The Fed moved to defense. A tactical disavantage.
In what appears to be surprising news for some, Reuters has an article titled "Americans brace for next foreclosure wave" whose key premise is that "a painful part two of the [housing] slump looks set to unfold: Many more U.S. homeowners face the prospect of losing their homes this year as banks pick up the pace of foreclosures." Thank the robosettlement, where in exchange for a few wrist slaps, contract law was thoroughly trampled by America's attorneys general, but far more importantly to the country's crony capitalist system, the foreclosure pipeline was once again unclogged, and whether one does or does not have a legal title on a given house, the banks are now fully in their right to foreclose on it. What this means also is that America's record shadow housing inventory, which is far greater than any fabricated number the NAR reports on a monthly basis, is about to get unleashed on buyers, shifting the supply curve much further to the right, as up to 9 million new properties slowly but surely appear on the market. And while many will no longer be able to live mortgage free, forcing them to go out and rent (and no longer be able to afford incremental iGizmos), it also means that the prevalent price of homes is about to take another major tumble, making buffoons out of all those who, once again, called for a housing bottom in early 2012. Here's the simply math: there will be no housing bottom until the 9 million excess homes clear. Period. Until then it is a buyer's market, even if said buyer is unable to obtain bank financing, as ultimately it will be the seller who is forced to monetize (or vacate if underwater) their home in a world of ever diminishing cashflows. The fear of the supply onslaught will only make the dumpage that much faster.
Treasury yields retraced more than 60% of their rise post-FOMC yesterday leaving them only marginally higher on the week as, despite another late afternoon light volume surge to VWAP, stocks closed with their second biggest daily loss of the year. Three days in a row now, ES (the S&P 500 e-mini futures contract) has closed at its VWAP - suggesting institutional blocks continue to look for opportune/efficient selling levels (as opposed to buying the dips which we are so used to). After Spain's auction debacle and the ISM Services miss, it seems that with no Fed standing guard that good is good but bad is not better anymore as the S&P 500 cash lost over 1% (down 2% from Monday's peak to today's trough). Financials underperformed and the majors (which we noted on Monday sagging after Europe's close) have been really hurt with Citi, BofA, and MS down 6 to 7% since then. Equity markets in the US and Europe played catch up once again to credit's more realistic assessment of the world as HYG (the high-yield bond ETF) is back at one-month lows, down 2.7% from its end-Feb highs (or five months worth of yield, oops). Investment grade credit (which remains rich to its fair-value) was not helped as Treasuries were the place of refuge for the day as 30Y yields dropped their most in 2012. Commodities suffered significant damage as Silver tumbled to meet Gold's loss for the week, both down 3% Copper and Oil also dropped notably and are now back in sync with the USD for the week -1% or so. Most major FX remained USD positive except for JPY which retraced its snap lower from yesterday as carry trades were generally exited (with EUR and AUD weakness mirroring JPY strength post-FOMC) leaving DXY near 3-week highs. Who-/What-ever was doing the buying in the afternoon clearly levered the position (using AAPL or options) as VIX dumped once again out of nowhere intraday - closing near its lows of the day. However, VIX did close up near one-month highs as it catches up to Europe's VIX flare. Given the drop in implied correlation (and in-line VIX-S&P move) we suspect the covered-call strategy of the year was coming undone a little at the seams as single-name vol underperformed.
It’s important to put yourself in the minds of OECD policy makers. They are largely managing a retirement class that is moving out of the workforce and looking to draw upon its savings -- savings that are (mostly) in real estate, bonds, and equities. Given this demographic reality, growth in nominal terms is undoubtedly the new policy of the West. While a 'nominal GDP targeting' approach has been officially rejected (so far), don't believe it. Reflationary policy aimed at sustaining asset prices at high levels will continue to be the policy going forward. While it’s unclear how long a post-credit bubble world can sustain such period of forced growth, what is perfectly clear is that oil is no longer available to fund such growth. For the seventh year since 2005, global oil production in 2011 failed to surpass 74 mbpd (million barrels per day) on an annual basis. But while the West is set to dote upon its retirement class for many years to come, the five billion people in the developing world are ready to undertake the next leg of their industrial growth. They are already using oil at the margin as their populations urbanize. But as the developing world comes on board as new users of petroleum, they still need growing resources of other energy to fund the new growth which now lies ahead of them. This unchangeable fact sets the world on an inexorable path: a competitive race for BTU.
It ain't that bullish.
