Baseline Scenario

Nike recently published a series of ads declaring “winning takes care of everything,” in reference to Tiger Woods’ recapture of the world #1 golfer ranking. The slogan went over with certain critics like an illegal ball drop. Many economists insist that “economic growth takes care of everything,” and the related debate is no less contentious than the Nike ad kerfuffle. Listening to some pundits, you would think there’s one group that appreciates economic growth while everyone else wants to see the economy crumble. It seems to me, though, that growth is just like winning – there’s no such thing as an anti-winning camp, nor is there an anti-growth camp. More fairly, much of the growth debate boils down to those who think mostly about long-run sustainable growth and those who advocate damn the torpedoes, full speed ahead growth. I’ll break off one piece of this and consider:  How much of everything does growth take care of?

We all know what's supposed to happen in the global economy: we get more of everything: more stuff manufactured, more coal dug up and burned, more "aggregate demand" i.e. insatiable desire for more of everything, more innovation, more wealth, more money printed, more debt taken on to buy more stuff and more education, more tourists occupying more beaches sipping more drinks, more strip malls built, more airports expanded, more jobs created, more taxes collected-- more "growth" of everything, in every way and every day. But what if this baseline scenario doesn't appear and the center cannot hold, and the Status Quo devolves - there will be less of everything, not more, and a gradual but steady erosion of all "growth" baselines: fewer jobs, lower wages, fewer taxes collected, less profits, fewer retail outlets. In this case, printing more money and spewing more reassuring propaganda will no longer tamp down the crisis. Rather, the failure of these Status Quo responses will unleash an even more destabilizing crisis.

As expected, it is all about Cyprus this morning, and overnight, and just as naturally it wouldn't be a centrally-planned market without the generic BTFD overnight ramp attempt, which we got from the EURUSD, as the pair rose from sub 1.29 to 1.2973, which also pushed the US futures up to nearly fill half the overnight gap lower. Citi explained this, observing the "EUR/USD squeezed higher on reports Cyprus bailout terms may be eased, CitiFX Wire says", but it did add that "selling was likely to materialize; flow has 60% bias in favor of downside, Seeing heavy net selling, mainly from leveraged funds." Naturally, the market does what it does best - clutches at straws, although not even this centrally-planned market could ignore news that today's Cyprus parliament vote has been cancelled, that banks will likely remain closed tomorrow, and that a vote may not happen until Friday, which likely means the bank holiday is about to stretch to one week, and possibly much longer as Cyprus is terrified to open its banks to the fury of scrambling "bank-runners." Things started to get interesting following another RIA report citing finance minister Siluanov, that Russia may reconsider its role in the Cyprus rescue following the bank tax. Siluanov added that bank tax breaks the plan for joint steps on Cyprus and that the decision was made without Russia.

Today's stunning comeback by Berlusconi, which is really a slide in support for Bersani and Monti whose joint coalition government is unlikely to have the 158 seats needed in the Senate to avoid elections in a few months, means the "Plan B" aka "worst" outcome is in play. How "worst"? In a note released over the weekend, JPM strategist Gianluca Salford attributed a tiny 15-20% probability to an outcome that now appears to be the base case. A far more likely result (defined by JPM as 75%) would have been a continuation of the status quo, which saw an easily-formed Center Left government. As of this moment, that no longer appears feasible. So as the next steps play out, the fulcrum security will be Italian BTPs, which according to JPM will be whacked to the tune of 40 to 100 bps (at least to start), and with deleveraging feedback loops picking up after, who knows where this will end, especially in a worst-er case scenario where there will be months of political and social uncertainty in Italy.

While the topic of net Fed capital flows, and implicit balance sheet risk has recently gotten substantial prominence some three years after Zero Hedge first started discussing it, one open question is what happens when we cross the "D-Rate" boundary, or as we defined it, the point at which the Fed's Net Interest Margin becomes negative i.e., when the outflows due to interest payable to reserve banks (from IOER) surpasses the cash inflows from the Fed's low-yielding asset portfolio, and when the remittances to the Treasury cease (or technically become negative). To get the full answer of what happens then, we once again refer readers to the paper released yesterday by Morgan Stanley's Greenlaw and Deutsche Bank's Hooper, which discusses not only the parabolic chart that US debt yield will certainly follow over the next several decades, but the trickier concept known as the Fed's technical insolvency, or that moment when the Fed's tiny capital buffer goes negative. In short what would happen is that the Fed will be then forced to print money just so it can continue to print money.

