PIMCO

Uncertainty. That has become the key word of the day, the month, and of 2011 in general. And while broad uncertainty has manifested itself most notably in the capital markets, it has a far more practical representation in labor markets, where the main reason why employers are not hiring more people, arguably the primary scourge of the Obama administration's record low approval rating, is due to corporate uncertainty about the future: about taxes, about government demanding its pound of flesh when the time comes, and about the economy in general. Ironically, as PIMCO speculates in its daily note authored by Tony Crescenzi, probably the primary driver of global uncertainty is the increasingly uncoordinated response by monetary policy authorities (read Central Banks) in which where before all had cooperated in the global game theory, now increasingly it is every printer for himself, as the default response turns to one of defection. And as everyone who has studied Game Theory knows, it is only the first defection that provides the biggest return, with each subsequent act generating far less benefits to the uncooperative actor, forcing even more uncooperative irrationality, and so on in a toxic spiral until outright belligerent action develops. For now said belligerence has begun to manifest itself in plain vanilla trade wars, such as that pointed out last night with the Chinese response to Europe's lack of response to its "bailout" overtures, and following up with the just announced complaint filed by the US against China on chicken prices. Naturally this is just the beginning. The real concern is that where trade wars end (which in turn begin when FX wars end), real ones start. When a year ago we first branded the Chairsatan as "genocidal" we were mostly joking. Perhaps it is time to reevaluate our definition, as it is far less comical under the current environment. Here is what Pimco has to say on the issue.

Bill Gross came, saw, and i) stopped shorting govvies, and ii) doubled down on QE3, after, as he himself said, he did not anticipate how bad the US economy would get. As the just released latest monthly Total Return Fund data indicates, PIMCO now has a substantial net long position in Government Related securities, at $51.5 billion (net of swaps), a more than 100% increase from the $22.1 billion in July (and a far cry from the $9.6 billion short in April). As a reminder, Gross skepticism was predicated by the concern of who would buy bonds in an inflationary environment coupled with the end of QE2. Well, since then the bottom fell out of the market, and the Fed is about to re-enter the securities market to prevent the latest re-depression with Operation Twist if not much more. So while it no longer makes sense to be short bonds (as Gross has figured out the hard way), what makes sense is to be very, very long duration, since this is what the Fed will be buying in Operation Twist/Torque. Enter Exhibit A - the chart of maturity/distribution of PIMCO holdings, of which most notable is the explosion in average holding duration, which from 4.56 in July, has soared to 6.27 in August, the highest since 6.23 in October, and possibly the highest on record (that said our records only go back to 2007). As part of this expansion, Gross has seen his Mortgage Securities soar to $78.5 billion, the highest since February, when Gross was actively reducing his MBS holding profile, and now is doing the opposite, and is accumulating Agency paper hand over fist in an attempt to extend duration. Bottom line: Pimco is now balls to the wall in the QE3 camp, first to be manifested by Operation Twist, and then, likely by outright Large Scale Asset Purchases. Look for numerous other copycat investors to expand the duration of their fixed income holdings from 4-5 to over 6.

Zero Hedge has been among the most vocal critics of Keynesian economics, and specifically the misinterpretation by modern governments of the core approach of the "Keynesian revolution", which essentially gave them a carte blanche to drown society in preemptively failed stimulus after stimulus, funded with a relentless tsunami of public debt, which, while some believe will never be "called", others, who actually base their opinions on real world empirical evidence and not textbooks, realize all too well that such debt is ultimately unsustainable, reserve currency or not. Which is why we were amused to read today in a letter by Pimco's Tony Crescenzi, the core gist of our argument, repeated so often through the years, namely finally "Saying no to Keynes and fiscal folly." The key paragraph from Pimco: "Politicians and the beneficiaries of their fiscal illusions for the past 80 years abused the Keynesian philosophy, relentlessly and dangerously pursuing the use of debt for self-aggrandizement. Today, the citizens of indebted nations bear a heavy burden and must begin repaying the debts. It is a herculean task, because the debts are mountainous. Yet, there is no choice, because investors have become intolerant of fiscal follies. They are saying no to Keynes, in other words." This also explains why during Bernanke's Jackson Hole speech the Chairman basically threw the ball back in Congress' court. Unfortunately he will soon realize that absolutely nothing will come out of this, and it will be up to him to once again guarantee that Wall Street generates yet another year of record bonuses.

Bond King's cardinal sin at the Treasury market analyzed..... 

Time for deeply introspective Op-Eds galore. Not too surprisingly, the first one comes from blogging powerhouse Pimco, and its chief literary superstar, Mo El-Erian, titled "U.S. Downgrade Heralds a New Financial Era." While Mohamed's outlook is mostly politically correct fluff, he does bring up the absolutely spot on point that FrAAAnce is about to become FrAAnce, which also means that Germany's worst nightmare: that of backstopping the EFSF entirely on its own, is about to become reality.

