Central Banks

Riskier assets advanced today, as market participants reacted to yesterday’s FOMC statement, as well as reports that Greece is making progress in talks for a debt-swap deal. However despite a solid performance by EU stocks, German Bunds remain in positive territory on the back of reports that the ECB has ruled out taking voluntary losses on its Greek bond holdings but is now debating how it would handle any forced losses and whether to explore legal options to avoid such a hit according to sources. As such, should talks between private creditors and other governing bodies stall again, there is a risk that Greece may not be able to meet its looming financial obligations. Of note, Portuguese/German government bond yield spreads continued to widen today, especially in the shorter end of the curve.

Gold rose 2.5% yesterday and broke $1,700/oz to $1,712.80, its biggest one-day gain in the past 4 months, as the US Federal Reserve’s 11 out of 17 members voted that interest rates would likely remain near zero into late 2014. Investors sought safe haven refuge into gold fearing their portfolios would lose value as Central Banks flood the markets with loose monetary policies and more cash for governments that can't seem to manage their balance sheets.  A group of 7 major economies now have interest rates that average .5%.  Silver also rallied up 4%.  Today's Comex February gold option expirations will show more activity in the gold markets. One trader stated that gold's gains on Wednesday could be due to a huge cover on a short position before today's option expiration.

As a reminder, the primary reason why the Greek PSI deal "officially" broke down last week, is because the European Fin Mins balked at the creditor group proposal of a 4%+ cash coupon. So now that creditor talks, which incidentally don't have a soft deadline so they can continue indefinitely, or until the money runs out on March 20, whichever comes first, have resumed we already are getting the first totally unsubstantiated "leaks" that negotiations are on the right path. As various US wires reported overnight, including DJ, BBG and Reuters, citing completely "unbiased" and "unconflicted" local Greek media, "Greece's private creditors are willing to improve their "final offer" of a four percent interest rate on new Greek bonds in order to clinch a deal in time to avert a messy default, Greek media said on Thursday without quoting any sources. With time running short ahead of a major bond redemption in March, private creditors are now considering an average coupon of around 3.75 percent on bonds they will receive in exchange for their existing investments, the newspapers wrote." All is good then: the hedge funds will make the proposal to Europe and Europe will accept, right? Wrong. "Another daily, Kerdos said participation of public sector creditors including the ECB in the swap deal was a pre-condition for that offer, which it said could bring the average interest rate to about 3.8 percent." And that as was reported yesterday is a non-starter. So in other words, the latest levitation in the EURUSD started at about 4am Eastern is nothing but yet another rumor-based attempt to ramp up risk. Only this time the rumor is actually quite senseless, which probably explains why even the market which has been completely irrational lately, has seen the EURUSD drop from overnight highs. That said, expect this rumor to be recirculated at least 5 more times before end of trading.

As we have pointed out previously, the primary if not only driver of relative risk returns (because in a world of relative fiat value destruction, it is all relative, except for gold which is revalued relative to all on a pro rata basis), will be who of the big two - the Fed and the ECB - can print more. And up until now, at least since the end of December when the market "suddenly" realized that the ECB's balance sheet has soared to unseen records, the consensus was that it was the ECB that would be the primary source of easing. Especially when considering that there is another ~€500 billion LTRO due on February 29. Yet today's rapid reversal in the EURUSD, driven by Bernanke's uber-dovish comments suggest that something has changed and that the Fed is now expected to ease substantially. How much? For that we look to the latest balance sheet cross-correlation, where if we go by simple correlation, the market is now pricing in (based on the EURUSD cross ratio) that the relationship of the two balance sheets will rise from a multi year low of 1.08 as of a few days ago to 1.15, at least based on the rapid move in the EURUSD higher as can be seen in the chart below. Indicatively, the actual value of the two balance sheets is €2.706 trillion for the ECB and $2.92 trillion for the Fed (or a 1.08 ratio). So now that the EURUSD has risen as high as it has, it implies that the pro forma "priced in" ratio is about 1.15. But wait: one should also factor in the fact that the ECB's balance sheet will rise by at least another €500 billion in just over a month, which will bring the ECB's balance sheet to €3.2 trillion. Which means that to retain the 1.15 cross balance sheet relationship, the Fed's own balance sheet will have to rise to $3,687 billion, or a whopping $767 billion increase!

