White House

Harry Reid’s publicly displayed dismay at the lack of progress in the fiscal cliff negotiations finally injected a dose of realism into the process after investors threw caution to the wind and seized on the optimism offered by the Senate Majority Leader and Speaker Boehner on November 16.  We view yesterday’s sound bite as more negative than the aforementioned statement on the White House Lawn, for we now sit 11 days closer to the New Year’s deadline.  Despite this asymmetry, equities suffered only moderate losses giving up just a modicum of the gains from last week. The relative lack of a response to the comments seem puzzling given the price action from the prior several days; however with month end looming, enough buyers kept stocks from selling off violently. My November 13 “Missive” outlined a game theory exercise that suggests this rancor will continue until very late into December and/or the capital markets dislocate thereby ensuring either a falling over the cliff or a band aid solution to avoid the crisis temporarily.  Both parties unfortunately may assume that by agreeing to postpone the tough decisions, they will have prevented a rout in equities; however, the August, 2011 precedent of raising the debt ceiling out of desperation hints otherwise.

It seems like it was only 24 hours ago that Europe bailed out Greece for the third time and everything was "fixed", with a resultant desperate attempt to validate this by pushing the EURUSD above 1.3000. Sadly, as always happens, Europe, and especially Greece, refuses to be fixed, because as we will not tire of saying: you can't fix debt with i) more debt, ii) hockeystick projections or iii) soothing words of platitude and an outright bankruptcy, just like that which Argentina is about to undergo, will be needed. If that means the end of the EUR and the delusion that the Eurozone is a viable monument to the egos of a few technocratic career politicians, so be it. As a result, this time around the halflife of the latest bailout was precisely zero, as was that of the latest Japanese QE episode, as the entire world is now habituated to the lies emanating from Europe, and demands details, which in turn are sorely lacking, especially as relates to the question of just where will Greece get the money desperately needed to fund the Greek bond buyback. But at least Kathimerini was kind enough to advise readers that said buyback must take place by December 7 in time for the euroarea finmins to approve the payment of the next Greek loan tranche at the December 13 meeting, something which will likely not happen, especially if Germany's SPD party delays the vote on the Greek bailout until the end of December as was reported yesterday. We can't wait to learn the details of the buyback package, which will come in the "next few days" per ANA, and especially where the buyback money will come from, especially with the FT reporting that various European countries will already lose money next year on the latest Greek bailout.

By now there is likely not a single individual who is not aware of the impending "fiscal cliff" and the economic impact that it represents. Obama, and the Democratic controlled Senate, have already lined up on raising taxes on the "rich" while the Republican controlled House has firmly asserted that they are amenable to closing tax loopholes in conjunction with spending cuts.  The two sides could not currently be farther apart from reaching a deal - yet, as Yoda would say: "Reach a deal we must." The Democrats have given no indication that they will compromise on any front and that tax hikes are all that is available for discussion.  Likewise, the stance by the Republicans is just as firm as they stand behind their pledge of no tax increases.  However, in the end, it will be the Republican led house that will again define "insanity" by repeating the same mistakes of their past - 'Caving'. In the next few days as the "fiscal cliff" draws nearer that media pressure from the White House will intensify to a fevered pitch with threats of economic recession due to Republican's unwillingness to compromise. This is the same tactic that was used during the debt ceiling debate in 2011 and until the politicians realize that slower economic growth is the "short term pain" required to establish the stable economic foundation from which "long term gains" may be achieved, the Republicans (in this case) will repeat the same 'caving' errors and expect a different outcome.

With hope high that TPTB will see fit not to plunge us over the cliff, we thought it useful to get some perspective on what the grand compromise might look like. Goldman's central assumption - albeit a close call - is that an agreement is found that includes a tax increase of a magnitude similar to the upper income tax cuts, though the composition might differ. Entitlement reforms also seem likely to be part of a package, particularly related to health programs. "Down-payments" in both areas seem likely, with additional deficit reduction to be enacted in 2013 as part of a two-stage process. The working deadline for an agreement appears to be December 21. While talks are ongoing, we, like Goldman, would not expect serious negotiations to begin for another couple of weeks. In the interim, headlines out of Washington are likely to be mixed, but we would expect more negative than positive news until at least mid-December.

CME Group declared a force majeure at one of its New York precious metals depositories yesterday, run by bullion dealer and major coin dealer Manfra, Tordella and Brooks (MTB), due to “operational limitations” posed by Hurricane Sandy. MTB has “operational limitations” following Hurricane Sandy and can’t load gold bullion, platinum bullion or palladium bullion, CME Group Inc., the parent of the Comex and New York Mercantile Exchange, said today in a statement. MTB must provide holders with metal at Brinks Inc. in New York to meet current outstanding warrants in relevant delivery periods with compensation for costs, Chicago-based CME said. The CME said that MTB will not be able to deliver metal as the lower Manhattan company deals with "operational limitations" almost a month after the arrival of Hurricane Sandy. MTB is one of five depositories licensed to deliver gold against CME's benchmark 100-troy ounce gold contract, held 29,276 troy ounces of gold and 33,000 troy ounces of palladium as of Nov. 23, according to data from CME subsidiary Comex. In a notice to customers on Monday, CME declared force majeure for the facility, a contract clause that frees parties from liability due to an event outside of their control.

