Global Economy

Better stock up on the Depends now. 

"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.

Further confirmation of gold’s continuing but gradual renaissance as a safe haven asset was given by the IMF yesterday who warned that a “growing shortage of safe assets” poses a threat to “global financial stability.”  The IMF identified $74.4 trillion of potentially safe assets today, including gold, investment grade government and corporate debt, and covered bonds. Sovereign debt crises are reducing the number of governments that investors trust to issue "risk-free" bonds just as new financial regulations are increasing demand for safe securities from banks. Importantly, the IMF’s latest Global Financial Stability Report’s introduction finds that  "In the future there will be rising demand for safe assets, but fewer of them will be available, increasing the price for safety in global markets.” “Both the lack of political will to reshape fiscal policies at times of rising concern over debt sustainability and an overly rapid reduction of fiscal deficits limit governments’ capacity to produce assets with low credit risk.” The IMF has warned regarding illiquidity in “safe haven” markets. Gold remains one of the most liquid markets in the world and the illiquidity in bond markets would see increased safe haven demand for gold.  The IMF is warning regarding deteriorating public finances. As many governments see themselves being downgraded - safe haven bonds may become less safe.

We all know that central banks and governments have been actively intervening in markets since the 2007 subprime mortgage meltdown destabilized the leveraged-debt-dependent global economy. We also know that unprecedented intervention is now the de facto institutionalized policy of central banks and governments. In some cases, the financial authorities have explicitly stated their intention to “stabilize markets” (translation: reinflate credit-driven speculative bubbles) by whatever means are necessary, while in others the interventions are performed by proxies so the policy remains implicit.  All through the waning months of 2007 and the first two quarters of 2008, the market gyrated as the Federal Reserve and other central banks issued reassurances that the subprime mortgage meltdown was “contained” and posed no threat to the global economy. The equity market turned to its standard-issue reassurance: “Don’t fight the Fed,” a maxim that elevated the Federal Reserve’s power to goose markets to godlike status. But alas, the global financial meltdown of late 2008 showed that hubris should not be confused with godlike power. Despite the “impossibility” of the market disobeying the Fed’s commands (“Away with thee, oh tides, for we are the Federal Reserve!”) and the “sure-fire” cycle of stocks always rising in an election year, global markets imploded as the usual bag of central bank and Sovereign State tricks failed in spectacular fashion.

Americans have been listening to the mainstream financial media’s song and dance for around four years now.  Every year, the song tells a comforting tale of good ol’ fashioned down home economic recovery with biscuits and gravy.  And, every year, more people are left to wonder where this fantastic smorgasbord turnaround is taking place?  Two blocks down?  The next city over?  Or perhaps only the neighborhoods surrounding the offices of CNN, MSNBC, and FOX?  Certainly, it’s not spreading like wildfire in our own neck of the woods…Many in the general public are at the very least asking “where is the root of the recovery?”  However, what they should really be asking is “where is the trigger for collapse?”  Since 2007/2008, I and many other independent economic analysts have outlined numerous possible fiscal weaknesses and warning signs that could bring disaster if allowed to fully develop.  What we find to our dismay here in 2012, however, is not one or two of these triggers coming to fruition, but nearly EVERY SINGLE conceivable Achilles’ heel within the foundation of our system raw and ready to snap at a moment’s notice.  We are trapped on a river rapid leading to multiple economic disasters, and the only thing left for any sincere analyst to do is to carefully anticipate where the first hits will come from. Four years seems like a long time for global banks and government entities to subdue or postpone a financial breakdown, and an overly optimistic person might suggest that there may never be a sharp downturn in the markets.  Couldn’t we simply roll with the tide forever, buoyed by intermittent fiat injections, treasury swaps, and policy shifts? The answer……is no.

If yesterday was risk off on concerns Europe is sinking following last week's disastrous Spanish long-term auction, today is risk on after Italy managed to successfully place 91 and 361-Day bills, in line with expected amounts, if at much higher yields, and lower Bid To Covers. Specifically, Italy sold €3 billion in 91 day bills. The yield soared from 0.492% on March 13 to 1.249%, while the Bid to Cover plunged from 2.23 to 1.81. Same for the 361-Day Bill auction, where €8 billion in Bills (in line with target) were sold at 2.840%, double the yield of 1.405% from a month ago, and a Bid To Cover just modestly better: from 1.38 to 1.52. As usual the market continues to blatantly ignore the thin white line of bond issuance: every Bill and Bond auction that matures within the maturity (3 Years) of the LTRO will succeed: period. It is the ones maturity longer than 3 years - such as Spain's last week - that are the test. Comparing one to another is apples and oranges. But risk on don't care, and as a result futures are surging disproportionately, even as Spanish and Italian bonds are just modestly tighter following the bond results. But we will once again meander whack-a-mole style from auction to auction until the market is reminded of this little nuance. In other news, Iran just announced it is following its cut in Greek and Spanish exports, by halting exports to Germany next, while continuing the theme of 2011 Deja Vu, Indonesia's Aceh was struck two hours ago with a massive 8.7 Earthquake, with an 8.8 aftershock off Sumatra, coupled with a tsunami warning. Luckily, there are no initial reports of casualties or major damage.