Our discussions (here, here, and here) of the dispersion of deleveraging efforts across developed nations, from the McKinsey report last week, raised a number of questions on the timeliness of the deflationary deleveraging process. David Rosenberg, of Gluskin Sheff, notes that the multi-decade debt boom will take years to mean revert and agrees with our views that we are still in the early stages of the global deleveraging cycle. He adds that while many believe last year's extreme volatility was an aberration, he wonders if in fact the opposite is true and that what we saw in 2009-2010 - a double in the S&P 500 from the low to nearby high - was the aberration and market's demands for more and more QE/easing becomes the volatility-inducing swings of dysphoric reality mixed with euphoric money printing salvation. In his words, perhaps the entire three years of angst turned to euphoria turned to angst (and back to euphoria in the first three weeks of 2012?) is the new normal. After all we had angst from 1929 to 1932 then ebullience from 1933 to 1936 and then back to despair in 1937-1938. Without the central banks of the world constantly teasing markets with more and more liquidity, the new baseline normal is dramatically lower than many believe and as such the former's impacts will need to be greater and greater to maintain the mirage of the old normal.

Because live is better than dead. And just in case he lets one slip just what his price target for the Russell 2000 (aka the US GDP) is and how much gold the Fed will secretly lease. As a reminder, from Alan Greenspan testimony to Congress in July 1998: "Central banks stand ready to lease gold in increasing quantities should the price rise."

Formal central bank independence is increasingly under pressure as societal preferences for a lender of last resort savior grow ever stronger (and more priced into nominal risk markets) as do demands for politicizing the monetary authorities under the pretext that they should more politically independent. Morgan Stanley takes on the question of constitutionality among the G3 Central Banks and rather unsurprisingly finds the mandates, targets, and prohibition treaties to be 'flexible' at best and 'practically meaningless' at worst. We-the-people appear to have little if any remit to constrain - even if our collective call for more printing leads to 'be careful what you wish for' reactions, as Michael Cembalest noted yesterday, "first prize in the Central Bank balance sheet expansion race is not necessarily one you want to win".

The markets follow the money. 

Where did all the bears go?  We cannot find more than one person willing to be outright bearish.  What is particularly strange is that the reasons most people are bullish seem to have little, if anything to do with fundamentals – either macro or micro.  The reason for being long that is closest to being “fundamental” is that Europe is muddling through.  We're not sure Europe is muddling through, but in any case, wasn’t the bullish case for US stocks that we were decoupling?  Conspicuously absent as a reason to be long is earnings. It seems as though everyone is reasonably long (though not fully committed), but thinks everyone else is underweight.  It really feels like the “consensus” is that everyone else is underweight so you better be long for when that money comes into the market. The conversations are far more bearish than the positioning.

All you need to read.

Investors are waiting on the outcome of a 2 day Federal Reserve meeting which ends on Wednesday.  Here they are following any signs that interest rates will remain low, as that could put pressure on the U.S. dollar. The Tokyo Commodity Exchange, December, gold contracts climbed as high as 4,167 yen/gram, its biggest gain since mid-December. The gains initially propelled cash gold even though trading was slow during the Lunar New Year break. Japan has been notably absent in the gold market in recent years. This may be changing as concerns about the Japanese economy and continuing debasement of the yen may be leading to Japanese diversification into gold.  The scale of domestic savings in Japan remains enormous. This would be a new and potentially extremely important source of demand in the gold market which could help contribute to much higher gold prices. 

