Debt Ceiling

To some, today is Martin Luther King day and as a result the US markets are closed, especially since today is also the day when Obama celebrates his second inauguration with Beyonce, Kelly Clarkson and James Taylor at his side (hopefully not on the taxpayers' dime). To others, January 21 is nothing more than the anniversary of the real beginning of the end, when five years ago a little known SocGen trader named Jerome Kerviel could no longer hide his massive futures positions and was forced to unwind them, sending global indices plunging resulting in the biggest single day drop in the Dax (-7.2%), and punking the Fed into an unannounced 75 bps cut. Luckily, today such cataclysmic unwinds are impossible as the market is priced perfectly efficiently, without central bank intervention, price transparency is ubiquitous and the Volcker rule has made prop trading by banks, funded by Fed reserves (which are nothing more than the monetization of excess budget deficits) and excess deposits, impossible.

An overview of the key factors and events that are shaping the investment climate in the week ahead.  It looks at some emerging market developments as well.  These are the main talking points and considerations that ought to be on your radar screen as investors or pundits.  

We make more than we’ve ever made, we owe more than we’ve ever owed, and we have less than we've had in decades which is distributed to those that did not earn the money. This is a working definition of Trouble. The stock market is at an all-time high while the financial condition of the country has seriously deteriorated. The world is in a gigantic bubble and it is going to get pricked. You cannot keep printing money without consequences and when absolute and intrinsic valuations replace relative valuations then the game is afoot. When the survival of the State puts its people in dire straits then, eventually, the citizens will rebel as the nation has forgotten just who composes its constituents. The people and institutions that have the capital will only go along quietly for so long when nations try to take what they have earned and dispossess it for others. The rich will become poorer and the poor will become poorer and when those with the capital have been deprived of it so that everyone is worse off then the Lords of Chaos will be in control once again.

Following the recent fall of the Swiss franc against the euro, there were paradoxical comments on the opportunity on both moving the Swiss National Bank’s floor lower (say to 1.25 for example) or on abandoning it altogether (or moving it higher). We believe both options are very unlikely, at least in the coming months. Moving the floor lower would be a bad idea in our view. As we have seen, the extent of the franc’s overvaluation is quite debatable and the lower the floor, the quicker a monetary policy dilemma may emerge. Moreover, in the event renewed upward pressures on the franc occur once again, a lower floor may prove more costly in terms of FX interventions.

After witnessing the fighting of undeclared never ending wars, passage of freedom destroying legislation like the Patriot Act & NDAA, approval of pork barrel spending to the tune of hundreds of billions, rule by Executive Order, using ZIRP to extract hundreds of billions from senior citizen savers and give it to criminal Wall Street banks, forcing the American people at gunpoint to replenish the Wall Street banks with $700 billion after they had committed the greatest financial fraud in history, and a continuing trampling of the U.S. Constitution, the American people continue to remain willfully ignorant of the truth. The American Dream is dead. We’ve allowed a rich, privileged, elite few to achieve hegemony over our economic and political system with their control of the media and manipulation of our financial markets. They will collapse the country because they will never be satisfied with the amount of wealth and power they’ve accumulated. Their voracious greed will be their downfall.

The market ramped, modestly, on the earlier news that the House would push the debt ceiling by three months with an implied budget/spending cut provision. That the market actually moved on this headline shows front and center just how clueless the algos doing all the trading truly are, because one doesn't need Politico to tell them that this proposal is absolutely DOA and is nothing but more theater. However, those who do need Politico to tell them that, here it is: "House Republicans will vote next week on a bill that would raise the nation’s debt ceiling for three months and attach a provision that would stop pay for members of Congress if the Senate doesn’t pass a budget, GOP officials said Friday. It’s an attempt to force the Senate to lay out a spending plan, but is sure to go nowhere in the Democratic controlled upper chamber."

Yesterday, UBS' Maury Harris released a naive note titled "UofM confidence bounce after tax deal?" which we did not understand: would the bounce be on the ongoing depression, the uncertainty over the debt ceiling, the fate of the sequester and coming spending cuts, the manipulated market which just saw a $610 million reserve injection via repo to be followed by another $1.5 liquidity injection via POMO, or the fact that everyone is now paying more taxes in 2013? Turns out the confusion was irrelevant as the preliminary January UMichigan consumer confidence number just printed at 71.3, far below the December final 72.9, and the biggest miss to expectations in seven years. It was also the lowest print since November 2011. And of course, the reaction of the central bankers' soapbox formerly known as the "market" is.... up.

US politicians have opted to begin mimicking their EU counterparts when it comes to dealing with our debt issues. What could go wrong?

Demand for gold is likely to rise as the world heads towards a multi-currency reserve system under the impact of uncertainty about the stability of the dollar and the euro, the main official assets held by central banks and sovereign funds. This is the conclusion of a wide-ranging analysis of the world monetary system by Official Monetary and Financial Institutions Forum, (OMFIF), the global monetary think-tank, in a report commissioned by the World Gold Council, the gold industry’s market development body. The report warns of “twin shocks” to the dollar and the euro and of a “coming dollar shock” and points out how gold would be a safe haven in a dollar crisis. “Gold has a lot going for it; it correlates negatively with the greenback, and no other reserve asset seems safe from the coming dollar shock.” “The world is preparing for possible twin shocks from the parlous. position of the two main reserve currencies, the dollar and the euro... The OMFIF offers a confidential, convenient and discreet forum to a unique membership of central banks, sovereign funds, financial policy-makers and market participants who interact with them. They note that “western economies have attempted to dismantle gold's monetary role. This has failed.”

