Asset-Backed Securities

While many would argue that youth unemployment (the real scariest chart here), in fact we suspect it is the following two charts that are really keeping Mario Draghi up at night. The lip service paid by the French and the Germans to growth strategies and youth unemployment pale in relation to the desperation of the European collateralizer-of-last-resort to de-fragment his transmission channels and unleash his own QE to the starving banking systems of Spain and Italy. As BNP notes, recent data on Italian and Spanish banks’ bad and non-performing loans (NPLs) have reignited the debate on the health of the banking sector in the eurozone’s peripheral economies and its implications for the bloc’s credit supply and, ultimately, economic growth. But what is worse is that interest rates on new loans for a company in Italy or Spain are almost double those in Germany and France. It is against this backdrop that Draghi expressed plans to revive the ABS market - but implementation will prove significantly more challenging than market hopers believe (as is clear in credit markets) and direct purchases will probably face vetoes by a number of influential members of the board. To add further salt to these fresh wounds, the FT reports that Spanish banks will need to set aside more than EUR10 billion more reserves to cover the rolling over of EUR 200 billion of 'extend-and-pretend' loans.

Up until today, the narrative was one trying to explain how a soaring dollar was bullish for stocks. Until moments ago, when Bill Dudley spoke and managed to send not only the dollar lower, but the Dow Jones to a new high of 15,400 with the following soundbites.

• DUDLEY: FED MAY NEED TO RETHINK BALANCE SHEET PATH, COMPOSITION
• DUDLEY SAYS FISCAL DRAG TO U.S. ECONOMY IS `SIGNIFICANT'
• DUDLEY: FED MAY AVOID SELLING MBS IN EARLY STAGE OF EXIT
• DUDLEY: IMPORTANT TO SEE HOW WELL ECONOMY WEATHERS FISCAL DRAG
• DUDLEY SAYS HE CAN'T BE SURE IF NEXT QE MOVE WILL BE UP OR DOWN

And the punchline:

• DUDLEY SEES RISK INVESTORS COULD OVER-REACT TO 'NORMALIZATION'

Translated: the Fed will never do anything that could send stocks lower - like end QE - ever again, but for those confused here is a simpler translation: Moar.

So much for Europe's "recovery." In a quarter when the whisper was that some upside surprise would come out of Europe, the biggest overnight data releases, European standalone and consolidated GDPs were yet another flop, missing across the board from Germany (+0.1%, Exp. 0.3%), to France (-0.2%, Exp. 0.1%), to Italy (-0.5%, Exp. -0.4%), and to the entire Eurozone (-0.2%, Exp. 0.1%), As SocGen recapped, the first estimate of eurozone Q1 GDP comes in at -0.2% qoq, below consensus of a 0.1% drop. The economy shrank by 1.0% yoy, the worst rate since Dec-09. The decline of 0.5% qoq in Italy means that the economy has been in recession continuously since Q4-11. A 0.2% qoq drop in France means the economy has ‘double-dipped’, posting a second back-to-back drop in GDP since Q4-08. The increase of 0.1% qoq in Germany was disappointing and shows the economy is not in a position to support demand in the weaker member states (table below shows %q/q changes).

With home prices rising at near-record paces in SoCal, corporate debt yields at record-lows, equity markets surging at near-record rates, and high quality assets dwindling by the minute under the heel of a central bank jack boot; it is perhaps no surprise that investors have switched from finding leverage through the balance sheet (i.e. crappy quality firms) to finding leverage through the instrument (i.e. structured credit). The trouble this time is that yields (and spreads) being so low, the creators of the new-normal ABS, CDOs, and CLOs have to stoop to the old tricks to make their money (as we noted here). As Bloomberg reports, bond issuers are once again exploiting the credit rating agency pay-for-performance business model to create "high-quality" collateralizable assets from utter garbage - such as auto loans.

A look at the main drivers.

Put down the Sunday newspaper; grab a pot of coffee; and call 'mom' and tell her she has to read this. Doug Rudisch has written a far-reaching summary of the true state of the world and 'why policy has failed'. Simply put, there is no faith in the system; real underlying faith and trust in the system, as opposed to the confidence born from economic steroid injections or entitlements. There also is a subtle but important distinction between faith and trust versus confidence. Faith and trust are longer term and more powerful concepts.There is more going on than a temporary lull in animal spirits that current fiscal and monetary policy will cure. If that was the case, it would be working already... We have ended up with a system where the worst of the risk takers have the ability to take the most risk and are currently taking it at extreme levels. We wish we could be more prescriptive and offer more solutions for the problems. But in order to solve a problem, you must first realize you have one. With respect to the Fed, we don’t think the U.S. realizes it has a problem.

More thoughts on the ECB's balance sheet and why a negative deposit rate is unlikely.