Watching Barack Obama and Mitt Romney duel in the presidential campaign should have convinced the spectators that we live in an age of illusionists. Few of the assertions and conjectures thrown around have been subjected to what the political chattering classes deem to be the indignity of factual verification. This brings us to the sharp pencil people in the Obama administration, specifically the OMB. They claim to know what the relative size of the federal government will be in 2016, at the end of President Obama’s term. According to the OMB’s plans, the federal government, as a percent of GDP should be 22.5%. That’s a 1.8 percentage point drop from the current level. Given that President Obama’s first term recorded a record growth in the relative size of the federal government, and that the President campaigned on a platform of more big government, it is doubtful that he will come close to meeting his own OMB forecasts, in his second term. Yes, the illusionists, not the President’s sharp pencil people, will probably carry the day. What will make the President’s task even more onerous is money – as in the money supply. Thanks to Basel III, the U.S. money supply isn’t the only one creating growth headwinds. Europe faces significant money supply deficiencies. Will Asia continue to be the world’s locomotive? We will have to wait and see. At present, though, one thing is certain – an age of illusionists has arrived.

The S&P 500 achieved its anticipated 4-5% bounce off the recent 7-10% pullback, most of it accomplished in a very light holiday trading week.  Much of the gains were attributed to overly effusive optimism over the prospects of resolving the fiscal cliff.  Ironically, with Washington abandoned the past ten days for Thanksgiving, we have not heard anything substantive on the negotiations since Senator Reid and Speaker Boehner spoke jointly on the White House Lawn on November 16. The returns in equities that resulted from this perceived positive outlook has likely run its course as the blue chip index has regained the levels from the morning after the Election. Certainly, the mundane increases in open interest for the futures and the outperformance by the blue chips versus smaller capitalization names on a beta adjusted basis hint at such vacuous motivation for the upward move.

Another week begins which means all eyes turn to Europe which is getting increasingly problematic once more, even if the central banks have lulled all capital markets into total submission, and a state of complete decoupling with the underlying fundamentals. The primary event last night without doubt was Catalonia's definitive vote for independence. While some have spun this as a loss for firebrand Artur Mas, who lost 12 seats since the 2010 election to a total of 50, and who recently made an independence referendum as his primary election mission, the reality is that his loss has only occurred as as result of his shift from a more moderate platform. The reality is that his loss is the gain of ERC, which gained the seats Mas lost, with 21, compared to 10 previously, and is now the second biggest Catalan power. The only difference between Mas' CiU and the ERC is that the latter is not interested in a referendum, and demand outright independence for Catalonia as soon as possible, coupled with a reduction in austerity and a write off of the Catalan debt. As such while there will be some serious horse trading in the coming days and week, it is idiotic to attempt to spin last night's result as anything less than a slap in the face of European "cohesion." And Catalonia is merely the beginning. Recall: "The European Disunion: The Richest Increasingly Want To Fragment From The Poorest" - it is coming to an insolvent European country near you.

With America shut for Thanksgiving today, what was going to be an abysmal volume day, coupled with the usual any news is good news levitation following the lowest volume day of the year, will be even worse. Sure enough, the overnight session started off with a bang, when in the vacuum of night, a lift everything algo sent the EURUSD soaring by 40 pips higher on no news. With the entire risk complex firmly anchored to the EURUSD pair as the key driver, it pushed risk across the entire market well higher to set the early session mood with the very first trade. Followed light trading and a gradual drift lower which could not be offset even with a China HSBC Flash PMI print of 50.4, up from 49.5 in October, and the first 50+ print in 13 month (to accompany the new political regime: after all, the US is not the only nation where economic data mysteriouly levitate with key political events). This continued until about Europe open, when the monthly release of European PMIs came out, which once again were confusing to say the least with France posting the biggest and most surprising pick up, after its Manufacturing PMI rose from 43.7 to 44.7, on expectations of 44.0, while the Services PMI increased from 44.6 to 46.1, well above the expected 45.0 print. Germany was less exuberant with manufacturing rising from 45.5 to 46.2, although the Services PMI dropped from 48.4 to 48.0, missing expectations of 48.3, sending the series to its lowest in 41 months.

The week's most anticipated speech (given Obama's absence from DC) is here. Bernanke's Economic Club of New York extravaganza - where he has previously hinted at new or further policy - is upon us. Sure enough, it's a smorgasbord of we'll do whatever-it-takes (but won't bailout Congress) easing-to-infinity, housing's recovering but we want moar, simply re-iterating his comments from last week...

• *BERNANKE SAYS FISCAL CLIFF WOULD POSE `SUBSTANTIAL THREAT'
• *BERNANKE SAYS CONGRESS, WHITE HOUSE NEED TO AVERT FISCAL CLIFF
• *BERNANKE SAYS FED TO ENSURE RECOVERY IS SECURE BEFORE RATE RISE
• *BERNANKE SAYS HOUSING RECOVERY `LIKELY TO REMAIN MODERATE'
• *BERNANKE SAYS CRISIS REDUCED ECONOMY'S POTENTIAL GROWTH RATE

However, as we have noted previously, once you've gone QE-Eternity, you never go back... and we would this is the 3rd time in a row that someone from the Fed has spoken and stocks have sold off.