The most talked about story of the last week was undoubtedly the relentless chatter about that massive $18 billion in equity fund inflows as reported by Lipper (not ICI), which tracks primarily institutional and ETF flow of funds, and which, as we explained even before the Lipper data came out, was driven exclusively by a surge in bank deposits into the year end, to be recycled for risk investment purposes by the commercial banks' own prop desks. The details, however, were largely ignored by the mainstream media which took that inflow as an indication that the tide has finally turned and that the great rotation out of bonds into stocks is on. Turns out that just as we expected it was a year end calendar asset rebalancing. As Lipper reported earlier, the enthusiasm for US stocks appears to have abruptly ended, with a whopping $4.2 billion pumped out of domestic equities, offset by some $4.5 billion invested in non-domestic equities. The blended flow? Just $286 million going into equities. Now our math may be a little rusty, but $18 billion followed by $0.2 is not really indicative of an ongoing rotation out of bonds and into stocks, and is more indicative of a one-time, non-recurring event, just the opposite of all the Bank of America addbacks.

In what is sure to be a complete non-starter with the Obama administration, WSJ reports that Paul Ryan said that "Republicans are discussing whether to support a short-term increase in the nation's borrowing authority, possibly linking the debt ceiling to future talks aimed at reaching a major deficit deal....Mr. Ryan said no decisions have been made about how to approach the debt and spending negotiations, but that leaders hope House Republicans will reach consensus on a strategy by the end of the week. The former vice-presidential candidate said "we're discussing the possible virtue of a short-term debt limit" increase that would lead to broader deficit talks with Senate Democrats and the White House. "We hope to achieve consensus on a plan to proceed so we can make progress on controlling spending and deficits and debt," Mr. Ryan said." The logical question immediately arose, and promptly received a non-answer "Mr. Ryan wouldn't say what he meant by a temporary debt-ceiling increase, declining to give a specific increase figure or timeframe for an extension."

Whether the repatriation of only some 20% of Germany's gold reserves from the Federal Reserve Bank of New York and the Banque of Paris back to Frankfurt manages to allay German concerns remains in question.  Especially given that the transfer from the Federal Reserve is set to take place slowly over a seven year period and will only be completed in 2020. The German Precious Metals Association and Germany's ‘Repatriate Our Gold’ campaign said that the move by the Bundesbank did not negate the need for a full audit of Germany's gold. They want this to take place in order to protect against impairment of the gold reserves through leases and swaps. Indeed, they have called for independent, full, neutral and physical audits of the gold reserves of the world's central banks and the repatriation of all central bank gold - the physical transport of gold reserves back into the respective sovereign ownership countries. It seems likely that we may only have seen another important milestone in the debate about German and global gold reserves.

The last few months have seen US equity markets swinging from confidence to grave concerns (briefly) and back to exuberance even as the looming 'debt ceiling' and sequester remains dead ahead. The pattern is eerily similar in price (and volatility) terms to the movements ahead of the Summer 2011 'debt ceiling' debacle. What is just as concerning is, as Bloomberg's Chart of the Day shows, is the mass psychology aspect, as mentions of the words 'debt ceiling' are once again gathering pace, just as they did in 2011. Markets may not repeat, but they do echo; and as UBS' Art Cashin noted, this month marks the 40-year anniversary of a significant top in the market as stocks broke to all-time highs and "all appeared right with the world." Perhaps, it is our inexorably optimistic belief that the politicians will fix it all (or kick the can) at the last minute - so there is nothing to fear but fear itself; or perhaps this time, there is a line in the sand that both sides need to defend.

Same overnight pattern, different day. After a late day ramp in the US market, followed by a selloff in the futures after hours, taking the ES to trading session lows, we get the European trading crew which day after day sends the EURUSD soaring as Europe opens, pushing futures to unchanged or even green and easily negating the key news event of the day, in this case the full grounding of the entire global Boeing fleet which will once again weigh on the stock and DJIA. In the meantime, the big rotation behind the scenes in FX land continues, with the ongoing and very sudden pounding of the Swiss Franc taking the EURCHF to 1.2450, or the highest, since 2011. Same with the USDJPY which after another attempt to fall, rallies on more of the same regurgitated rumors. Not to mention the EURUSD of course, which as mentioned above has surged some 100 pips since the European open. In other words the overnight beating of the USD is enough to push the US stock market high enough in nominal terms, avoiding that there is no incremental cash flow. Then again, who needs cash flow when you have "multiple expansion."

From last Friday, the S&P 500 had decoupled somewhat (trading in a 10 point range) from credit markets (which had widened notably) while spot VIX had caught up (and over-taken) stocks. Today saw HYG (the high-yield bond ETF) trade sideways to lower all day long, catching down to its credit derivative market cousins, as VXX was the lever of choice to ramp stocks to test the week's highs once again (and scratch a few more stops). However, while AAPL made it up to the lows of the last swing down amid thin volumes, the last hour saw mid-dated volatility being bought which pushed VXX higher and reverted it towards rates and credit un-exuberance. Treasuries ended the day green once again and the USD drifted higher (though most of FX traded in extremely tight ranges). Silver rose further, Gold trod water, and oil played some catch up to the precious metals. Tech outperformed (thanks to AAPL) but financials (apart from some early vol) did nothing - despite Mario Monti's call that "the crisis is over." Another low-range, low volume, mediocre trade size, close-near-the-open day in stocks with bonds bid - and futures fade after-hours.