Monetization

A few months ago when the new French socialist president gave details of his particular version of the "fairness doctrine" and said he would tax millionaires at 75%, we said that "we are rotating our secular long thesis away from Belgian caterers and into tax offshoring advisors, now that nobody in the 1% will pay any taxes ever again." While there was an element of hyperbole in the above statement, the implication was clear: France's richest will actively seek tax havens which don't seek to extract three quarters of their earnings, in the process depriving France (and other countries who adopt comparable surtaxes on the rich) of critical tax revenues. It took three months for this to be confirmed, and with a bang at that. The WSJ reports that Bernard Arnault, the CEO of LVMH, and the richest man in France, has decided to forego hollow Buffetian rhetoric that paying extra tax is one's sworn duty, and has sought Belgian citizenship.

Two different people, or the two faces of the same person? In a week dominated with news about Europe's "third time's the charm" monetization round, we leave it up to our readers to decide.

Total meltup panic and confusion in all but the US equity market where the INTC punch has sent stocks reeling, as an epic, Volkswagen-like short covering squeeze has taken the EURUSD up well over 100 pips in the past few hours (with technicals now running rampant as predicted three months ago), and where gold has now soared by nearly $40 on the day, sending it to just shy of $1740 and at the highest level since February. And all of this is happening without the Fed having announced QE, which it very well may not as it would then be seen as a largely political organization, or the ECB having bought a single bond under its restarted conditional monetization program, which paradoxically still needs Spain to crumble and demand a bailout before any of its bonds are eligible for purchases. In short: total centrally planned confusion, whose ultimate achievement will be to scare the last remaining non vacuum-tube based traders out of the market. 

Monetary Outright Transactions - MOT

Moths??? Like those burning up on light bulbs??? Or like in “to mothball”, buy and store?

With one day to go until the European soap opera hits its peak, and with the ECB doing all it can to spread disinformation and sow discord and disunity between Germany and everyone else on both the ECB governing council and everywhere else, Germany has decided to again make it clear just where it stands on the topic of hyperinflation and other printing matters. The punchline:

• ECB'S DRAGHI DOESN'T HAVE 'TOO MUCH' SUPPORT FROM MERKEL, MERKEL BACKS WEIDMANN
  
• ECB CAN ONLY BUY BONDS ATTACHED TO CONDITIONALITY

But wait, there is much more. Readers may recall that yesterday that one of the articles we pointed out came from Dutch Dagblad which suggested that it was Weidmann who was isolated on the ECB governing council, and that the Dutch member of the ECB council Klass Knot as well as all other members was "for buying government bonds of Southern European countries." Well, prepare to be shocked, because what kind of soap opera would it be if it wasn't for unexpected narrative plot lines. Today, Frankfurt-based Market News reported precisely the opposite, and not only is Knot on the same side as the Germans, but so are virtually all the other "virtuous" European countries, aka the non-beggars.

In two days Mario Draghi may, although without Germany's blessing most likely will not, announce vague terms of how the ECB plans on monetizing hundreds of billions in short-term (sub-3 Year) bonds by Spain and Italy, which according to the ECB is not really monetization, and the only thing that is needed is for the two countries to admit they are insolvent, something which paradoxically will never happen as long as the ECB does everything in its power to spook markets away from fair clearing levels, and to keep the cashflow implied price at record divergence from the centrally-planned "valuation" determination. But let's assume Draghi does go ahead and one up Bernanke, announcing the next easing round a week ahead of the September FOMC meeting, as both central banks take the lunge into the latest lap of currency devaluation. What happens then? Well, as JPM's Michael Cembalest puts it quite succinctly, Draghi will unleash nothing short of the transformation of the ECB from the European Central Bank to the European Creosote Bank (see below for the reason). Numerically, this will mean that once the ECB is done monetizing another €1 trillion or so in bonds in the next year, the ECB will then hold just shy of a unimaginable 50% of the entire Eurozone GDP, taking the New Normal monetary world well beyond the rabbit hole and deep inside the twilight zone.

Don't look at 10Y Spanish bond yields; ignore Swiss 2Y rates dropping; it's all about the front-end of the Spanish yield curve - that's your tell that "everything's awesome." We even saw some proclaiming the 5Y Spain 'strength' as indicative that the market is 'buying it, and Draghi will deliver'. Problem is - he can't! Even if he announces a non-monetizing short-dated monetization plan, and gets it by his BuBa buddies - the market knows the problem: that without this 'temporary feature' becoming permanent (and therefore the ECB basically embarking on open-ended monetization - see Gold), the market expects Spain's short-dated cost-of-funding to more than double (to 6.5% from 3% currently) over the next three years. The steeper the curve, the more the ECB will have to buy and while thin illiquid bond markets manipulated by CB intervention are 'most' people's indicator, consider youth unemployment, capital outflows, and loan delinquencies before becoming euphoric.

