Crude

Following a busy overnight session, which saw a surprise announcement out of the Brazilian Central Bank cutting rates more than expected, and confirmation of the deterioration in the Japanese economy where January saw a record current account deficit, today we have already seen the Bank of England proceed as expected keeping its key interest rate unchanged (at 0.50%) and QE fixed at GBP325 billion. The ECB is next with its rate announcement, expected to keep things on hold. Yet the mood of the morning is set by speculation that the Greek debt swap may see a sufficient participation rate for the PSI to go through, even if that means CAC activation, as somehow a Greek default is good, and only an "out of control" bankruptcy would be bad. That coupled with renewed expectations of more QE, sterilized or not, and hopes that tomorrow's NFP will be better than expected, as somehow the Fed will pump money even if the economy is "improving", is all that is needed to send the post-roll ES contract to session highs nearly 1% higher than yesterday's close.

All you need to read.

Today we observed how as the US is considering releasing crude from its Political, pardon Strategic Petroleum Reserve, China was doing just the opposite. Now, in a further step confirming that China is acting as a much more rational capitalist power, and is rapidly encroaching on the "reserve" status of the sacrosanct USD, the FT writes that China intends to extend renminbi loans to other BRIC nations in "another step toward the internationalisation of its currency." To those following the stealthy Chinese incursion into currency markets as a dollar alternative, this is not news: already we know that China and Japan have bypassed the dollar entirely and now engage in direct bilateral trade using JPY and CNY (even as most other nations in Asia have developed bilateral agreements to transact in a non dollar basis). This is merely the latest incremental step which will see China become the dominant player in the currency arena, and further puts to doubt the fate of the US Dollar as the default currency. Of course, the market will not acknowledge any of this until the developing (i.e., non-insolvent world) is transacting entirely with US intermediation. And at that point, the US will be merely another Zimbabwe case study, where it can print all the money it wants to fund its deficit, and the only ones who care will be wheelbarrow manufacturers.

Oil is battling hard with Greece to top the tail-risk-du-jour in financial markets recently. As Credit Suisse notes, the US economy so far seems to have shrugged it off as 'gasoline-sensitive' economic data for Feb have ignored the price rise for now. The extreme (warm) weather may be shielding the economy from the effect of these higher energy costs, as are consumers habituation with relatively high prices, and while CS remains more sanguine than us on energy's negative impulse they set forth some useful implications (rules-of-thumb) for what oil means for gas prices, headline inflation, real disposable income, and GDP growth pointing to $150 Brent as a critical threshold for the economy (or equivalently $4.50 retail gasoline prices). Of course, Fed policy precedents and implications are necessarily situational as the hope for this being a 'temporary' situation but the circular reaction to the consequences of any growth drag will merely exacerbate the situation. Was Bernanke's recent less unconditional dovishness an implicit effort to 'tighten' expectations and manage the war-premium out of oil prices?

Update: yup. It's Jon "Mouthpiece" Hilsenrath all right. This is nothing but a test to gauge if the market will ramp on the clarification that future QE may be sterilized. If market ramps regardless, the sterilized clause will be ultimately eliminated. Full story link.

While we have yet to see the actual report, almost certainly emanating from Jon Hilsenrath, it appears that the QE3 rumormill has started, initially with speculation that the Fed's activity will be merely "sterilized" or more Twist-type purchases, unclear however if in TSYs or also in MBS. Via the WSJ:

• Fed Officials consider "sterilized" option for Future bond buying
• Operation Twist Reprise, QE Other Options For Fed Bond
• Still Unclear Whether Fed Will Launch Another Bond-Buy

As a reminder, yesterday we said that according to the EURUSD, the implied market expectation is for a $750 billion QE out of the Fed. However, that is for unsterilized balance sheet expansion. If the Fed goes ahead and does not grow its balance sheet (hence "sterilized"), it may well be EURUSD, and thus risk, and gold, negative, as no new money will enter the market for actual speculation. Which perhaps is precisely what the Fed is planning, as every incremental dollar now goes into Crude first, and everything else later. In other words: this is a very big risk off indicator as no new money will be available to pump up stocks!

