Central Banks

Everyone and their mum knows by now that Italian bonds have rallied since the first LTRO and we are told that this is symptomatic of 'improvement'. While we hate to steal the jam from that doughnut, we note Peter Tchir's interesting chart showing how focused the strength is in the short-end of the bond curve (which we know is thanks to the ECB's SMP program preference and the LTRO skew) but more notably the significantly less ebullient performance of the less manipulated and more fast-money, mark-to-market reality CDS market as we suspect, like him, the CDS is pricing in the longer-term subordination and termed out insolvency risk much more clearly than the illiquid bond market does, and perhaps bears closer scrutiny for a sense of what real risk sentiment really looks like.

Today's second most important event is the testimony of Bernanke before the House Financial Services Committee (yes, Maxine Waters will be there). Lawmakers will  question him about the Fed's plans on avoiding inflation and the current unemployment rate. Committee members are also expected to inquiry about fiscal policy, the status of the nation's economic recovery, the impact of rising gas prices, and the debt crisis in Europe. Most importantly, Benny will be asked to testify on when more QEasing is coming as the markets need their fix. Watch it live at C-Span after the jump.

Dear Santa, I know Christmas is a long way off, but I was hoping that you could get me a European Bank License and another round of LTRO.   I promise to be a good boy, and borrow as much money as the ECB will possibly give me, with minimal equity, and buy as much 3 year in and in paper as I can.  I’m afraid I might not be able to bring myself to buy Spanish or Italian debt, but with the broad range of assets available against the money, I’m sure I can find something I like.  I’m not greedy, I don’t need to make 2% of carry, I would be happy with 1%, after all, I my only qualification is having a bank license, and I have no real equity in the deal (though after 3 years if all goes well, I will be a very rich man, or bank).

Back on January 27, before the impact of the trillions in liquidity injections by the central banks was fully appreciated, the advance Q4 GDP print came in below estimates of 3.0%, printing at 2.8%. Today, we just got the flip flop to that, after the second revision just printed at 3.0%, on expectations of an unchanged print at 2.8%. The reason: a fine-tuning, whether seasonally adjusted or not, which improved 4 of the components of Q4 GDP (Fixed Investment, Personal Consumption, Imports, Government Expenditures), while reducing two (Inventories and Exports) nominally. Net result, a slight bump from 2.8% to 3.0% for the second Q4 GDP print. The final GDP revision will be made public on March 29 - if history is any precedent, it will be back down to 2.8%. As for the reason why the market is less than delighted with this "beat" is that with EUR Brent at record highs, courtesy of everyone else but primarily the ECB doing the equivalent of QE 3 in 2011's biggest deception play, it firmly take the Fed's punchbowl away at least for 3 months. More at 10 am when Bernanke testifies.

Silver as ever outperformed gold yesterday and traders attributed the surge to “massive fund buying” and to “panic” short covering. Some of the bullion banks with large concentrated short positions covered short positions after the technical level of $35.50/oz was breached easily. Massive liquidity injections and ultra loose monetary policies make silver increasingly attractive for hedge funds, institutions and investors. This time last year (February 28th 2011) silver was at $36.67/oz. Two months later on April 28th it had risen to $48.44/oz for a gain of 32% in 2 months. There then came a very sharp correction and a period of consolidation in recent months. Silver’s fundamentals remain as bullish as ever and the technicals look increasingly bullish with strong gains seen in January and February.

Since everyone is buying everything that is not nailed down, preferably with both hands, on massive margin if possible, and since the global reflation trade is on full bore following trillions in cheap money dumped by central banks to prevent another re-recession within the broader Depressionary downtrend (offset for the time being only courtesy of $7 trillion in consolidated central bank funny money), it only makes sense that following record January gasoline prices, that February would see an all time high in gas as well (a detailed breakdown can be found at the AAA's website). But fear not: as the laws of supply and demand have also been usurped by the Fed, as has common sense and basic economics, both these data points indicate that Q1 GDP will also come at an all time high, because the entire economy is now purely a reflection of Apple, which as noted previously is almost bigger than the entire retail sector by market cap, and today hit an all time high as well. In fact, we are now seeing a record in new all time highs across the spectrum (if not volume - shhhh about volume), it means that even as IBM just laid off another 1,000 North American employees, that the economy has never been better either.

The modern, debt-based economy requires constant economic expansion if only to service all that debt. So what happens when the modern economy goes ex-growth and stops expanding? Iceland already found out. Greece is in the process of discovering. But we will all get a chance to participate in this lesson. Runaway fiscal and monetary stimulus throughout the western economies is in the process of destroying the concept of creditworthiness at the centre of the modern monetary system.  Private investors, we suspect, have little or no conception of the extent to which the state is now the predominant player in the financial markets. Central banks control the money supply and interest rates. Central banking and commercial banking interests have essentially become fused. The ECB's long-term refinancing operations are banking bailouts by the back door. Central banks are now also the swing players in government bond markets which directly influences the price for corporate credit. Central bank monetary stimulus also directly influences equity market direction and confidence. Be careful, be very careful about the sort of government debt you hold. You may well end up being paid in whole- but in such depreciated terms that being "kept whole" will be meaningless in real terms.