As widely expected by Zero Hedge, barely a few months after the arrival of former Goldmanite Mario Draghi to head ECB, the ECB's balance sheet exploded by nearly $1 trillion. Naturally, such is the way of central banks infiltrated by tentacles of the squid: no surprises. Which brings us to the first Fed meeting of 2012 and its public manifestation: the FOMC's January 25 statement. As is well known, while the Goldman addition to the ECB is a recent development, its agent at the Fed, the head of the FRBNY Bill Dudley has been there for a quite a while - in fact ever since the tax-challenged Mike Judge character impersonator left to become Treasury Secretary. As was suggested on Zero Hedge, it was the meetings of Bill Dudley with Goldman's Jan Hatzius at the Pound and Pence, and of course elsewhere but these are the only public recorded ones, that have shaped monetary policy more than anything. In other words, if anyone can predict, not to say define, US monetary policy, it would be Jan Hatzius. Below are his just released "thoughts" on what to expect on Wednesday. What is odd is that whereas a month ago Goldman was convinced that an LSAP version of QE was imminent, now the firm has become substantially less optimistic. Is it time to manage down expectations? To wit: "Given the improvement in the economic indicators and the easing of financial conditions that has occurred in the meantime, we believe it is less central now. While Fed officials are certainly not targeting a tightening of conditions, we doubt that they will "bend over backwards" to deliver a dovish surprise relative to current market expectations." So just how much QE3 is priced in if Goldman is already doing disappointment damage control. Or did Goldman finally wise up and realize that the only effective Fed statement is the one that surprises. So if Goldman does not publicly expect QE3, and we do in fact get a notice thereof, it will have an immediate knee jerk reaction on risk, and of course, Gold. These and many more questions shall be answered at 12:30 pm on Wednesday.

Two things of note in today's Rosie piece. On one hand he breaks out the 10 good and bad things that investors are factoring, and while focusing on the positive, and completely ignoring the negative, are pushing the market to its best start since 1997. As Rosie says: "The equity market has gotten off to its best start in a good 15 years and being led by the deep cyclicals (materials, homebuilders, semiconductors) and financials — last year's woeful laggards (the 50 worst performing stocks in 2011 are up over 10% so far this year; the 50 best are up a mere 2%). Bonds are off to their worst start since 2003 with the 10-year note yield back up to 2%. The S&P 500 is now up 20% from the early October low and just 3.5% away from the April 2011 recovery high (in fact, in euro terms, it has rallied 30% and at its best level since 2007)." Is there anything more to this than precisely the same short-covering spree we saw both in 2010 and 2011? Not really: "This still smacks of a classic short-covering rally as opposed to a broad asset- allocation shift, but there is no doubt that there is plenty of cash on the sidelines and if it gets put to use, this rally could be extended. This by no means suggests a shift in my fundamental views, and keep in mind that we went into 2011 with a similar level of euphoria and hope in place and the uptrend lasted through April before the trap door opened. Remember too that the acute problems in the housing and mortgage market began in early 2007 and yet the equity market did not really appreciate or understand the severity of the situation until we were into October of that year and even then the consensus was one of a 'soft landing'." Finally, Rosie steps back from the noise and focuses on the forest, asking the rhetorical question: "Isn't this still a "modern day depression?" - his answer, and ours - "sure it is."

So… are stock investors smarter than everyone else… or are they just gunning the market on low volume yet again regardless of reality? We’ll find out this week once we get past the Fed FOMC and Europe’s decision on Greece.

As of a few hours ago, Goldman's Francesco Garzarelli has officially told the firm's clients to go ahead and short 10 Year Treasurys via March 2012 futures, with a 126-00 target. While Garzarelli is hardly Stolper (and we will have more on the latest Stolpering out in a second), the fact that Goldman is now openly buying Treasurys two days ahead of this week's FOMC statement makes us wonder just how much of a rates positive statement will the Fed make on Wednesday at 2:15 pm. From Goldman: "Since the end of last August, we have argued that 10-yr US Treasury yields would not be able to sustain levels much below 2% in this cycle. Yields have traded in a tight range around an average 2% since September, including so far into 2012. We are now of the view that a break to the upside, to 2.25-2.50%, is likely and recommend going tactically short. Using Mar-12 futures contracts, which closed on Friday at 130-08, we would aim for a target of 126-00 and stops on a close above 132-00." As a reminder, don't do what Goldman says, do what it does, especially when one looks the firm's Top 6 trades for 2012, of which 5 are losing money, and 2 have been stopped out less than a month into the year.