Goldman's ex-employee Mario Draghi is in a box: he knows he has to do something, but he also knows his options are very limited politically and financially. Yet he has no choice but to escalate and must surprise markets with a forceful intervention as per his words last week or else. What does that leave him? Well, according to Goldman's Huw Pill, nothing short of pulling a BOJ and announcing on Thursday that he will proceed with monetization of private assets, an event which so far only the Bank of Japan has publicly engaged in, and one which will confirm the world's relentless Japanization. From Pill: "Given the (to us) surprisingly bold tone of Mr. Draghi’s comments last week, we nevertheless think a new initiative may well be in the offing. We have argued in the past that the next step in the escalation of the ECB response would be outright purchases of private assets. Acting in this direction on Thursday would represent a significant event. We forecast the announcement of measures to permit NCBs to purchase private-sector assets under their own risk to implement ‘credit easing’, within a general framework approved by the Governing Council. This would allow purchases of unsecured bank debt and corporate debt, enabling NCBs to ease private-sector financial conditions where such support is most needed." Why would the ECB do this: "A natural objection to outright purchases of assets issued by the private sector is that they involve the assumption of too much credit risk by the ECB. But substantial risk is already assumed via credit operations." In other words, the only thing better than a little global central banker put is a whole lot global central banker put, and when every central planner is now all in, there is no longer any downside to putting in even more taxpayer risk on the table. Or so the thinking goes.
So we have two weeks of sport to take our minds off the global financial malaise. The EU commissars have all gone on holiday, but not before Mario Draghi (ECB Chairman) announced that he will do whatever it takes to save the euro. Really? His statement did knock the Spanish 10 year bond yield back below 7%, but this had become a one way and illiquid trade that was due for break. We have seen it all before with Greece. Denial, denial, denial all the way until days before default restructuring. Talking of which, the Greeks think they are in line for a further handout. Those whirring sounds you can hear in the distance are printing presses knocking out “new” drachma.
"September will undoubtedly be the crunch time," one senior euro zone policymaker said. "In nearly 20 years of dealing with EU issues, I've never known a state of affairs like we are in now," one euro zone diplomat said this week. "It really is a very, very difficult fix and it's far from certain that we'll be able to find the right way out of it."
Fixed income markets have always focused closely on news about the US macro-economy; while traditionally, equity market participants have focused more on the “micro” data – in particular, news about current and prospective corporate earnings – to form their views about the relative attractiveness of different stocks or the market as a whole. Goldman finds that the financial crisis changed all that. The responsiveness of the US equity market to economic news increased dramatically, now showing about twice as much sensitivity to macro data as it did in the years before the financial crisis. While micro data remains important - especially in quantifying just how much QE-hope the market is 'abiding' by, macro news is likely to be the critical driver of equity markets until the global economic outlook is considerably brighter than it looks today (or macro decouples from Fed/ECB jawboning). On average the market’s responsiveness to all these economic indicators suggests that we are still very much living in a macro world. In the meantime, there are some exceptions to the fairly consistent reactions to economic news that we see between equity and bond markets.
The first estimate of the 2nd Quarter GDP was released at a 1.5% annualized growth rate which was just a smidgen better than the 1.4% general consensus. There has been a rising chorus of calls as of late that the economy is already in a recession. For all intents and purposes that may well be the case but the GDP numbers do not currently reveal that. What we are fairly confident of is that with the weakness that we have seen in the recent swath of economic reports is that the 2nd quarter GDP will likely be weaker than reported in the first estimate. It is this environment, combined with the continued Euro Zone crisis and weaker stock markets, as the recent rumor induced bump fades, that will give the Federal Reserve the latitude to launch a third round of bond buying later this year. While the impact of such a program is likely to be muted - it will likely push off an outright recession into next year.