Who will buy our debt in the coming months and years? Europe is saturated with debt and doesn’t have the means to purchase our debt. Japan is a train wreck waiting to happen. China’s customers aren’t buying their crap, so their economic miracle is about to go in reverse. The Federal Reserve cannot buy $1 trillion of Treasury bonds per year forever without creating more speculative bubbles and raging inflation in the things people need to live. The Minsky Moment will be the point when the U.S. Treasury begins having funding problems due to the spiraling debt incurred in financing perpetual government deficits. At this point no buyer will be found to bid at 2% to 3% yields for U.S. Treasuries; consequently, a major sell-off will ensue leading to a sudden and precipitous collapse in market clearing asset prices and a sharp drop in market liquidity. In layman terms that means – the shit will hit the fan. The Federal Reserve and Treasury will be caught in their own web of lies. The only way to attract buyers will be to dramatically increase interest rates. Doing this in a country up to its eyeballs in debt will be suicide. We will abruptly know how it feels to be Greek....The entire financial world is hopelessly entangled by the $700 trillion of derivatives that ensure mass destruction if one of the dominoes falls. This is the reason an otherwise inconsequential country like Greece had to be “saved”.
We have been warning of the uncomfortable current similarities to last year's (and for that matter cycle after cycle) high-yield credit underperformance / lagging behavior 'canary-in-the-coalmine' relative to the exuberant equity market for a month now. Now, Bank of America provides - in two succinct charts - the fundamental underpinning of this grave concern as across the high-yield credit universe revenues are not catching up with costs - creating significant margin pressures - and at the end of the day, a market that cares more for cash flow sustainability than the latest headline or quarter EPS upgrade from some sell-side pen-pusher is waving a red-flag as margins are the lowest they have been since March 2009 and is falling at a much faster clip than in the fall of 2008 as the reality of money-printing comes home to roost. And just to add salt to this fundamental wound, technicals are starting to hurt as supply picks up and 'opportunistic' issuance turns notably heavy - perhaps helping to explain how the ongoing inflows have been unable to push prices further up in the US. Lastly European high yield is trading tick-for-tick with sovereign risk still - as it has since the middle of last year and so as LTRO-funded carry fades, we would expect it to underperform - especially as austerity slows growth.
Today’s Spanish auction results were, in a word, awful. Not just higher yields, but a terrible bid-to-cover and perhaps even worse; all of the funding could not be accomplished. The effects of the LTRO are rapidly diminishing as the money has now generally been utilized and the national banks of a nation can no longer support the funding needs of the countries in the periphery. We have reached the turn here and I predict much higher yields to come now for the troubled nations in Europe including Italy. What could be accomplished by liquidity has been accomplished but solvency problems cannot be cured by liquidity alone and that lesson is about to be re-learned again.
Everyone's favorite stock pitchman, Bob Pisani, who lately apparently has the capacity to learn just one line and just regurgitate it ad nauseam, was on CNBC earlier screaming how gold is down because the US is so much better than the world, when in reality gold is once again being sold to fund early margin calls (yes, institutionals are that levered right now). As for the US decoupling story, which time after time is dragged out, only to be shelved once the impact of trillions in liquidity fades, and which is never different this time, here is none other than Bank of America explaining to the likes of Pisani why "the US economy is likely to prove a faulty engine of global growth." Read - no decoupling, despite what the market may be trying to say. And yes, the market, and especially the Russell 2000 is never the economy.
In the last week, both European and US equity markets have valiantly attempted to extend their rally into the stratosphere while the credit market has summarily dismissed this exuberance as 'oh those silly algo-driven momo monkeys'. Yesterday and today we have seen equities in both regions retrace aggressively to the much more realistic, liquidity spigot-lacking margin-compressing growth-slowing reality that credit has been pricing in.
We have previewed the phasing out of the LTRO effect previously here on several occasions. Now, courtesy of Art Cashin, everyone is aware that the eye of the European hurricane has officially passed, especially in the aftermath of this morning's horrendous Spanish bond auction, which shows that reality is back with a bang.
Having been an onlooker of the recent tiff between Paul Krugman and Steve Keen, I was very eager to see what Mr. Keen had to say in tonight's LSE public lecture on "Banks Versus the Economy." Observing how Keen had quarreled with Krugman and effectively ate his lunch, I thought he would bring a lot to the table. I was wrong. Keen had raised the (very interesting) issue about how neoclassical economists and their models fail to recognize the role of banks in the economy.
Seasonal adjustments are not forever.
Equities tumbled but Gold/Silver and Treasuries were the hardest hit as the potential reality of lower chance of more massive LSAPs was evident in the FOMC minutes. As we have argued for weeks now, the Fed is cornered and is unable to enact QE3 without a much more significant drop in markets and implicitly the economy. We assume now that the sell-side will refocus its efforts on telling us all just how bad the economic picture really is...