The latest monthly breakdown from PIMCO's Total Return Fund is out. Among the key findings for June are that the total AUM declined modestly by $400 million to $242.8 billion, well below the all time highs of $256 billion in October 2010. More notably, it appears that Gross has gotten tired of being mocked by CNBC for his Treasury short position and has raised his cash Treasury bond exposure by 3% to 8%, though even with that move he is still net neutral courtesy of a 1% Agency cash position and -9% in synthetic swap exposure, unchanged from May. Therefore Gross is no longer short on a net basis. He also reduced his IG exposure from 18% to 17%, offsetting an increase in emerging market corp bonds by 1%. Where he did however invest quite a bit of money in are Non-US Developed market: i.e. European sovereigns: arguably Italian names, as per the announcement of PIMCO's Bosomworth on Bloomberg TV last night. However, since this report is for June, and since the increase in bond exposure occurred before the massive rout in July, it probably means that Gross did not time his increase in European debt exposure quite as well as he had hoped. Lastly, and just as interesting, is the increase in the effective duration of the TRF, which rose from 3.73 to 4.37, the second highest in 2011, and a steep rise from the near record low 3.42 in April. At least Gross can now saw that he is no longer largely underweight duration. Lastly, the fund still has gobs of cash, at just over $70 billion.

And while Trichet is blatantly lying and making stuff up as he goes along, on line two we have Pimco's Mohamed El-Erian who has taken some time away from his daily blogging activity and is conducting a live Q&A on Reuters right now. Readers can follow his thoughts, which are hardly anything new as he has made his opinion known each and every day in at least one media venue, live at the link below.

It just has not been Morgan Stanley's year: first the bank's prop desk got decimated by the massive tightening in MBIA CDS (previously discussed here), and then, as noted last week, the firm's rates desk got creamed by a massively wrong bet on 30s - 5s TIPS breakevens (courtesy of another ex-master of the universe who realized the hard way that things are not quite as profitable when you move away from being God's right hand guy). We previously broke down the details of the trade, and the only open question was: qui bonoed? Courtesy of the WSJ we can now close the file on that one. The firm, which as so often happens to be the case, that took Morgan Stanley to the cleaners is the one true rates behemoth, PIMCO, which sooner or later, always gets it pay day. Bottom line: "Pimco made about $50 million from its trade over several months." Perhaps prop trading really should be banned to protect banks, if not from their stupidity, then certainly from their hubris.

One of the prevailing themes in FX land over the past year, courtesy of prevalent central bank intervention in the monetary arena, has been a pervasive conflict among the world's money printers whereby those who have been unable to keep up with the Fed's fiat printing, have been engaging in direct open market purchases of USD to keep their own currencies lower, and thus promote exports, etc. The fact that currency exchange rates have been as unstable as they have since the start of QE 1, and especially QE 2, is in our opinion, a main reason for the outflow of trading volume from equity markets and into venues that exhibit the kind of volatility desired by short-term speculators, such as FX. Today, PIMCO's Clarida, in an informative Q&A, proposes that the currency wars we have all grown to love so much over the past year, are coming to an end. The implications of this assumption are indeed substantial. While we do not agree with the assessment, it does merit further exploration, especially since it touches on PIMCO's outlook for the dollar: "In our baseline case we do
not see the dollar being supplanted as the global reserve currency in
the next three to five years. If foreign central banks were to decide
that they did not want to hold dollars as a reserve, they would have to
hold some other currency. And right now there is not a single viable
alternative to the dollar. Aside from the 60% that I mentioned earlier,
global reserves include about 30% in euros and the rest is mixed. Given
current circumstances in Europe, we would not expect the euro to
supplant the dollar." Oddly, there is still no mention of such currency alterantives as precious metals, which as the Erste Bank report noted yesterday, has already set the groundwork for a return to real sound money. Much more inside.

Three months ago, Goldman's Francesco Garzarelli released a note to clients advising them to short the 5 Year as follows: "We recommend going short 5-yr US Treasuries at 1.936% for a potential target of 2.30% and a close below 1.80%." Naturally, our cynical outlook on life prompted us to say the following: "As usual, since that would mean Goldman is now accumulating 5 Year inventory, it appears we will soon have a rather dramatic duel between the two biggest Wall Street titans: PIMCO and Goldman, at least as pertains to their outlook on rates." Well, Goldman won so far (its clients not so much). Today, Goldman is telegraphing that it is starting to accumulate the next batch of 5 years, which makes sense considering the point on the curve experienced its 3rd worst 3-day decline ever as reported yesterday. To wit: "Ahead of key data for June, starting with the June ISM report this Friday, we recommend initiating short positions in 5-yr UST at the current level of 1.70%, for an initial target of 2.00%, and stops on a close below 1.40%." Round two of Goldman vs PIMCO is now on.