With another listless macro day in the offing, the main event was the previously mentioned Bank of Korea 25 bps rate cut, which coming at a time when everyone else in the world is easing was not too surprising, but was somewhat unexpected in light of persistent inflationary pressures. Either way, the gauntlet at Abenomics has been thrown and any temporary Japanese Yen-driven export gains will likely not persist as it is the quality of products perception (sorry 20th century Toshiba and Sony), that is the primary determinant of end demand, not transitory, FX-driven prices. And now that Korea is set on once again matching Japan in competitiveness, the final piece of the Abenomics unwind puzzle has finally clicked into place.  Elsewhere overnight, China reported consumer price inflation increasing by 2.4%, on expectations of a 2.3% rise, driven by a 4% jump in food costs: hardly the thing of Politburo dreams. Or perhaps the PBOC can just print more pigs, soy and birdflu-free chickens? On the other hand, PPI dropped 2.6% in April, on estimates of a 2.3% decline, as China telegraphs it has the capacity, if needed, to stimulate the economy. This is ironic considering its inflation pressures are externally-driven, and come from the Fed and the BOJ, and soon the BOE and ECB. And thus its economy stagnates while prices are driven higher by hot money flows. What to do?

Currently, central banks around the world are walking in lock step down a dangerous path of money creation. Led by the Federal Reserve and the Bank of Japan, economic policy is driven by the idea that printed money can be the true basis of growth. The result is an unprecedented global orgy of currency creation. The only holdout to this open ended commitment has been the hard money bias of the German-dominated European Central Bank (ECB). However, growing political pressure from around the world, and growing dissatisfaction among domestic voters have shaken, and perhaps cracked, the German resolve. While German capitulations in the past have been welcome occurrences, in this instance the world would be better served if the Germans could stick to their guns. However, it seems presciently, that the ECB is looking for ways around Germany's oppostion to outright monetization by securitizing SME loans and buying ABS directly on to their own balance sheet.

• Pentagon Plans for the Worst in Syria (WSJ)
• Russia and US agree to Syria conference after Moscow talks (FT)
• Hedge Funds Rush Into Debt Trading With $108 Billion (BBG)
• Detroit is the new "deep value" - Hedge funds in search of distress take a look at Detroit (Reuters)
• Commodities hedge funds suffer weak first quarter (FT)
• But... but... Abenomics - Toshiba posts 62% decline in Q1 net profit (WSJ)
• Americans Are Borrowing Again but Still Less Than Before Freeze (WSJ)
• Man Utd announce Alex Ferguson to retire (FT)
• Asmussen Says ECB Discussed ABS Purchases to Spur SME Lending (BBG)
• Benghazi Attack Set for New Review (WSJ)
• Belgium Says 31 People Arrested Over $50 Million Diamond Theft (BBG)
• Brazilian diplomat Roberto Azevêdo wins WTO leadership battle (FT)
• Bangladesh Garment Factory Building Collapse Toll Reaches 782 (BBG)

The overnight economic data dump started in China, where both exports and imports rose more than expected, at 14.7% and 16.8% respectively, on expectations of a 9.2% and 13% rise. The result was a trade surplus of $18.16 billion versus expectations of $16.15 billion. The only problem with the data is that as always, but especially in the past few months, it continued to be completely made up as SocGen analysts, and others, pointed out. The good data continued into the European trading session, where moments ago German Industrial Production rose 1.2% despite expectations of a -0.1% drop, up from 0.6% and the best print since March 2012. The followed yesterday's better than expected factory orders data, which also came at the best level since October. Whether this data too was made up, remains unknown, but it is clear that Germany will do everything it can to telegraph its economic contraction is not accelerating. It also means that any concerns of an imminent ECB rate cut, or a negative deposit rate, are likely overblown for the time being, as reflected in the kneejerk jump in the EURUSD higher.

3D-printing, like decentralized crypto currencies, have the potential to change the world in which we live in extraordinary ways. Ways that are almost inconceivable at this point given we are so early in the game.  More than anything else, these technologies can empower the individual like never before, and we think that is generally a very good thing. We first covered the impact of 3D-printing on the firearms industry in January, where we discussed Defense Distributed’s success in printing magazines for semi-automatic weapons.  At the time, their next major goal was to print a fully functioning firearm. They have now done just that.

A look at the price action in the foreign exchange market and the technical forces in the week ahead.  

The pricing of 'safe' assets reflects the ongoing uncertainty in a world that is in the grip of the lunacy of policymakers who have seemingly lost all sense of perspective and are engaged in a huge gamble. This essential fundamental backdrop has not changed for the better lately, but for the worse. What this once again demonstrates is that intervention by central banks is creating incentives for many institutional investors to take inordinate risks in the name of preserving the purchasing power of the savings that have been entrusted to them. The problem is that the gains of today are absolutely certain to become the losses of tomorrow for investors taking the bait, as the echo bubble created by loose monetary policy is fated to turn into a major bust once the boom has played out. When the tide is going out, a great many naked swimmers will be revealed.

The biggest problem with the financial system is that of bad measurement. Without accurate data, no analyst can make sound investment judgments. Unfortunately for all of us, the data is gimmicked to the point that nothing is valid any longer.