The major problem with daily jawboning by central bankers, such as Draghi today, and the Fed via Hilsenrath on Tuesday, is that it "achieves" to price in QE without QE actually being implemented: in essence the various central banks try to run up assets on the rumor, knowing well that with every incremental "news" event, the news will be sold ever faster, and ever more forcefully. Which then begs the question: how much QE is currently priced in, in order to determine how much more "rumor" there is to buy. According to Bank of America: not much, as a full 65% of QE 3, or the NEW QE, to use the proper iNomenclature, is by now priced in.
As panties are being thrown at the feet of Mario Draghi all around Europe, and his comments are being heralded as 'confirmation' of Nowotny's restatement of absolutely nothing yesterday, we thought some context would be useful before we all cheer that all is well. Spanish and Italian 10Y bond spreads are still notably wider than the pre-EU-Summit 'panic' levels and dramatically wider than the post-EU-Summit best levels. Spain 2s10s, having flattened from 220bps to 60bps in a week has squeezed back up to 128bps as we can only imagine the bath-salting that caused a few people. The point is that this kneejerk reaction in an incredibly illiquid market at the front-end of the Spanish curve is nothing to rest your hat on yet. In fact, if there are more hints dropped of ECB restarting SMP then we suspect European asset managers will run to sell down their Spanish bonds to try and front-run the subordination this implies at the inevitable restructuring (as game-theoretically they know everyone else will also do the same).
In Hong Kong they are completing work on its largest gold vault due to open in September which can hold 22% of the gold that is in the US facility Fort Knox. The new secure storage facility will compete with services set up by the Airport Authority Hong Kong in 2009 that serviced governments, commodity exchanges, bullion banks, refiners, wealthy individuals and exchange-traded funds. The new facility is within the international airport compound and its capacity is 1,000 metric tons. This signals the growing interest from China currently the world’s second largest consumer of gold in owning physical gold bullion.
Here are the initial claims prints in the past 3 weeks: 376K, 352K, 388K, 353K (with the last week number naturally revised higher as always). Why the volatility? Same reason as the plunge two weeks ago: "onetime factors such as fewer auto-sector layoffs than normal likely caused the sharp decline." Naturally, this week's headline will say, 35K improvement in initial claims, and Wall Street will be (un)happy because we had a beat of consensus of 380K, which likely means QE is a little bit further. Looking at the other data point today will provide no help: headline June Durable Goods soared by 1.6%, on expectations of 0.3%, with the previous revised from 1.1% to 1.6%. But the number ex-volatile transports plunged from 0.8% to -1.1%, far below expectations of -0.8%, while Capital Goods orders ex air collapsed from a revised 2.7% to -1.4%. Which number is relevant? Probably the one which can be goalseeked to prolong the EURUSD jawboning rally started at 6 am this morning by Draghi, in which as we already showed, he said nothing new by regurgitating his open ended options, and merely awaits the refutation by Merkel et al who over the past 6 months has become the true European paymaster.
The Europeans have played the Great Game badly; are playing it badly and there will be consequences for their failures. All of this nonsense with Greece, with Spain, could have been avoided by telling the truth about the numbers, by not goose stepping with plans meant to mislead instead of illuminating the truth, with trying to hide the self-evident and presenting scams as solutions or by addressing the size of firewalls instead of trying to cure the sickness of the nations that lie within them. There is no Prince, there are no glass slippers and the bills have to be paid and the money to pay them will not be found in the pot of gold at the end of some rainbow. Unless the Germans are willing to have the same standard of living as those in Greece and that will not be happening so that it can be foretold that the play will end badly. It is not economics that will determine the end of the European fantasy but politics.
European markets started off on a quiet note with thin volumes as equities drifted lower and fixed income gradually made gains, however newsflow rapidly picked up as commentary from the ECB President Draghi picked up wide attention. The ECB President was very upbeat on the Eurozone’s future, commenting that the bank will do whatever is needed to preserve the Euro, fuelling the asset classes with risk appetite across the board. European equities as well as the single currency erased all losses and the Bund moved solidly into negative territory. As such, EUR/USD is seen comfortably back above 1.2200, with both the core and peripheral bourses making progress. In the wake of the moves, attention is particularly being paid to Draghi’s comment that if monetary policy transmission is affected by government borrowing, it would come within the bank’s policy mandate. As such, much of the focus now lies firmly on next week’s policy decision from the ECB.