One-stop summary of the key events and issues in the week ahead.

Moody's has stepped forward with the first warning shot across the bow that:

• *MOODY'S: MORE MEDIUM TERM ACTIONS MAY BE NEEDED TO SUPPORT Aaa

Has contradicted itself (from September) on the debt-ceiling breach; and warns that while the deal 'mitigates' some fiscal drag, it does not remove it. To wit: the IMF piles on:

• *IMF SAYS `MORE REMAINS TO BE DONE' ON U.S. PUBLIC FINANCES
• *IMF SAYS U.S. DEBT CEILING SHOULD BE RAISED `EXPEDITIOUSLY'

Full statements below.

This EU juggler simply has too many balls in the air...

Obama has been reelected, the Senate remains in the hands of the democrats, while Congress is controlled by the GOP. Most importantly, the printer is firmly in the hands of Ben Bernanke. In other words, nothing has changed, as was largely expected all along. The worst case scenario - a protracted litigation, challenging the results of the election - has been avoided after Mitt Romney contested shortly before midnight, and as a result the immediate downward gap in risk following the election has been largely recouped overnight. More importantly, '4 more years' of the same monetary policy and no end to currency dilution have resulted in a nearly $50 jump in gold overnight with the metal in the $1720s this morning, because while the Fiscal Cliff remains hopelessly unresolved, and the baseline scenario that the market will need to tumble to shock politicians into waking up, remains (as does Goldman's 1250 year end S&P price target), the reality is that no matter what happens, Bernanke and crew will print and monetize the coming deluge of debt (which would also have been the case if Romney had won). And with total debt set to rise to $22+ trillion over the next 4 years, a deluge it will be. Most importantly, with Obama reelected, Europe is now "off the hook" and can finally rock the boat, which means Greece can take its rightful place at the front of the domino chain. Remember: the latest Greek austerity vote is today and voting (i.e. debating) has begun, and with vote results expected later today. It also means that the military festivities in the middle east, where the US now has 2 aircraft carriers and 2 marine assault groups, can resume.

For those who are curious why Tim Geithner has been invisible in the past 2 months, the answer is he has been manning the phones like a true patriot, and making sure nobody dares to rock the European boat ahead of the US election (as was already disclosed), in this case exemplified by Moody's just released announcement that the rating agency will not downgrade Spain to junk, soaring debt, collapsing GDP and laughable unemployment rate notwithstanding (unless of course the ECB fails in its mission to scare all shorts from approaching within 10 miles of an SPGB, and Spain loses private market access again, in which case Moody's would proceed with a "multiple notch downgrade"). At least not until the US election that is. After that... well, with the fiscal cliff, debt ceiling, Greece vs Troika, etc, etc, buy VIX.

With the presidential elections fast approaching, the last thing the incumbent wants is for the one thing that can spoil the party - a surge in oil, and thus gas prices - to happen. Which is why despite a sharp return in Iran/Syria war rhetoric, we doubt that the trade off between a "wag the dog"-type transitory war euphoria and $5 gas will be an accretive one for the administration at least in the short-term. Others who certainly would prefer to avoid the record $140 WTI prices seen just before the Lehman collapse are the majors, where margin contraction can only be offset by very finite end-demand destruction. Yet there are those who not only would like to see a surge in oil prices, but in fact need it, to preserve their viability. Chief among them: Iran. Because according to a just released analysis by the Arab Petroleum Investments Corporation, the price at which oil (read Brent) must trade for Iran's budget to balance has soared to $127/barrel, the highest among all OPEC members, $20 higher than 2 years ago, and about $17 higher than the Friday closing price. And far more dangerously, the APIC study has also found that the cartel (which after last year's fiasco in Vienna is anything but) breakeven price has soared from just $77 two years ago to a whopping $99/barrel. Which means that any and every deflationary plunge in oil prices will inevitably be met with a supply collapse or else OPEC members are in danger of pricing themselves right into fiscal insolvency, and economic collapse.

