Capital Markets

Earlier today we disclosed what were not one but several massive central bank interventions in the Euro-Swiss Franc exchange rate. The intervention was large enough to push the rate up by 300 pips, a gargantuan amount in a world where applied leverage is often in the thousands. The amount of capital required to achieve this was likely unprecedented. Yet what bothered us was why would the SNB so glaringly intervene in the FX market not once but three or even more times. Thanks to the Telegraph we find out that the reason was a massive €9.5 billion capital flight from Germany into Swiss deposit accounts just this morning, according to BNP. Unfortunately for Germany this is only the beginning of capital reallocation from the country into neighboring Switzerland. And the technical bounce in the EUR today was in fact an even greater sign of weakness: in fact, as the IMF's Tim Kingdon pointed out, the money run in Club Med banks last week resulted in a massive €56 billion of interbank lending as the move from the periphery to the core accelerated. Now that the next stage of the run is from the core, Europe will very soon find itself with depleted depository capital very soon. Because if money is fleeing Germany, it is certain that France, Italy and the UK can not be far behind.

The whole world is still stunned from what just happened today. In essence, Germany has taken a major step to not only declaring it is the master of the European continent and all those who don't like it can just focus on their own bankrupt banks (Sarkozy), but is breaking ranks with the US, as the surprising nature of today's move was aimed not so much at European "speculators" but at Wall Street. Furthermore, knowing full well it may soon lose access to US capital markets, Germany is likely preparing to abandon the EU and EMU (to which "good riddance" is likely all it has to say). But the key implication from today is that Bernanke must now move with urgency to find a way to keep the pressure on the dollar as he is now solidly losing the currency devaluation race. The impact of this on major multinationals and on the "must do" reflation experiment could be cataclysmic. Additionally, without gobs of new domestic liquidity to prop it up, the US market will now likely collapse, further forcing Bernanke to act against the interests of the US Middle class and America's savers. We can not wait to see what he pulls out of his sleeve. With ZIRP ravaging the nation, and negative interest rates still illegal, he may just find his hands very much tied.

In the meantime, here are some preliminary shocked observations on today's events from Goldman Sachs and Morgan Stanley.

The latest bombshell: German Finance Ministry now saying it will likely Ban EUR derivatives that don't hedge against FX risk. And good luck quantifying what FX risk is legally allowed to be hedged. Look for the EURUSD market not to plunge, but to simply shut down as a result of this. Europe is about to isolate itself from capital markets entirely.

There are 4 hours until midnight in Germany. There are trillions in gross sovereign CDS notional. Germany alone had $71.4 billion in Gross CDS notional and $13.3 billion in net according to DTCC. Add up all of Europe and you get half a trillion. How on earth will the German market unwind these with all European traders already long gone. We also make the generous assumption that US CDS traders are still around: most of the BSDs tend to leave for the nearest Marriott Garden Inn by 1pm. So with naked CDS positions now verboten, who will be allowed to sell CDS? For a symmetric hedged transaction, anyone selling CDS (long credit), would have to be short cash govvies to be permitted to sell CDS. And who in their right mind would disclose that they are short anything. This is the most ill-thought out regulatory plan in the history of capital markets, and that, shockingly, includes the Frankenstein monster created by our own lame duck coruptus in extremis senator.

The US economy is in the midst of an epochal transition from a long term GDP growth rate from the 3.9% rate we saw during the last decade, to maybe 2%-2.5% this decade. The “V” is rapidly turning into a “square root.” The screaming great weakness in the global capital markets has long been that it is totally dependent on voluntary private capital. Market makers are now on a hair trigger to whip their capital right out of the market. Not answering the phones at Morgan Stanley. Sharing a single bed in a cheap motel with a gaggle of snoring regulators.

When Zero Hedge first wrote about the adverse role of prop trading in capital markets, long before it was a mainstream issue, which in turn incited the response of one Lucas van Praag, in which they assured us and our readers that there were never any issues with Goldman's prop trading desk and that all concerns about prop trading are misplaced. A few months later one of the luminaries of modern finance picked up the Zero Hedge banner and proposed a rule that would end banking prop trading for ever, in essence overriding Mr. van Praag explanation. Yet for the past three months most had left the Volcker Rule for dead, after the banking lobby had once again bought a two year full recourse lease on Obama and his cronies. Until the last two weeks, when first on May 6 we saw what happens how an entire market, gripped in computerized gambling and speculating can break in the span of a few minutes, without doubt facilitated by the banks' prop operations, and also when we saw that the big 4 banks had monopolized prop trading to such an extent (and disingenuously masking it as flow trading: yeah, right, flow trading with a VaR of $150 million... better luck finding greater idiots next time) that none had a losing day, in essence making Madoff's ponzi scheme, with its worse "win" track record a joke in comparison with the ponzi that the market has become. Which is why we read with great satisfaction in the FT that the banking lobby's power is slipping at a critical time: this week the Volcker Rule will be voted on by the Senate, and it may very well pass, despite the "cornered rat" response by the banks. As the FT notes, "the political mood is such that a straight vote on derivatives would be close and the Volcker Rule would be likely to pass." Should the Volcker Rule pass, this will be the beginning of the end for the current casino capitalism system that has gripped Wall Street. And don't be surprised to see a 10% drop in the market as a last ditch self defense mechanism by the primary dealers.

