Budget Deficit

A Monetary Cliff or a Fiscal Cliff: these are the two poisons that Barton Biggs sees rushing straight toward America, with little hope of an uneventful collision. While we have not been shy of our opinions on Barton Biggs' flip-flopping positions, his note on the US "as a nation of totally self-centered special interest groups that terrorize our politicians" struck a chord and deserves praise in its clarity. Noting that Europe seems stuck again, he points to the US market being data and Europe-dependent for the next month and believes the correction is little less than half way over (in terms of size not time). In Biggs opinion "although the Monetary Cliff is more long-term dangerous, the proximity of the Fiscal Cliff, if not dealt with, will trigger the dreaded double-dip recession we are all terrified of and bring on another financial crisis."

Following the all time record high February budget deficit of $232 billion, the US March budget deficit number is in, and in addition to being bigger than expected, coming at $198.2 billion on expectations of "only" $196 billion, the government outlay in the past month also is the largest March deficit on record. This brings the total deficit in fiscal 2012 to $779 billion, which is to be expected for a country gripped in total political chaos and which is unable to either raise revenues or lower spending. What is more disturbing is that over the same period (Oct 1 2011 - March 31, 2012), the US government issued $792 billion in debt, a trend that will continue. What is most disturbing is that the comparable tax revenues net of refunds, "matching" this increase in deficit and spending, are only $693 billion, in other words the US government is funding well more than half of its cash needs with debt rather than with tax revenue. Just like Japan.

There is no free-lunch - especially if that lunch is liquidity-fueled - is how Gluskin-Sheff's David Rosenberg reminds us of the reality facing US markets this year and next. As (former Fed governor) Kevin Warsh noted in the WSJ "The 'fiscal cliff' in early 2013 - when government stimulus spending and tax relief are set to fall - is not misfortune. It is the inevitable result of policies that kick the can down the road." Between the jobs data and three months in a row of declining ISM orders/inventories it seems the key manufacturing sector of support for the economy may be quaking and add to that the deleveraging that is now recurring (consumer credit) and Rosenberg sees six rather sizable stumbling-blocks facing markets as we move forward. On this basis, the market as a whole is overpriced by more than 20%.

US Households haven't shaken their 'junk bond' credit rating, given their poor income statement and balance sheet. Reversing Mitt Romney's famous quote "corporations are people", Bank Of America remains skeptical of this self-sustaining recovery - expecting second half growth to slow significantly as businesses and households react to the risk of a major fiscal shock (and in the short-term, momentum looks unsustainable). From an income statement perspective, 'a paycheck just ain't what it used to be' with food and energy prices rising and payroll growth (typically a good proxy for income growth) is disappointingly timid leaving real disposable income diverging weakly from a supposed job recovery. The balance sheet perspective has been helped by the rise of the equity market but the recovery in net worth in the last three years has barely outstripped income growth, leaving the ratio deeply depressed. The upshot is that the recent pick-up in consumption is not being fueled by income or wealth gains, but mainly by drawing down savings. Many households remain deeply distressed and react to higher costs of living by drawing down savings further. In sum, a true virtuous cycle still seems a long way off. As weather effects fade and gas pain builds the data should soften. BofA expects businesses to recognize the risks of the fiscal cliff first and pull back on hiring. Then with weaker job growth and with the growing awareness of the cliff, consumers will likely start delaying some discretionary spending.

A few weeks ago when discussing the imminent debt ceiling breach, and the progression of US debt/GDP into the 100%+ ballpark, we reminded readers that in February S&P said it could downgrade the US again in as soon as 6 months if there was no budget plan. Not only is there no budget plan, but the US is about to have its debt ceiling fiasco repeat all over as soon in as September. Which means another downgrade from S&P is imminent, and continuing the theme of deja vu 2011, the late summer is shaping up for a major market sell off. Minutes ago, Egan Jones just reminded us of all of this, after the only rating agency that matters, just downgraded the US from AA+ to AA, with a negative outlook.

More pain in Spain has been the theme so far in the European morning as poor auction results across three lines has resulted in significant widening in the 10-yr government bond yield spreads over benchmark bunds with the Spanish 10yr yield up some 24bps on the day. In combination with this the latest Germany Factory orders also fell short of analysts’ expectations and as such the lower open in bund futures following yesterday’s less than dovish FOMC minutes has been completed retracted and we now sit above last Friday’s high at 138.58.

European cash equities are trading in the red heading towards the US session, with particular underperformance in the periphery as financials continue to remain the biggest laggard. The EU session so far has consisted of downbeat commentary in regards to both Ireland and Portugal. An EU/ECB report noted that, Portuguese debt is now predicted to peak at 115% of GDP in 2013 and that contraction in 2012 is likely more pronounced than thought. Elsewhere, the Irish Fiscal panel said Ireland may need extra budget cuts to reach its 2012 target and 2012 growth has weakened. In terms of economic releases the UK observed a stronger than expected reading on its Construction PMI hitting a 21-month high, which saw some brief strength in GBP.