While the discipline of behavioral finance is relatively new, the performing art of magic has long exploited many of the same principles about human nature and decision-making.   While much is made of the smoke-and-mirrors market we exist in, Nic Colas, of ConvergEx Group, reviews the 'Basics' of this ancient form of entertainment, courtesy of a recent Smithsonian magazine article by Teller (the quiet half of Penn & Teller), and draws some analogies to the modern world of investing and economic analysis.  The seven crossover points include pattern recognition, overconfidence, and the illusion of free choice. It seems to us that investors can benefit from reminding themselves that their own powers of perception are severely limited.   As Nic points out, if we can be regularly fooled by a Las Vegas magic act, then many of the same flaws in our thinking must be at play when we watch the screens at work.  We seek out patterns that don’t really exist.  We confuse choice with freedom. We grow emotional and limit our ability to process information.  Watching a show, this is amusing.  Making investment decisions, not so much.

Earmuffs time for our German readers.

So far there are no dramatic consequences of the Greek default.  The ECB did say they couldn’t accept it as collateral, but national central banks (including Greece’s somehow solvent NCB) can, so no real change.  We will likely get a Credit Event prior to March 20th once CAC’s are used to get the deal fully done.  Will the market respond much to that?  Probably not, though there is a higher risk of unforeseen consequences from that, than there was from the S&P downgrade. It just strikes us that Europe wasted a year or more, and has created a less stable system than it had before. Tomorrow’s LTRO is definitely interesting.  It seems like every outcome is now bullish – big take up is bullish because of the “carry” trade.  Low take up is bullish because “banks are okay”. Any weak bank looking to borrow from the LTRO to buy sovereign debt would be insane to buy bonds longer than 3 years and take the roll risk, but on the other hand, the weakest and most insolvent, got there by doing insane things in the first place.

While the gold standard may no longer exist, nations and international organizations still have 30,877 metric tons of bullion reserves, valued at about $1.77 trillion. The dollar has been the world’s reserve currency since the U.S. and allies agreed at the 1944 Bretton Woods conference to peg it to a rate of $35 per ounce of gold. It remained the most- traded legal tender after global currencies began freely floating in the early 1970s. The greenback dropped 12 percent against a basket of six major currencies since March 2009. The U.K. suspended the gold standard in 1931, Chatham House said. “Greater discipline on financial markets might have been helpful in inhibiting the reckless banking and excessive debt accumulation of the past decade,” the task force said. “However, with the onset of the global crisis, had gold had a more formal role to play, the rigidity it imposes might also have been a handicap when a more flexible policy response was required.” “For gold to play a more formal role in the international monetary system, it would be imperative for it neither to hamper the system’s performance nor to create unacceptable constraints on national economic policies,” the task force said.  Gold may “continue playing a significant role in the international monetary system, serving as a valuable hedge and safe haven, particularly in times when tail risks predominate.”

Yep! If you push that sausauge too far in an attempt to hide it, it's bound to start hurting someone... somewhere... 

Yesterday following the S&P announcement of the Greek 'selective default', we had one simple question to the ECB:

Today we get the answer.

Americans can handle soaring rent, gas, and even food prices (all those thing that the Fed conveniently ignores) with the stoic patience of a Greek who welcomes 160 German tax collectors on his rehypothecated front porch. But if there is one thing that is sure to kindle the revolutionary spirits it is the soaring price of booze. As it just so happens, ships are parked in the Boston harbor with crates of Grey Goose prepped for tossage overboard as we speak. As the following chart of alcoholic beverage inflation indicates, courtesy of John Lohman, January saw the biggest month over month spike in booze inflation in 20 years. In other words, about 90% of all traders alive today have never seen a bigger jump in liquor inflation in their lives. Then again, with nobody trading any more, and since the new venue du jour of most of said now ex-traders is the local watering hole, perhaps we are seeing demand pull inflation in at least one item. Needless to say, there is something very ironic that surging alcohol inflation is the only thing that is resilient to the central banks (un)sterilized liquidity explosion. The good news: there is distinct relative deflation in the cost of ammunition. At least for the time being...

From S&P: "We lowered our sovereign credit ratings on Greece to 'SD' following the Greek government's retroactive insertion of collective action clauses (CACs) in the documentation of certain series of its sovereign debt on Feb. 23, 2012....We do not generally view CACs (to the extent that they are included in an original issuance) as changing a government's incentive to pay its obligations in full and on time. However, we believe that the retroactive insertion of CACs will diminish bondholders' bargaining power in an upcoming debt exchange. Indeed, Greece launched such an exchange offer on Feb. 24, 2012." Translation: Greece better have that PSI in the bag or else the "Selective" goes away and "Greece would face an imminent outright payment default." Our question for former Goldmanite and current ECB head Mario Dragi: does the ECB allow defaulted bonds to be pledged as collateral within the Euro System?