A tale of two civilizations, one in ascent and one in decline, can probably be best summarized by how they ration for the future in that most important of commodities - energy, in this case vis-a-vis the respective treatment of the strategic oil reserves of China and the US. Because while all the rage in D.C. political gab in recent weeks has been whether the US will allow a release of oil from the SPR, just to appease those Obama voters who actually have a job and have to take a car to get to it, things over at America's nemesis in civilizational conflict are diametrically opposite. As Bloomberg reports, China has "started filling its emergency petroleum reserve at Lanzhou in the nation’s northwest, according to an official at the nation’s largest crude producer." Unlike the US, where everything is now a function of market liquidity, evil speculators, and political ambitions (rest in peace supply and demand), China is completely ignoring all the day to day mundane drivel, and is doing what is right - which is to make sure it is prepared for an "eventuality" in the crude supply. Said eventuality is 100% guaranteed to happen if the Panetta-McCain is given a green light to allow the liberation of Iranian crude to finally proceed following years of foreplay.

Looking for some clues of US military strategy in Syria, especially in the aftermath of McCain's statement that he requests an air strike over Syrian government forces? Curious why Crude may gyrate over the next hour? Then watch the following webcast from the Senate Armed Services Committee where the honorable warmonger #1 John McCain is presiding, and questioning US Defense Secretary Leon Panetta over the latest thoughts on what to expect in Syria and thus Iran.

German lawmakers are to review Bundesbank controls of and management of Germany’s gold reserves.  Parliament’s Budget Committee will assess how the central bank manages its inventory of Germany’s gold bullion bars that are believed to be stored in Frankfurt, Paris, London and the Federal Reserve Bank of New York, according to German newspaper Bild.  The German Federal Audit Office has criticised the Bundesbank’s lax auditing and inventory controls regarding Germany’s sizeable gold reserves – 3,396.3 tonnes of gold or some 73.7% of Germany’s national foreign exchange reserves. There is increasing nervousness amongst the German public, German politicians and indeed the Bundesbank itself regarding the gigantic risk on the balance sheet of Germany's central bank and this is leading some in Germany to voice concerns about the location and exact amount of Germany’s gold reserves. The eurozone's central bank system is massively imbalanced after the ECB’s balance sheet surged to a record 3.02 trillion euros ($3.96 trillion) last week, 31% bigger than the German economy, after a second tranche of three-year loans. The concern is that were the eurozone to collapse, Bundesbank's losses could be half a trillion euros - more than one-and-a-half times the size of the Germany's annual budget. In that scenario, Germany’s national patrimony of gold bullion reserves would be needed to support the currency – whether that be a new euro or a return to the Deutsche mark.  The German lawmakers are following in the footsteps of US Presidential candidate Ron Paul who has long called for an audit of the US’ gold reserves. It is believed that some 60% of Germany’s gold is stored outside of Germany and much of it in the Federal Reserve Bank of New York.

Markets appear to be tentatively recovering some of yesterday’s heavy losses, recording modest gains so far this morning. Comments made overnight by the German finance minister as well as senior officials from the Greek finance ministry may have mercifully given market participants some hope as they are confident the Greek PSI deal will be completed by the deadline tomorrow evening. The DAX index has underperformed the other European equity indices in recent trade following the release of some disappointing factory orders data for January, with markets expecting an expansion of 0.6%, however the reading came in at -2.7%, moving DAX stock futures into negative territory. WTI crude and Brent have also retraced some of their losses made earlier in the week following a drawdown in US gasoline inventories reported last night as well as a generally weak USD index in the FX markets today. Markets are awaiting US ADP employment change later in the session, as well as the weekly DOE oil inventories casting further light on the US energy stocks.

Something funny happened in January as the EURUSD rose from its period low in the 1.26 level: German Industrial Orders imploded as the joint currency strengthened. But not so much for domestic orders within the Eurozone, which actually increased by 0.9% in January (as a reminder, the sole reason mercantilism still works efficiently within the Eurozone is that the Bundesbank, via TARGET2 and the ECB, subsidizes the import economies of the periphery via recycled Current Account proceeds, as shown here). Where the demand collapse came from was non-Eurozone (read China and America) orders which fell a whopping 8.6% in January, after posting a 12.1% rise in December as the EUR was plumbing 2011 lows. As a result, the blended orders rate was down 2.7% on expectations of a 0.6% increase. Does it become clear now why resolving the Greek crisis is not in Germany's interest, as all that would do is send the EUR even higher, and impair German industry - the lifeblood of Europe - even more? Alternatively, does it become clear why Bernanke is just itching to shift the weak currency regime from Europe and back to the US again, with the only thing holding him back being the fear of crude exploding, especially if some Made in Israel bunker busters explode somewhere deep in the Zagros mountains?

