Capital Markets

Regular readers know that since the beginning, Zero Hedge has been vehemently opposed to the official SEC explanation of the chain of events that brought upon the Flash Crash of May 6, 2010, in which the Dow Jones Industrial Average lost 1000 points in a span of seconds, and during which billions were lost when stop loss orders were triggered catching hapless victims unaware (unless of course, one had a stop loss well beyond a reasonable interval of 20%, in which case the trades were simply DKed). It is no secret that one of the main reasons why the retail investor has since declared a boycott of capital markets, which lasts to this day, and manifests itself in hundreds of billions pulled out of equities and deposited into bonds and hard assets, has been precisely the SEC's unwillingness to probe into this still open issue, and not only come up with a reasonable and accurate explanation for what truly happened, but hold anyone responsible for the biggest market crash in history in absolute terms. Instead, the SEC, naively has been pushing forth a ridiculous story that the entire market crash was the doing of one small mutual fund: Waddell and Reed, and its 75,000 E-mini trade, which initially was opposed to being scapegoated, but subsequently went oddly radio silent. Well, if they didn't mind shouldering the blame, the SEC was likely right, most would say. However, as virtually always happens, most would be wrong. Over the past few days, Nanex has one again, without any assistance from the regulators or any third parties, managed to unravel a critical component of the entire 104 page SEC "findings" which as is now known, indemnified all forms of high frequency trading (even as subsequently it was found, again by Nanex, that it was precisely HFT quote churning that was the primary, if not sole, reason for the catastrophic chain of events) with a finding so profound which in turn discredits the entire analytical framework of the SEC report, and makes it null and void.... The only open question is whether the SEC, which certainly co-opted the authors of the paper to reach the desired conclusion, real facts be damned, acted out of malice and purposefully fabricated the data knowing very well the evidence does not support the conclusion, or, just as bad, was the entire supporting cast and crew so glaringly incompetent they did not understand what they were looking at in the first place.

"In the last three plus years, central banks have had little choice but to do the unsustainable in order to sustain the unsustainable until others do the sustainable to restore sustainability!" is how PIMCO's El-Erian introduces the game-theoretic catastrophe that is potentially occurring around us. In a lecture to the St.Louis Fed, the moustachioed maestro of monetary munificence states "let me say right here that the analysis will suggest that central banks can no longer – indeed, should no longer – carry the bulk of the policy burden" and "it is a recognition of the declining effectiveness of central banks’ tools in countering deleveraging forces amid impediments to growth that dominate the outlook. It is also about the growing risk of collateral damage and unintended circumstances." It appears that we have reached the legitimate point of – and the need for – much greater debate on whether the benefits of such unusual central bank activism sufficiently justify the costs and risks. This is not an issue of central banks’ desire to do good in a world facing an “unusually uncertain” outlook. Rather, it relates to questions about diminishing returns and the eroding potency of the current policy stances. The question is will investors remain "numb and sedated…. by the money sloshing around the system?" or will "the welfare of millions in the United States, if not billions of people around the world, will have suffered greatly if central banks end up in the unpleasant position of having to clean up after a parade of advanced nations that headed straight into a global recession and a disorderly debt deflation." Of course, it is a rhetorical question.

While equity trading last March trading was affected by the excess volatility arising from the Fukushima explosions a year earlier, and the Japan earthquake induced volatility in general, today's monthly volume update by the NYSE shows that no matter what the reason for the volume collapse, toplines for banks and traders will suffer, on both a Y/Y as well as sequential basis. Per the NYSE: "European and U.S. Cash ADV Down 13% and 24% Year-over-Year.... NYSE Euronext European cash products ADV of 1.6 million transactions in March 2012 decreased 12.7% compared to March 2011, but increased 0.5% compared to February 2012. NYSE Euronext U.S. cash products handled ADV in March 2012 decreased 23.6% to 1.8 billion shares compared to March 2011 and decreased 0.6% from February 2012." An even bigger year-over-year collapse took place in the one product which everyone thinks is taking the place of individual stock trading: the synthetic CDOs known as ETFs: "NYSE Euronext U.S. matched exchange-traded funds ADV (included in volumes for Tape B and Tape C) of 222 million shares in March 2012 decreased 29.3% compared to March 2011, but increased 4.1% compared to February 2012. In the first quarter of 2012, NYSE Euronext U.S. matched exchange-traded funds ADV of 221 million shares was 21.8% below prior year levels." The YoY collapse in trading volumes for derivatives was less compared to cash, but the sequential drop from February 2012 was even more pronounced: "NYSE Euronext global derivatives ADV in March 2012 of 8.1 million contracts decreased 11.5% compared to March 2011 and decreased 15.4% from February 2012 levels." We can only hope that banks have found some innovative ways of compensating for this collapse in overall market participation, such as traditional revenue pathways like underwriting and advisory fees, as well as lending and arbing the carry trade. Alas, as the following Bloomberg piece points out, this will hardly be the case, as Zero Hedge has warned previously.

In a few weeks the Treasury will most likely launch Floating Rate Notes. Will that be the signal to get out of Dodge? If history is any precedent, and especially the 1951 Accord... you bet.