The only benefit of hitting rock bottom is you can't really fall further. Which is precisely what has happened with Greece. The little country that started off the chain reaction that has already led to a currency and liquidity crisis, and made the solvency crisis in Europe all too tangible, by belonging to a monetary union it had no place in (a union which no reason to exist in the first place), is once again reminding the world of its existence, this time by G-Pap opening his mouth and inserted two whole legs in it. In an interview with CNN's Fareed Zakaria to be aired today, G-Pap has threatened he may sue US banks for "contributing" to his country's debt crisis. For those of you lacking in analogy skills, Greece is in the same shoes as a bankrupt debtor who wants to sue his creditors for daring to hike up his interest rate when the only means he has to roll his debt is by using another credit card (this one issued by US and European Taxpayers), even as bankruptcy is literally hours away. The Greek summation: that of a petulant 5 year old who has just broken dad's favorite gadget: “We have made our mistakes,” Papandreou said. “We are living up to this responsibility. But at the same time, give us a chance. We’ll show you.” Now that would be amusing - after Greece destroyed its economy the first go round, we can't wait to see what the country does for an encore. The only reason Greece is not bankrupt now is because even as its past mistakes have caught up with it and climaxed in a solvency and liquidity crisis unseen since the Lehman days, the country's end would bring down all of Europe. If Greece would not have impaired French, German and UK banks, the country would have long been allowed to default. Yet diversion is always a good tactic: let's bring the "speculators" into this yet again. After all it is unheard of in these turbulent Keynesian times for anyone, especially our own Fed Chairman, to own up to their endless mistakes. It is always, without exception, someone else's fault.

Just because this is what a fully normal market should look like. Imagine what would happen if 7% of the population, according to Zero Hedge's somewhat non-scientific poll, actually did not have faith in capital markets.

One of the most delayed IPOs in the history of capital markets, that of Apollo's Noranda Aluminum, which first was allegedly coming to market in 2008, has finally priced. And it's a stunner: after preliminary expectations for raising as much as $266.7 million (16.66 million shares at $16/share), the company barely managed to attract interest for 30% of this amount, or a paltry $80 million. The 70% reduction in the price is a record for 2010 IPOs and shows that the IPO window in which the Goldman "Idiot Money" Rolodex is put to full use, is pretty much shut. Only this time it wasn't Goldman leading the underwriter brigade: GS was only fourth in the line up of managers. This IPO debacle is exclusively the work of lead manager Bank Of America, which more or less explains the fiasco. If you need a crap REIT upgraded you go with Merrill. Everything else will end in tears. And it also goes to show that if you need to find fools willing to part with their money, Goldman is and always will be the way to go. We are very much surprised Leon Black is not fully aware of this. As a result even pro forma for the IPO, Noranda is still leveraged 5x+, or more than three times its peer universe average. Dear latest money investors: our message to you is to prepare to lose your entire investment within a year.

The weekly ICI number for long-term domestic mutual fund flows is out, and not surprisingly, retail investors were bailing out in droves from the stock market even before the massive flash crash of May 6. In fact, in the week ended May 5, retail investors had pulled a massive $2.235 billion out of the market, after the S&P had dropped a mere 5% or so from the prior week. We are positive that when the number for the current week comes out, the outflows will be stunning now that investors have no faith left in the rigged casino "capital markets." Of course, this is simple to explain: with everyone and their grandmother habituated to a market that can only go up, at the first sign of jitteriness everyone and their grandmother bails, although only the big institutions really get to exit: everyone else has to hope the SEC will not cancel their trades the next day. And now that the market has been thoroughly discredited, the primary dealers have no choice but to ramp it up on no volume yet again, in hopes of pulling in the momos and the housewives into it as usual, courtesy of the CNBC cheerleaders, just to pull the rug a few days before the next trillion dollar bail out is needed and "justified." Oh, and whoever cares, retail domestic flows into stocks year to date are negative by $1.5 billion. Tells you all you need to know about who is buying this "market" - momo emptor.