Following yesterday's broad risk off day, some positive sentiment has returned to markets despite ugly economic data from Germany, and an odd indefinite halt of trading of Greek bonds on the Milan Borse. As BAC notes, for the third straight day, Asian equity markets sold off, as investors are concerned about a Greece debt-swap deal. The regional MSCI Asia Pacific Index slid 0.9%, to finish at its lowest close in a month. The worst-performing market was the cyclical-sensitive Korean Kospi. Its economy, along with many other emerging Asia economies, is highly dependent on exports, so yesterday's data that showed that the Euro area's economy contracted in the fourth quarter added to the bad news. The Hang Seng also lost 0.9%, while the Shanghai Composite fell 0.7%. Japan's Nikkei lost 0.6% and the Indian Sensex fell 0.2%. In Europe, equities are rebounding from their biggest drop since November. Part of the rebound is investors returning to equities to buy the dip, while investors are also expecting a strong ADP employment report later in the day - at 8:15 am. In the aggregate, European equities are up 0.4%. At home, futures are pointing to a solid opening later today. The S&P 500 is set to open 0.5% higher. Elsewhere, German factory orders plunged -2.7% M/M on expectations, from a +1.6% December print, driven by a total collapse in orders from outside the Eurozone which imploded by 8.6% down from +12.1% in December (more shortly). And Europe is now bracing for a Greek default as the Milan Bourse earlier announced it has suspended Greek bonds from trading indefinitely - perhaps related to this is the fact that after trading in the triple digits yesterday, the Greek 1 Year just slid to an all time record 1114% - looks like there is not much value in that post-reorg Greek package offered to PSI volunteers. Finally, the deposit money held at the ECB barely budges, as it prints at €817 billion, down just modestly from yesterday's record print as Europe's banks brace for Thursday's PSI announcement with a big cash buffer.

All you need to read.

Something interesting happened when the ECB announced last week that its balance sheet was about to rise by €1 trillion gross, and hit a record €3 trillion net earlier today: the EURUSD barely budged. Why? Because as a reminder, the key driving relationship for relative risk performance of 2012 as we forecast back in December is the correlation of the Fed and the ECB's balance sheets, and the EURUSD, respectively, because while we may pretend that there is still alpha in this joke of a market, the truth is that in this new normal only beta matters (the more lever the better), and the only beta that matters is that generated by relative USD strength/weakness. In this context, we bring back readers to the chart that may be the only one that matters: the cross-correlation of the Fed/ECB total assets, and the EURUSD spot, where the first thing that stands out is that the pair should be 1000 pips lower at least. And yet it isn't. The reason for that is that the FX market is actively expecting, despite all rhetoric otherwise, an injection from the Fed. What is convenient is that the chart allows us to calculate how much the expected QE3 will be: since the absolute value of the Fed/ECB size (currency invariant) is now 0.9685m or the lowest in history, the ratio would have to raise to 1.18 for EURUSD asset implied parity. Which means the Fed's balance sheet would have to increase by about $650-700 billion promptly.

Wonder why risk is sliding, and taking crude with it? Here's why:

• DEFENSE SECRETARY PANETTA SAYS THE US WILL TAKE MILITARY ACTION TO PREVENT IRAN FROM ACQUIRING NUCLEAR WEAPON IF ALL ELSE FAILS - RTRS

Guess what - all else will fail, as there is no "all else" - this whole charade has been set up precisely to leave Iran with no options. Then again, even the Pentagon knows that starting with a lower baseline in Crude, supposedly in the double digits, is preferable to a $110 jumping board when Operating Enduring Iran Oil Liberation is a go.

A few days ago when discussing the "stability" of Europe's biggest and most undercapitalized hedge fund, we said that "The adjusted balance sheet is pro forma for today's LTRO 2, which we noted earlier will add at least €311 billion in net assets to the ECB's balance sheet, and potentially much more. Assuming the minimum, it means the ECB's balance sheet will now hit €3 trillion." Sure enough - as of minutes ago, the total ECB balance sheet just passed €3 trillion, or €3.023 trillion to be precise (which is just why of $4 trillion based on today's exchange rate), as our estimate of net LTRO contribution was on the low side, with total assets increasing by €331 billion in the past week. Needless to say, capital and reserves has been unchanged, which means that our analysis from a week ago factoring in the ECB balance sheet expansion of the "well-capitalized" ECB was correct. Incidentally, the spike in the chart below was factored in long ago (about 20% lower in the market ago). And as we have been saying all along, the next bank on the docket to ease is the Fed, as everyone else has already done so. However before that happens stocks and more importantly crude, have to plunge by at least 15-20%, much to Dick Fisher's shock. It seems that the market is finally getting the hint today.