Equities suffered their largest single-day drop in 4 months as for once Apple was unable to single-handedly hold up the index letting it drop closer to its credit-oriented risk. A monster day for NYSE and ES (S&P 500 e-mini futures) volume saw Financials and Discretionary sectors underperforming and the Energy sector joining Utilities in the red for the year. The S&P closed at its lows as it broke its 50DMA for the first time since DEC11 as AAPL dropped 1.25% for the day (and -2.5% from the highs) but most notably equities and Treasuries are back in sync from early March as 10Y closed under 2% for the first time in a month. Gold and Silver surged around the European close, on little news, as we suspect safe-haven buying and an unwind of the gold-hedged bank-stress-test rally - with another relatively unusual divergence between Gold and stocks on the day. VIX broke above 21% closing just below it back near one-month peaks as the term structure bear-flattened (but notbaly pushing ahead of its credit-equity implied fair value). JPY strengthened all day (and AUD weakened) as carry trades were unwound in FX markets leaving the USD marginally higher on the day (and EUR marginally lower despite the turmoil in European markets). Oil fell back below $101.50 but it was Copper that has suffered the most - down almost 4% since Last Thursday. Credit markets were weak with HY marginally underperforming IG (beta adjusted) but still implying further weakness in equities as HYG closed just shy of its 200DMA.

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.

Simply great piece on Volatility and more.

There is no free-lunch - especially if that lunch is liquidity-fueled - is how Gluskin-Sheff's David Rosenberg reminds us of the reality facing US markets this year and next. As (former Fed governor) Kevin Warsh noted in the WSJ "The 'fiscal cliff' in early 2013 - when government stimulus spending and tax relief are set to fall - is not misfortune. It is the inevitable result of policies that kick the can down the road." Between the jobs data and three months in a row of declining ISM orders/inventories it seems the key manufacturing sector of support for the economy may be quaking and add to that the deleveraging that is now recurring (consumer credit) and Rosenberg sees six rather sizable stumbling-blocks facing markets as we move forward. On this basis, the market as a whole is overpriced by more than 20%.

• JPMorgan Trader Iksil Fuels Prop-Trading Debate With Bets (Bloomberg), but, but, he is just proividing liquidity, and serving JPM's clients
• Short on tools, central banks left with words (Reuters)
• And the mainstream media finally catches up: Investors braced for fall in US profits (FT)
• Iran rules out pre-conditions to talks: Salehi (Reuters)
• North Korea ‘planning third nuclear test’ (FT)
• Japan to Hold Talks With China on IMF Contributions (Reuters)
• American Universities Infected by Foreign Spies Detected by FBI (Bloomberg)
• Is the Fed Promoting Recovery or Desperation? (Hussman)
• In Europe, Unease Over Bank Debt (NYT)
• Banks test ‘CDOs’ for trade finance (FT)

The Fed moved to defense. A tactical disavantage.

(The most) bankrupt countries to bail out bankrupt countries. And taxpayers get to foot the bill.

The Deepwater Horizon incident demonstrated that most of the oil left is deep offshore or in other locations difficult to reach. Moreover, to obtain the oil remaining in currently producing reservoirs requires additional equipment and technology that comes at a higher price in both capital and energy. In this regard, the physical limitations on producing ever-increasing quantities of oil are highlighted, as well as the possibility of the peak of production occurring this decade. The economics of oil supply and demand are also briefly discussed, showing why the available supply is basically fixed in the short to medium term. Also, an alarm bell for economic recessions is raised when energy takes a disproportionate amount of total consumer expenditures. In this context, risk mitigation practices in government and business are called for. As for the former, early education of the citizenry about the risk of economic contraction is a prudent policy to minimize potential future social discord. As for the latter, all business operations should be examined with the aim of building in resilience and preparing for a scenario in which capital and energy are much more expensive than in the business-as-usual one.

European cash equities are trading in the red heading towards the US session, with particular underperformance in the periphery as financials continue to remain the biggest laggard. The EU session so far has consisted of downbeat commentary in regards to both Ireland and Portugal. An EU/ECB report noted that, Portuguese debt is now predicted to peak at 115% of GDP in 2013 and that contraction in 2012 is likely more pronounced than thought. Elsewhere, the Irish Fiscal panel said Ireland may need extra budget cuts to reach its 2012 target and 2012 growth has weakened. In terms of economic releases the UK observed a stronger than expected reading on its Construction PMI hitting a 21-month high, which saw some brief strength in GBP.