Bank of America may be about to part with more money than it has earned since 2008 in what will soon be the biggest financial settlement in the industry to date According to the WSJ, the Charlotte, NC-based bank is preparing to pay $8.5 billion to settle mortgage (mis)representation claims (aka the Mortgage putback issue) brought on by such high profile figures as BlackRock, Pimco, MetLife and, of course, the Federal Reserve, previously discussed on Zero Hedge. "A deal would end a nine-month fight with a group of 22 investors that hold more than $56 billion in mortgage-backed securities at the center of the dispute, including giant money manager BlackRock Inc., insurer MetLife Inc. and the Federal Reserve Bank of New York." Keep in mind that this is actually not good news for the bank, contrary to what the company's stock is doing after hours, as this still keeps the company exposed to a multitude of other rep and warranty litigation (which will now be largely underreserved), not to mention fraudclosure issues, which are totally unrelated, and which will plague the bank for years and years. Lastly, BAC is largley underreserved (see below) for a settlement of this size which means its Tier 1 capital ratio will likely be impacted due to a major outflow of cash.

PIMCO Scott Mather has released a fascinating Q&A in which the key topic of discussion is the artificial push to keep rates low in developed economies, also known as central bank hubris to maintain the "great moderation" in which he clearly explains i) what this means for global fund flow dynamics (using developed country reserves and purchasing EM bonds) and ii) for the future of a system held together with glue and crutches. To wit: "Financial repression is any public policy
that is designed to influence the market price of financing government
debts, either through government bonds or the nation’s currency. Direct
methods of repression include things like setting target interest rates,
monetizing government debt or implementing interest rate caps. Indirect
methods include polices designed to change the amount of debt or
currency at a given price. Examples include requirements to hold minimum
amounts of government debt on bank balance sheets or establishing
minimum requirements for government bonds in pension funds." Just in case anyone is confused why central planning is a bad idea: "Governments may take these steps to improve their ability to
finance public debt and forestall more painful adjustment processes,
though there can be other motives, and because these methods are less
transparent, and thus less controversial, than direct tax hikes or
spending cuts. Investors should be wary of financial repression because
it is primarily a tool to redistribute wealth from creditors (citizens)
to debtors (governments) to the detriment of creditors, fixed income
investors and savers." Needless to say, central planning always fails: "It is important to realize these methods as practiced are only
partially effective and cannot go on forever, as advanced economies
continue to add significantly to their public debts despite low
financing costs. Some intensification of financial repression, fiscal
austerity, or stronger growth must occur to lower the likelihood of a
future debt crisis." Bottom line: "kicking the can" can only go on for so long before EMs (read why below) provide a natural counterbalance to an artificial market created by developed world central banks. PIMCO's advice: get out of balance sheet risky DM bonds ahead of central planning failure, and buy up every EM bond possible, or bypass paper and just buy EM currencies as "EM policymakers who have resisted appreciation will
eventually allow more appreciation over the next three to five years as
they nurture domestic consumption and their economies become less
dependent on export demand." We expect to see much more on this topic as the MSM realizes the implications of this new risk regime change.

Pimco has just released its May Total Return Fund holdings data, and we are delighted to discover that following all the recent debate over whether PIMCO is or is not short Treasurys, the firm has relented and has actually changed the way it reports it exposure, which in turn is precisely just as we had speculated: a modest long cash position offset by a substantially larger swap short. Yet combining the three (the firm now breaks out its "Government Related" category into Government- Treasury, Government- Agency and Swaps and Liquid Rates, which had been lumped before), we find that on a Market Value basis PIMCO is still short government securities to the tune of -3%, a minimal increase in its exposure from April when this was -4%. Yet on a duration weighted exposure basis, the firm's Swaps and Liquid Rates, the flagship fund's positioning is a whopping -31! Just as importantly, semantics aside, TRF's net cash position declined from 37% of its $243.2 billion in AUM to...35%, or $85 billion in cash. Hardly much of a vote of confidence in US government paper.

Recently Bill Gross appeared on CNBC stating that contrary to what some "blog" had said, the firm was not short bonds. This provoked said "blog" to pen a response (actually two) to this somewhat misleading statement, which we equated to someone claiming they are long x million in cash exposure offset by y billion in synthetic. Today, when interviewed by Bloomberg TVs' Tom Keene, Gross declined to refuse he was short treasuries (in fact, ignored the topic entirely), merely saying the following: “We're not overweight Treasuries. We're certainly underweight Treasuries, but that does not mean we don't own lots of other bonds...It does not mean as well that we're not a little bit shy in terms of duration." And once again the bottom line, and what it is really all about: "We’re having a good year...so don't cry for Pimco." Simply said, Gross is concerned by what traditionally skittish fund investors will think about the fund manager being correct (yes, Gross is correct to be short bonds, especially in the long-run) but being late. That is understandable. But making statement such as Pimco is not short market, and especially duration equivalent exposure, that is both misleading and condescending. Far more from the Pimco boss in the full interview.