Italian Regulator Extends "One Week Only" Shorting Ban Through September 14 Due To "Persistent Conditions"Submitted by Tyler Durden on 07/27/2012 11:07 -0500
Europe is so fixed, and so jawboned to death, that the Italian regulator who launched this year's BanWagon episode of financial stock short selling bans with what was supposed to be just a one-week ban of shorting, has just extended the ban for nearly two more months, through September 14. The reason: "persistent conditions" - in other words Europe appears to be only fixed and stuff on a transitory basis. But yes, absolutely nobody could see this coming.
Will the Fed then just keep printing forever and ever? As an aside, financial markets are already trained to adjust their expectations regarding central bank policy according to their perceptions about economic conditions. There is a feedback loop between central bank policy and market behavior. This can easily be seen in the behavior of the US stock market: recent evidence of economic conditions worsening at a fairly fast pace has not led to a big decline in stock prices, as people already speculate on the next 'QE' type bailout. This strategy is of course self-defeating, as it is politically difficult for the Fed to justify more money printing while the stock market remains at a lofty level. Of course the stock market's level is officially not part of the Fed's mandate, but the central bank clearly keeps a close eye on market conditions. Besides, the 'success' of 'QE2' according to Ben Bernanke was inter alia proved by a big rally in stocks. But what does printing money do? And how does the self-defeating idea of perpetual QE fit with the Credit Cycle relative to Government Directed Inflation (or inability to direct inflation where they want it in the case of the ECB and BoE)?
On one hand we have Mario Draghi promising he has a magic wand (not a printer - remember the keys to that are now held by Angela Merkel who is on vacation) and to "believe him" that the EUR will survive. On the other we have Greece which is a poster child of everything that is wrong in Europe. And that we summarize as follows: i) an epic and now relentless deposit outflow from Greek banks which continues as all trust in the local banking system is now gone, as €7 billion in deposits or the second biggest amount ever, is pulled and 20% of the entire corporate and household deposit base has vaporized in the past year, and ii) an economy in which it is every man for himself and where nobody pays any taxes any more, period. Good luck Super Mario.
European markets started off on a quiet note with thin volumes as equities drifted lower and fixed income gradually made gains, however newsflow rapidly picked up as commentary from the ECB President Draghi picked up wide attention. The ECB President was very upbeat on the Eurozone’s future, commenting that the bank will do whatever is needed to preserve the Euro, fuelling the asset classes with risk appetite across the board. European equities as well as the single currency erased all losses and the Bund moved solidly into negative territory. As such, EUR/USD is seen comfortably back above 1.2200, with both the core and peripheral bourses making progress. In the wake of the moves, attention is particularly being paid to Draghi’s comment that if monetary policy transmission is affected by government borrowing, it would come within the bank’s policy mandate. As such, much of the focus now lies firmly on next week’s policy decision from the ECB.
The kneejerk short covering reaction to Draghi's remark that he will do "anything to preserve the euro" (this must be news because yesterday the ECB would not do anything to preserve the euro supposedly) is over. Now the analysis begins of what was actually said. The realization is... nothing.
"The global growth picture is, as per our long-term contention, weak and deteriorating, pretty much everywhere – in the US, in the eurozone and in the emerging markets/BRICs.... We in the Global Macro Strategy team still think the market consensus is far too optimistic on policy expectations both in terms of the likelihood of seeing more (timely) fiscal and/or monetary policy assistance (globally), and in terms of any meaningful and/or lasting success of any such policy moves. In particular, we think that the period August through to November (inclusive) represents a major global policy and political vacuum. Based on the reasons set out earlier and also covered in my two prior notes, over the August to November period I am looking for the S&P500 to trade off down from around 1400 to 1100/1000 – in other words, I expect over the next four months to see global equity markets fall by 20% to 25% from current levels and to trade at or below the lows of 2011! US equity markets, along with parts of the EM spectrum, will I think underperform eurozone equity markets, where already very little hope resides. For iTraxx crossover, this equates to a spread wide for 2012 of – in my view – 800/1000bp.... And of course I still see a very clear path to 800 on the S&P500 at some point in 2013/2014, driven by market revulsion against pump-priming money printing central bankers, but this discussion is also for nearer the time."