Equities now officially have an active memory of about 24 hours. The biggest market drop in history is now long forgotten, and the only consolation to investors is that SEC is actively fixing the problem even though it has no idea what the problem is. Overnight, futures went up by 20 handles in the span of 4 hours as the invisible bid appeared yet again, afraid of what would happen if the immediate drop in ES was not breached. Luckily, funding markets are not nearly as stupid as stocks, and as a result the TED spread has yet to show any signs of moderating. At last check 3 month LIBOR was 0.4302%, the highest it has been since Q3 2009, and certainly a change from the funding market calm that hadenveloped all market participants like Federal Reserve "no risk" amniotic sack over the past year. At the same time the 3 Month Bill is once again grinding tighter, as investors unsure what to buy, buy everything: stocks, bonds, oil and especially gold. Another perfectly insane day in US capital markets glutted by endless liquidity.

"Most institutional and retail investors have no idea that the private trade information they are entrusting to the market centers is being made public by the exchanges. The exchanges are not making this clear to their clients, but instead are actively broadcasting the information to the HFT’s in order to court their order flow. The exchanges are likely to counter that when a subscriber signs up to their exchange they then allow the exchange to use this data as they see fit. However, how many investors would have signed that agreement knowing that their hidden orders were being exposed? This practice has been going on for years but not many investors have read the market data specifications. Every day high frequency traders are using the information that some exchanges are supplying to disadvantage unsuspecting investors.
Every time a trader places an order in certain market centers, whether at the market centers directly, or through a third-party DMA, those market centers are collecting data regarding the trader’s order flow. They are supplying the information to HFT’s that allows them to track when an investor changes price and how much stock has been accumulated. This information is helping HFT’s predict short term price movements. Institutional as well as retail footprints are being detected, and “modus operandi” and trading profiles are being created. Traders believe that their trading strategies are protected, when actually their strategies (personal data) -- including variables such as displayed quantity, time stamp, side, revisions, reserve orders, linked executions, order id numbers, accumulations, number of shares -- are being misappropriated for sale by the market centers." - Themis Trading

David Rosenberg is out with some very fitting analogies of the current sovereign crisis. If he is proven prescient, which we have no doubt he will, the Greek near-default will have massiverepercussions to the entire developed world when all is said and done."In my opinion, Greece is the same canary in the coal mine that Thailand was for emerging Asia in 1997, which ultimately led to the Russian debt default and demise of LTCM; the same canary in the coal mine that New Century Financial in early 2007 proved to be in terms of being a leading indicator for the likes of Bear Stearns and Lehman. So, the most dangerous thing to do now is to view Greece as a one-off crisis that will be contained." Furthermore, as he makes all too clear, if a $1 trillion bailout can only buy 400 points in teh Dow, Europe, aside from all the other fundamentals which confirm the same, is doomed, and even the ever-optimistic market now realizes it. Lastly, should Europe pursue the required austerity measures, the hit to European GDP will be massive, and is certainly not being priced in European stocks, but certainly not in US stocks, whose primary export market is about to disappear.

Hilarity ensues!

Not one bit embarrassed by their last witch hunt against speculators that led European politicians to discover that the biggest CDS "speculator" against Greece was in fact the Greek post bank (a fact that received very little publicity surprisingly), they are back at it again. It seems there might be a slight confusion though on their part between investors and speculators. By taking on the supposed speculators with an unprecedented galore of currency debasement, European countries are very unlikely to attract any foreign capital going forward. This is nothing else than capital markets fascism and a poorly disguised ponzi scheme. Fact is that fiscal finances are in poor order and not expected to get much better in the future. Rather than tighten the belt and address the gap as they should, governments around the world are lending themselves the money they need to spend. Throughout the financial crisis the only category of workers that has seen a pay rise are those working for the government. Yes there have been layoffs, but very little pay cuts. Talk about a collective effort! While capital markets seem happy to celebrate the madness this morning, also a by-product of a lot of shorts of risk being chased through the gates of hell, I expect that the markets will see through this mascarade in due time. The only trade that makes complete utter sense is being long Gold, and once the short covering is over short EURUSD. It is worth noting that the precious metal now trades with a positive correlation to the USD, and the weakness this morning should not be expected to last as the weekend's news is exactly what gold investors have been counting on: complete global monetization of debt. It won't be long before central banks run out of gold to sell to put a lid on the market at this pace. Maybe the financial bill will also include a speculation limit on the purchase of physical commodities. - Nic Lenoir, ICAP

The race to the currency devaluation bottom is now in its final lap. And gold is the only alternative to the now imminent collapse of the fiat system: the world had a chance to take writedowns on losses, punish those who took risk and failed, and refused to do so. There is now no risk left, but it only means that eventually all the risk will come back and lead all capital markets to zero. The result will be the end of Keynesian economics as we know it. Do not trade in this broken market, do not hold your money in a bank as they are all now one hour away from a terminal bank run - buy and hold real, FASB mark-to-myth independent assets.