Despite the hope of the last day or two, policymakers remain, we suggest, as far apart as they ever have, with 'no news' simply that. An oversold bounce does not a fiscal cliff fix, and as BofAML's Michael Hanson suggests in his 'brief history of brinksmanship': "one lesson from the recent past is that market reaction has been an important mechanism to reaching compromise and forcing action." Unfortunately, he adds, as we have been quite vociferous about, that "history also shows that the equity markets have to sell off sharply before policy makers listen to the 'stock market vigilantes'." With some politicians still thinking going over the cliff might be their best strategy, it could once again take a sharp market sell-off to focus the minds of the negotiating parties. If we actually manage to go over the cliff, even if only for a brief period of time, a repeat of the TARP sell-off seems only too probable.

Austerity is coming our way, it's just a matter in what manner and by how much, and whether it becomes an orderly or disorderly process. The fiscal cliff is really a bit of a ruse in that respect, but the key here is that years of fiscal profligacy is coming to an end and the Fed at this point, having used its bazookas, is now down to firecrackers. The economic outlook as such is completely muddled and along with that the prospect for any turnaround in corporate earnings... Once we get past the Fiscal Cliff we will confront the inherent inability of the Democrats and the GOP to embark on any grand bargain to blaze the trail for true fiscal reforms. The U.S. has not had a rewrite of its tax code since 1986, which was the year Microsoft went public and a decade prior to Al Gore's invention of the Internet. The tax system is massively inefficient and leads to a gross misallocation of resources that impedes economic progress — rewarding conspicuous consumption at the expense of savings and investment. It is the lingering uncertainty over the road to meaningful fiscal reform that is really the mot cause of the angst — the fiscal cliff is really a side show because who doesn't know that we are going to have a Khrushchev moment?

You've probably noticed the cookie-cutter format of most financial media "news": a few key "buzz words" (fiscal cliff, Bush tax cuts, etc.) are inserted into conventional contexts, and this is passed off as either "reporting" or "commentary" depending on the number of pundits sourced. Correspondent Frank M. kindly passed along a template that is "officially deny its existence" secret within the mainstream media. With this template, you could launch your own financial media channel, ready to compete with the big boys. Heck, you could hire some cheap overseas labor to make a few Skype calls to "the usual suspects," for-hire academics, hedge fund gurus, etc. and actually attribute the fluff to a real person.

With precisely 13 working sessions left for Congress in 2012, it is time to ratchet up the can kicking rhetoric a bit. Sure enough, here comes the White House, via the Wall Street Journal, doing just that.

• WHITE HOUSE IN ADVANCED INTERNAL DISCUSSIONS ON PLAN TO REPLACE SEQUESTER - SOURCES - DJ
• CONCEPT WOULD KICK MAJOR DEFICIT-REDUCTION TALKS INTO 2013 - DJ
• CONCEPT WOULD BE PART OF BROADER NEGOTIATIONS ON TACKLING 'FISCAL CLIFF' - DJ

Because when unable to reach a compromise over anything, what is the best option? Just stick head in sand, and demand that the Mr. Chairman gets to work. As for the news above, this is largely irrelevant for the actual fiscal cliff negotiations and the futures buying algos are once again in for a rude awakening.

There was precious little in terms of actionable news in the overnight session, which means that, like a broken record, Europe falls back to contemplating its two main question marks: Greece and Spain, with the former once again making noises about the "inevitability" of receiving the Troika's long delayed €31.5 billion rescue tranche. The chief noise emitter was Italian Finance Minister Vittorio Grilli who said he was "confident that euro-region finance chiefs will reach an agreement on aiding Greece when they meet next week." He was joined by Luxembourg Finance Minister Frieden who also "saw" a Greek solution on November 20. Naturally, what the two thing is irrelevant: when it comes to funding cash flows, only Germany matters, everything else is noise, and so far Schauble has made it clear Germany has to vote on the final Troika report so Europe continues to be in stasis when it comes to its main talking point. In fundamental European news, there was once again nothing positive to report as Euro-area exports fell in September as the region’s economy slipped into a recession for the second time in four years. Exports declined a 1.1% from August, when they gained 3.3%. Imports dropped 2.7%. The trade surplus widened to 11.3 billion euros from a revised 8.9 billion euros in the previous month. Global trade, at whose nexus Europe has always been at the apex, continues to shrink rapidly. Elsewhere, geopolitical developments between Israel and Gaza have been muted with little to report, although this will hardly remain as is. Providing some news amusement is Japan, where the LDP opposition leader Shinzo Abe continues to threaten that he will make the BOJ a formal branch of the government and will impose 2% inflation targeting, which in turn explain the ongoing move in the USDJPY higher. This too will fade when laughter takes the place of stunned silence.