As the first day of the quarter brings new money and new hope for global asset allocators, Credit Suisse has shifted to a more negative 'underweight' stance to European equities. Laying out 10 reasons for their displeasure, they dig into the details a little with a positive view on domestic German equities and the broad DAX index (and USD earners) while notably negative on France and Spain in general (with Spain expected to underperform Italy). Varying from too much complacency on the resolution to the crisis, to political flash points, valuations, and relative economic momentum. This smorgasbord of anxiety-inducing 'facts' may well prove enough to topple the 'fiction' of a liquidity-levitated equity market - that credit seems to have already realized. Most notably the five factors that need to be 'fixed' before the Euro crisis is resolved, and the under-estimation of the de-leveraging required in the periphery, leaves mutualization of debt as the game-changer that still seems a long-way off. The complacency angle seems the most relevant to us - and we see equities once again pull away from any sense of reason indicated by the sovereign, financial, and corporate credit market, this complacency becomes more and more dangerous.

European cash equities are seen mixed as the market heads into the US session, with the DAX index the only bourse to trade higher at the midpoint of the European session. European markets were seeing some gains following the open after the weekend release of better than expected Chinese manufacturing data, however the main price action of the day occurred after some European press reports that the Bundesbank had stopped accepting sovereign bonds as collateral from Portugal, Ireland and Greece garnered attention, however the Bundesbank were quick to deny reports and state that it continues to accept all Eurozone sovereign bonds. Following the denial, participants witnessed a slight bounceback, but failed to push most markets into the green.  Data releases from Europe so far have been varied, with outperformance seen in the UK Manufacturing PMI, beating expectations and recording its highest reading since May of 2011. However, the French manufacturing PMI came in below expectations, weighing on the CAC index as the session progresses. A further release from the Eurozone has shown February unemployment coming in alongside expectations recording a slight increase from January to 10.8%.

• Greek PM does not rule out new bailout package (Reuters)
• Euro zone agrees temporary boost to rescue capacity (Reuters)
• Madrid Commits to Reforms Despite Strike (FT)
• China PBOC: To Keep Reasonable Social Financing, Prudent Monetary Policy In 2012 (WSJ)
• Germany Launches Strategy to Counter ECB Largesse (Telegraph)
• Iran Sanctions Fuel 'Junk for Oil' Barter With China, India (Bloomberg)
• BRICS Nations Threaten IMF Funding (FT)
• Bernanke Optimistic on Long-Term Economic Growth (AP)

When the world's central bankers speechified in DC, ironies abounded. But off to the side, Turkey had just floated a plan to grab its people’s gold.

There are relatively few natural buyers of Spanish long dated bonds here. Fast money is likely caught long, and it will take a potentially reluctant ECB and some already overly exposed Spanish institutions to step up and stop the slide. It may happen, but many of the policies that “bailed out” Greece created very bad precedents for bondholders, and some of those are coming home to roost, as is the understanding that LTRO ensures that banks can access liquidity, but does nothing to fix any problem at the sovereign level.

After deconstructing the labor report for signs of false positives, Michael Cembalest of JPMorgan, sees muddle-through data in the US as sustaining a below trend growth rate - noting his belief that the US economy would not withstand a withdrawal of stimulus (read promise of liqudity to come) right now. While not as ebulient as many on the street, the JPM CIO sees a US job market that is gradually getting better - as is spending. However, what keeps him up at night is the budget deficit (as we noted very specifically last night). Critically, jobless claims have just crossed a threshold that in the past has signaled risk-on is primed to pay-off as the business cycle becomes self-sustaining but at the same time, the budget deficit is at massively 'different-this-time' levels. As he notes: "But as Big Bird used to say, one of these things is not like the other: the US primary budget deficit which supports this recovery is a bigger now", and so the US economy had better improve markedly in order to merely 'pay-the-freight'. "I lose a lot of sleep over this, but I don’t know a lot of other people that do."

Fourteen months, one MF Global carcass and $1.6 billion in "vaporized" funds later, does the CFTC still regulate the futures markets by fax?

Minutes ago Apple announced that first thing tomorrow it will "host a conference call to announce the outcome of the Company’s discussions concerning its cash balance. Apple® will not be providing an update on the current quarter nor will any topics be discussed other than cash." As a reminder, Apple has just about 100 billion in cash. Everyone expects a dividend. So what happens when everyone finally gets what they have been expecting for so long? Will it mean the end of the growth phase and the advent of the "MSFT" anti-growth curve? Also, which bank will claim the commission for advising Apple on how to spend a cash amount that while nearly a third of Greek GDP, is less than half of the US February budget deficit (in other words, Apple could fund just 12 days of the US spending burn rate in February)? Finally, was the pre-election administration at all involved in the making of this decision - remember the company was expected to announce a cash-related decision a month ago, and nothing happened. Why now? All shall be revealed tomorrow at 9 am.