For those stunned that the market is reacting as euphorically as it is to remarks which are basically a rehash of prior Draghi statements and are nothing new, or that bond yields are ripping in on the implicit threat that Draghi may reactivate the SMP, in the process further subordinating bondholders and cramming them down forcing even more selling, here is a sampling of previous Draghi statements explaining what he can do, and more importantly, what he is allowed to do under the existing European framework. Which is why we find it not very surprising that Draghi waited until all usual German suspects are on vacation and are thus unable to immediately issue a press release as to the structural limitations of what Draghi can do. Because when in doubt, ask this: does export-heavy Germany want a strong or a weak euro?
The kneejerk short covering reaction to Draghi's remark that he will do "anything to preserve the euro" (this must be news because yesterday the ECB would not do anything to preserve the euro supposedly) is over. Now the analysis begins of what was actually said. The realization is... nothing.
- Draghi Says ECB To Do Whatever Needed As Yields Threaten Europe (Bloomberg)
- Spain not mulling seeking further EU help (Reuters)... and it won't need a Bank bailout either. Oh wait
- Weak lending adds pressure for ECB action (Reuters)
- Sweden's economy still resilient to eurozone woes (Reuters)
- Bo Xilai’s Wife, Zhang Xiaojun, Prosecuted for Homicide (Xinhua)
- China’s Changsha City Unveils $130 Billion Investment Plan (Bloomberg)
- Foreclosure Filings Increase in 60% of Large U.S. Cities (Bloomberg)
- Free ECB’s hand to aid states, says minister (FT)
- Hungarian Premier Says Aid Deal Not Near (WSJ)
- Nomura Chief Resigns Over Insider Trading Scandal (NYT)
When you can't act, you talk. Sure enough, here we go again:
- DRAGHI SAYS ECB WILL DO WHATEVER NEEDED TO PRESERVE THE EURO
- DRAGHI SAYS THE EURO IS IRREVERSIBLE
- DRAGHI SAYS YIELD DISRUPTING POLICY TRANSMISSION ARE IN ECB REMIT
- DRAGHI SAYS SHARING SOVEREIGNTY ON EU LEVEL TO COME
- DRAGHI SAYS LAST EU SUMMIT WAS MOMENT OF RECOGNITION
And of course the weak hands cover until they realize Draghi just said absolutely nothing, as at this point everything is in Germany's hands. And not only has Germany not said anything, and won't until September when the constitutional court will approve or deny the ESM, but in fact they have been saying overnight that Spanish bonds are not eligible for EFSF purchases. In the meantime, Europe has devolved from a continent of coordinated action to coordinated jawboning.
Sayonara internal funding. In what we suspect will become a major issue (and warned in April of last year), Bloomberg reports that Japan’s public pension fund, the world’s largest, said it has been selling domestic government bonds as the number of people eligible for retirement payments increases. "Payouts are getting bigger than insurance revenue, so we need to sell Japanese government bonds to raise cash." It would appear the Ponzi has reached it's Tipping Point. Japan’s population is aging, and baby boomers born in the wake of World War II are beginning to reach 65 and eligible for pensions. That’s putting GPIF under pressure to sell JGBs so it can cover the increase in payouts. The fund needs to raise about 8.87 trillion yen this fiscal year. GPIF is historically one of the biggest buyers of Japanese debt and held 71.9 trillion yen, or 63 percent of its assets, in domestic bonds as of March.
While it might seem like somewhat stating the obvious, it is nonetheless worth driving home to the politicians and public policy wonks who see rates at record lows and perceive a Keynesian borrow-and-spend-fest as once again the solution to borrowing-and-spending too much. As Morgan Stanley puts it, fiscal policy is sailing between the Scylla of chase-your-tail austerity and the Charybdis of sovereign insolvency. In short, it is impossible for developed market (DM) governments to grow their way back to solvency. Doing nothing would sail governments towards the whirlpool of national insolvency – at some stage. But avoiding insolvency would risk being monstered by recession. If 'expansionary austerity' worked, then Europe would now be booming. The outlook for fiscal policy and public sector finances is a major uncertainty for investors and, critically, is part of the reason why risky assets are being de-rated and 'safe' assets are at unprecedented valuations. There is no question that negative-net-worth governments will impose a cost on the private sector. The only questions are when and how. The options are asset confiscation, explicit default, surreptitious default (financial oppression), or conventional fiscal tightening.