Lumber giant Universal Forest Products’ CEO Matt Missad said in the company’s latest earnings conference call, “We are watching our inventories closely and trying not to get too far ahead because we are concerned about disappointing employment figures and lack of construction growth in the U.S.” Rather than observe the trends in the Mortgage Bankers Association’s headline Mortgage Applications Index, which includes refinancing, a far better gauge of economic conditions is the Mortgage Purchases Index trends. This weekly representation of demand for mortgages related to home buying is little changed from levels registered at the bottom of the housing market collapse. The level of residential housing construction is an important indicator, and has made little improvement since the apparent market bottom in 2009. The sunken pace of residential construction spending in May was $268 billion – essentially the same levels seen in 1997. This profoundly low level of activity is not limited to the residential sector; spending on commercial structures is currently the same as in 1996. Since there is diminished activity, the need for workers in the construction industry has also stagnated. During June construction employment totaled 5.5 million workers – a near 30 percent decline from the peak in April 2006 and the same number as in mid 1996.
Curious just how we were 100% certain that the June 29 summit was an epic disaster, in addition to the obvious? Because in a note from that morning we said the following: "Below is Goldman's quick take on the E-Tarp MOU (completely detail-free, but who needs details when one has money-growing trees) announced late last night. In summary: "We recommend being long an equally-weighted basket of benchmark 5-year Spanish, Irish and Italian government bonds, currently yielding 5.9% on average, for a target of 4.5% and tight stop loss on a close at 6.5%." By now we hope it is clear that when Goldman's clients are buying a security, it means its prop desk is selling the same security to clients." Sure enough, its prop desk was selling, and selling, and selling. Since then Spain and Italy have blown out, and only the strange tightening in Ireland has prevented yet another stop loss from the squid which is now known for cremating clients more than anything else. The stop loss is certainly not far: the basket is now at 6.20%, and has just 30 bps to go until yet another batch of Goldman clients is slaughtered. Which is now only a matter of time - Goldman just told its clients it has a little more of its 5 Year exposure left to sell, and then it will be done. Of course by then another muppet murder scene will have to be cordoned off.
In what has become one of the most widely read and distributed of our posts, we first introduced the world to the intricacies of legal 'subordination' and protection among European bonds back in January of this year (and reaffirmed it specifically for Spain in early June). This strategy proved exceptionally successful in the case of Greece, and has, in recent weeks, also done extremely well in the case of Spain. Since we first noted it, the local-law Spanish 2029s are down over 14% while the non-local 'UK-law' Spanish 2029s have managed to gain 1.1% providing arbitrageurs with a massive profit on a duration-matched low-capital pairs trade. More importantly, for all the European fixed income asset managers who owe their clients as least some fiduciary duty, we can only hope they rotated to the non-domestic-law bonds before early May - when trouble really hit. While gloating on one's success at non-vaporizing cash once again is not our way, we much more critically note that one can read the fundamentals (as opaque as they are and known to everyone) or one can look at what the market is saying. What it is saying is that the differential between UK- and non-UK-law bonds has been crushed and is absolutely on a path to repeat the Greek PSI experience. There is plenty of room left for the trade since the UK-law bonds will likely be taken out at Par (just as with GGBs) while Spain's PSI is just as likely to be the 20s/30s - and any TROIKA funding will prime everyone but the UK-Law bonds.
A few hours ago, the IBEX hit a level of 5905, the lowest since April 2003. The irony is that as recently as weeks ago, various momentum chasing self-professed stock "experts" saw some technical formation or another, making them believe that the bottom is finally in for the IBEX, which is "fixed." Turns out it wasn't; it also turns out the market was completely wrong and the result is a 12% slide in the Spanish stock market in two days as reality's return is fast and furious. If this happened in the US, it would be the equivalent of 1500 DJIA point collapse in 48 hours, and unleash mass panic and civil disobedience as people realized their 201(k) is really a +/- 001(k).