Yesterday's "leak" of Draghi's comments that it is not monetization if just the tip only bonds with a maturity of 3 years or less are monetized, aka, legitimate monetization does not cause inflation was so horribly handled that the ECB huffed and puffed in a desperate attempt to appear angry, even though it was absolutely delighted that it had even more ammo in its war against Germany. Today, the leakage continues only this time nobody cares that Draghi's desperation is hitting the headlines left and right. As a result, Draghi literally pulled a carbon copy of Hank Paulson, and while he did not have a three page term sheet in hand, threatened that the Euro would end unless he was allowed to monetize short-term bonds. Here's looking at your Germany. From Bloomberg: "European Central Bank President Mario Draghi said the bank’s primary mandate compels it to intervene in bond markets to wrest back control of interest rates and ensure the euro’s survival. Mounting his strongest case yet for ECB bond purchases, Draghi told lawmakers in a closed-door session at the European Parliament in Brussels yesterday that the bank has lost control of borrowing costs in the 17-nation monetary union."

• The ESM Violates the Law And EU Treaties (Welt)
• Fears Rising, Spaniards Pull Out Their Cash and Get Out of Spain (NYT)
• RBA stays put for third straight month (SMH)
• Why PBOC will not cut rates: China’s Repo Rate Drops Most in Six Months as PBOC Injects Cash (Bloomberg)
• Manufacturing Downturn Spreads Gloom Across Asia, Europe (WSJ)
• "Sources" tell Dutch Dagblad that Weidmann is isolated in his objection to ECB monetization (Reuters, FD)
• Europe Bank Chief Hints at Bond Purchases (WSJ)
• Australia's Fortescue slashes capex as iron ore mkt drops (Reuters)
• Loan rates point to eurozone fractures (FT)
• U.S. nears deal for $1 billion in Egypt debt relief (Reuters)
• Majority of New Jobs Pay Low Wages, Study Finds (NYT)

Yesterday we dedicated significant space to the most recent piece of perfectly ludicrous propaganda out of the ECB, namely that monetizing debt with a maturity up to three years is not really monetization but is instead within the arena of "money market management" (images of Todd Akin defining when something is 'legitimate' and when it isn't swimming our heads). The implication of course is that debt under 3 years is not really debt, but some mystical piece of paper that nobody should be held accountable for. Hopefully all those consumers who have short-maturity credit card debt which nonetheless yields 29.95% APR are made aware of this distinction and decide to follow through with Mario Draghi's logic, which is about to take the war of words between Germany and the ECB to the next level. Sure enough, this is precisely the news item that is dominating bond risk markets this morning, if not so much futures, and sending Spanish and Italian 2s10s spreads to record wides on hopes Draghi will definitely announce some sub 3 year monetization program for the PIIGS. Bloomberg summarized this best last night when it commented on the move in the EURUSD, since retraced, that we now have speculation Draghi's move will bolster confidence.  In other words: the market is now hoping there is hope. Sure enough, even if Draghi follows through, for the ECB to monetize Spanish bonds, Spain still has to demand a bailout, which however is now absolutely out of the question as mere jawboning has moved the entire highly illiquid curve so steep Rajoy (and Monti) have absolutely no reason to hand over their resignations (i.e., request a bailout). And so we go back to square one. But logic no longer matters in these markets.

Who knows? not me.

Since the peak in the S&P 500 around two weeks ago, equities and their sectors have traded in a considerably more disperse manner than one would expect given all the talk of central-bank intervention, liquidity-gasms, and monetization. This is borne out empirically as the average pairwise realized correlation within the 100 stocks of the S&P 100 and the 125 credits of the CDX investment grade credit index has dropped dramatically. Extreme peaks or troughs in realized correlation have tended to coincide with notable (and tradable) trend changes in the market - though we note, as shown below, that the moves are not always so clearly bullish or bearish for stocks (though VIX shows a more consistent reaction). Critically, the outperformance of Healthcare and underperformance of Industrials and Materials in the last two weeks suggests more than a little apprehension at the Central Banks being able to 'bridge' yet another global slow-down with money-printing.

Oh, and France just nationalized its second largest mortgage lender. But don’t worry, the EU Crisis is definitely contained and Draghi and others have got everything under control. After all, when the US nationalized Fannie Mae and Freddie Mac in 2008 the financial crisis came to a screeching halt… didn’t it?

The legitimacy of vulgar acts has been making headlines recently and so this morning's rumors of Mario Draghi's insistence to the European parliament that direct ECB buying three-year sovereign bonds is not 'monetary' state-financing got us thinking - just what is 'legitimate monetization' or perhaps "It's not monetization if..."

Weidmann rejected suggestions that he was isolated on the ECB Governing Council in having such reservations. "I hardly believe that I am the only one to get a stomach ache over this," he said. Alexander Dobrindt, a senior German politician who has been the Executive Secretary of the Christian Social Union of Bavaria since 2009, was more direct, saying Draghi risked passing into the history books as the "currency forger of Europe". A conservative ally of Merkel, Dobrindt echoed Bundesbank’s Weidmann that Greece should leave the currency bloc by next year. The comments show the huge divisions in Germany over the debt crisis now in its 3rd year and the understandable concerns of inflation and even hyperinflation. The Bundebank and senior politicians and allies of Merkel may thwart Mario Draghi’s big plans to do “whatever it takes” to solve Europe’s financial collapse. One way or another, the euro is certain to fall in value in the long term.