.
On Tuesday, new Federal Reserve Chairman Janet Yellen went before Congress and confidently declared that "the economic recovery gained greater traction in the second half of last year" and that "substantial progress has been made in restoring the economy to health". This resulted in glowing headlines throughout the mainstream media such as this one from USA Today: "Yellen: Economy is improving at moderate pace". Sadly, tens of millions of Americans are going to believe what the mainstream media is telling them. But it isn't the truth. As you will see below, there are all sorts of signs that the economy is taking a turn for the worse.
While the eyes of the world were focused on the now infamous "Credit Equals Gold #1" Chinese wealth management product - it's imminent default and last-minute bailout by 'investors' unknown - the coal industry in China continued to collapse (as we noted here). We noted at the time how bailing out current high-yield product investors would merely amplify the problems down the line and it seems that Chinese authorities have heard that message. As Reuters reports, a high-yield investment product backed by a loan to a debt-ridden coal company failed to repay investors when it matured last Friday, state media reported on Wednesday.
The default cycle that should have occurred, given historical patterns of issuance cycles, has morphed (thanks to the Fed) into a refinancing cycle; but while DoubleLine's Jeff Gundlach suggests that fundamentals are supportive, "the valuation of junk bonds as a category is at its all-time overvalued versus long-time treasury bonds." So despite Yellen exclaiming that she sees no bubbles, one of the world's largest bond fund managers has never seen corporate bonds (investment grade and high yield) more expensive. Gundlach goes on to note he has sold some Apple (but believes it will remain range-bound), is baffled by the valuation of Chipotle, and sees 10Y Treasury yields dropping to 2.5% or lower.
In the aftermath of yesterday's 3 Year auction, which was nothing to write home about except for the surge in Indirect demand (and corresponding plunge in Direct take down), the Treasury just priced it latest soon to be POMO-ed 10 Year paper, $24 billion of it to be exact with a couple of reopenings scheduled in the near future, at a closing yield of 2.795% which was inside the 2.801% When Issued at 1 pm indicating solid demand dynamics during the auction process. That said, the Bid to Cover of 2.54 was well below both the January 2.68, and the TTM average of 2.69, and in fact was the lowest since the 2.44 print from last August. The internals were more solid, as Dealers took down 34.1%, below the 38.4% TTM average, while Indirects - like yesterday - soared to 49.7% of the final allocation, the highest since June's 51.7%. This means that Directs were left with 16.2% of the auction, or just below the 19.8% average. As a result of the auction failing to tail, the Treasury complex popped modestly higher in the aftermath of the announcement, although this bullish sentiment may not last unless DE Shaw links up its bond buying algo to the USDJPY to match its SPOO buying "logic."
UPDATE: Trannies and Industrials are now red...
Gold has pressed up to almost $1,295 this morning - fresh 3-month highs - as silver and WTI crude also rise notably. The S&P 500 continues its inexorable USDJPY-inspired levitation (and is set for 1,900 by Monday morning at this rate) though remains negative year-to-date (for now) and a small roll-over in JPY is dragging stocks off their highs for now. US Treasuries are offered with the belly underperforming as 5Y reached 2-week highs at 1.56%.
As Deutsche Bank revealed in a note overnight, the GCC may have, quite deliberately, opened a Pandora's Box with its decision which according to Europe's largest bank, and the one whose derivatives exposure makes that of JPM pale by comparison, (i) made it clear it regards OMT as exceeding the competences granted to the ECB by the European Treaty and that (ii) would not consider itself bound by a positive ruling of the European Court of Justice. And while in DB's opinion this action does not have any immediate market consequences, the report's authors think that it "alters substantially the level of insurance we could expect from the ECB against any return of sovereign turmoil."
The growing tensions between Italian Prime Minister Enrico Letta (and his fragile coalition) and Matteo Renzi - the head of parliament's largest (center-left Democratic) party are intensifying this morning. Calls for Letta's resignation, sparked by a junior coalition party head "hoping he was ready to step down," have escalated into more open speculation that the Italian government could collapse within days. Following the failure today of a 'strategy meeting' with center-right coalition partners, Renzi's pro-job-creation and electoral law reforms agenda is gaining consensus. While Letta has stated he will move ahead with his government (and address the public later today), Renzi warned, via Twitter, that he will talk tomorrow afternoon on the way forward.