Imagine the world economy as an armada of ships passing through a narrow and dangerous strait leading to the sea of prosperity. Navigating the channel is treacherous for to err too far to one side and your ship plunges off the waterfall of deflation but too close to the other and it burns in the hellfire of inflation. The global fleet is tethered by chains of trade and investment so if one ship veers perilously off course it pulls the others with it. Our only salvation is to hoist our economic sails and harness the winds of innovation and productivity. It is said that de-leveraging is a perilous journey and beneath these dark waters are many a sunken economy of lore. Print too little money and we cascade off the waterfall like the Great Depression of the 1930s... print too much and we burn like the Weimar Republic Germany in the 1920s... fail to harness the trade winds and we sink like Japan in the 1990s. On cold nights when the moon is full you can watch these ghost ships making their journey back to hell... they appear to warn us that our resolution to avoid one fate may damn us to the other.

Now that the world is covered in at least $707 trillion in assorted unregulated Over the Counter derivatives (as of June 30, the most recent number is easily tens of trillions greater) and with at least one JPMorgan prop|non-prop trader exposed to having a ~$100 billion notional position in some IG-related index trade, pundits, always eager to score political brownie points, are starting to ruminate over ways to put the half alive/half dead cat back into the box. Unfortunately they are about 20 years too late: with the world literally covered in various levered bets all of which demand hundreds of billions in variation margin on a daily basis, the second the one bank at the nexus of the derivative bubble (ahem JPMorgan) starts keeling over, it will once again be "the end of the world as we know it" unless said bank is immediately bailed out. Again.

The regulators have "fixed" a big problem. Actually they just created a much larger one.

The one sentence that may change everything: "...we have found some evidence that at the very long end of the yield curve, where Operation Twist is concentrated, it may be not just the stock of securities held by the Fed but also the ongoing flow of purchases that matters for yields..."

While the idea of a futuristic tale of the resurgence of Greece and how Germany shot itself in the foot could well be the work of the horror-writer, HSBC's Chief Economist Stephen King opines on what could well be with a moral for those who want Athens out of the Euro. "The idea that Greece can leave and that the rest of the eurozone will then live happily ever after – a view that is quickly becoming the conventional wisdom – is surely wrong. Departure might eventually be an answer to Greece's difficulties but it only asks questions of everybody else." And the fantastic journey King lays out is rooted in a sad reality that he sums up thusly: "Germany's gamble had failed. In the attempt to punish Greece, it had ended up with an impossible choice: creating a fiscal union or huge currency upheaval. Berlin had taken aim at Greece but shot itself in the foot."

Too close for comfort. 

Today's aggressive intervention by various monetary authorities to prevent the Swiss Franc from trading anywhere close to its fair value (yes "intervention", the same that happens each day in other capital markets, like stocks and commodities, read gold) reminded us once again that it is always and only a central planner's world. Yet while it is easy to assume there is some big black box doing all this manipulation, the truth is that the decision chain ultimately ends with carbon-based lifeforms, who push the buy or sell button, respectively: i.e., the human element. Which is why we wanted to present our readers the decision making chain expressed in flesh and blood terms, namely the people who over and over demonstrate to the market just who is in control.

Confused by stock bubbles and furious episodes of manic market euphoria? SocGen's Dylan Grice explains it in one brief sentence: "we’re hardwired to overvalue excitement and undervalue boredom."

More pain in Spain has been the theme so far in the European morning as poor auction results across three lines has resulted in significant widening in the 10-yr government bond yield spreads over benchmark bunds with the Spanish 10yr yield up some 24bps on the day. In combination with this the latest Germany Factory orders also fell short of analysts’ expectations and as such the lower open in bund futures following yesterday’s less than dovish FOMC minutes has been completed retracted and we now sit above last Friday’s high at 138.58.

• Low cost era over for China's workshops to the world (Reuters)
• The HFT scourge never ends: SEC Probes Ties to High-Speed Traders (WSJ)
• Rehn says Portugal may need "bridge" (Reuters)
• China's GDP likely to have slowed in the first quarter (China Daily)
• Chinese Premier Blasts Banks (WSJ)

Oh where to begin. The weakness in the markets started late last night when Australia posted a surprising second consecutive deficit of $480MM on expectations of a $1.1 billion surplus (with the previous deficit revised even higher). This is obviously quite troubling because as we pointed out 3 weeks ago when recounting the biggest Chinese trade deficit since 1989 we asked readers to "observe the following sequence of very recent headlines: "Japan trade deficit hits record", "Australia Records First Trade Deficit in 11 Months on 8% Plunge in Exports", "Brazil Posts First Monthly Trade Deficit in 12 Months " then of course this: "[US] Trade deficit hits 3-year record imbalance", and finally, as of late last night, we get the following stunning headline: "China Has Biggest Trade Shortfall Since 1989 on Europe Turmoil." So who is exporting? Nobody knows, but everyone knows why the Aussie dollar plunged on the headline. The shock sent reverberations across Asian markets, which then spilled over into Europe. Things in Europe went from bad to worse, after Germany reported its February factory orders rose a modest 0.3% on expectations of a solid 1.5% rebound from the -1.8% drop in January. But the straw on the camel's back was Spain trying to raise €3.5 billion in bonds outside of the LTRO's maturity, where the results confirmed that it will be a long, hard summer for the Iberian country, which not only raised far less, or €2.6 billion, but the internals were quite atrocious, blowing up the entire Spanish bond curve, and sending Spanish CDS to the widest in over half a year.