From what seemed like a very low bar on expectations, last week's summit headlines surprised modestly on the upside, even if the details remain far from clear - and implementation even murkier. Political talk of wanting to break the link between sovereign and banking risk was well-received by markets - but we remind all that talk-is-cheap with these Euro-pols. As Goldman noted this weekend, "we do not see the outcome as a game changer", rather can-kicking until one of four possible endgames are realized. The absence of any explicit commitment to plans for fiscal or political integration; the lack of reference to any pan-European deposit insurance; and Ms. Merkel's limited concessions (to ensure passage of the growth compact) to the terms on which the existing pool of EFSF/ESM resources are offered leaves the underlying issue - the terms on which mutualisation of financial risk is offered by Germany in return for mutualization of control over fiscal decisions throughout the Euro area - remaining inharmonious. German tactical concessions at the summit do not change their basic position on this issue: that discipline, reform and consolidation must be achieved and cemented first before mutualization of financial obligations is possible. Looking to the future Goldman sees four paths for the Euro are from here - and short-term too many crucial issues are left unresolved.

While the world has known for over two weeks that the Spanish banking system is insolvent and locked out of global liquidity, the country was reticent about formally bowing down to Germany and announcing in proper protocol that it was broke. Until a few hours ago, when Spain's Economy Minister Luis de Guindos Monday sent a letter to Eurogroup President Jean-Claude Juncker, as expected, formally requesting aid to assist with the recapitalization of Spanish banks that need it, the ministry said in a statement. Sadly, at this point we can all just sit back and await for the next Spanish bailout letter demanding more cash, because, as we have explained on several occasions, the ultimate funding need of Spanish banks will be well over €100 billion, as further confirmed overnight by another analysis from Open Europe, which notes the patenly obvious: "Up to mid-2015 Spain faces funding needs of €547.5bn, over half its GDP and a large majority of its debt."

Sometime in 2042 the CBO will need a bigger chart to represent US public debt because per the just updated Extended Alternative Fiscal Scenario, which the CBO itself admits " is more representative of the fiscal policies that are now (or have recently been) in effect than is the extended baseline scenario," this is when it literally falls off the chart. And it is to ridiculous debt load that Keynesian lunatics want to add MORE debt? Actually why not, it is not as if the US will ever repay any of these exponentially-rising obligations.

If it appears like it was only yesterday that Goldman was advising clients to short the 10 Year Treasury, it is because it was... give or take a few months: From January: "Since the end of last August, we have argued that 10-yr US Treasury yields would not be able to sustain levels much below 2% in this cycle. Yields have traded in a tight range around an average 2% since September, including so far into 2012. We are now of the view that a break to the upside, to 2.25-2.50%, is likely and recommend going tactically short. Using Mar-12 futures contracts, which closed on Friday at 130-08, we would aim for a target of 126-00 and stops on a close above 132-00." We added the following: "As a reminder, don't do what Goldman says, do what it does, especially when one looks the firm's Top 6 trades for 2012, of which 5 are losing money, and 2 have been stopped out less than a month into the year." Sure enough, as we tabulated last night, those who had listened to this call, and also gone long stocks as Goldman urged on March 21, have lost nearly 30% in about 2 months. Those who listened to us and did the opposite, well, didn't. Which is why the just released note from the very same Garzarelli who 4 months ago was so gung ho on shorting bonds, just cut his bond yield forecast for the entire world, US Treasurys included: "We now see 10-year US Treasuries ending this year at 2.00% (from 2.50% previously, and 30bp above current forwards), rising to 2.50% (previously 3.25%, and 60bp above the forwards) by December 2013. The corresponding numbers for German Bunds are 1.75% and 2.25%." In other words, it is now that Doug Kass should have made his short bonds call: not when he did it, a month ago and got his face bathsalted right off. For those asking - yes: Goldman is now selling bonds to clients.