Key Events In The Week Ahead

When even Goldman says the rally is based on male cow feces, Houston, we have a very big problem: "To some extent it is remarkable that markets continued to rally last week and that Eurozone-related risk premia declined, because at the surface, there has been very little concrete progress regarding the Eurozone fiscal crisis. The extent of Greek haircuts, the details of bank recapitalisations, the use of leverage in the EFSF or not – all these and many other issues remain basically unresolved at the moment. Only one thing is clear, policymakers continue to work overtime while trying to find solutions."

ECB Tells Belgium Not To Backstop Dexia Interbank Deposits, Says Bailout Plan May Be Against The Euro Charter

If anyone is surprised that things in Europe will get massively surreal before this is all over, we suggest finding another thread. In the meantime, for the latest example of the utter chaos and "make it up as we go along" we go to the ECB which has just, in very polite terms, warned Belgium that its bailout-cum-nationalization plan may not be quite feasible. From Bloomberg: "The European Central Bank advised Belgium not to backstop Dexia SA’s interbank deposits and to avoid providing guarantees on debt maturing within three months because it risks interfering with the central bank’s monetary policy." Reading between the lines here, it means that the ECB is effectively telling national governments to not try and become their own central banks under the ECB's umbrella, which would likely result in not only in various sovereign downgrades (that is guaranteed) but in loss of conviction in the European Central Bank, something which the insolvent European continent and the insolvent hedge fund in its core, aka Jean-Claude Trichet Capital et Cie. which holds hundreds of billions of Greek bonds at par, can certainly not avoid. It gets better: "The ECB also said the planned debt guarantees for Dexia may last as long as 20 years, which is inconsistent with European Union guidelines for national support measures to be temporary in nature, according to a statement published on the Frankfurt- based central bank’s website and dated Oct. 13. Belgium sought the ECB’s opinion on draft legislation that would grant state guarantees on Dexia loans." Oops: the ECB may have just scuttled the currently envisioned Dexia bailout plan. Oh well, just like with the Greek 50% bond haircut, so here to it is now back to the drawing board.

Daily US Opening News And Market Re-Cap: October 14

  • S&P downgraded the long-term sovereign rating of Spain by one notch to AA- from AA with a negative outlook
  • Fitch placed five major European commercial banks – namely, Barclays, BNP Paribas, Credit Suisse, Deutsche Bank and Societe Generale - on credit watch negative
  • Strong corporate earnings from Google boosted appetite for risk during the European session
  • The French/German 10-year government bond yield spread widened to a record level on concerns surrounding the impact of an EFSF leveraging on the French sovereign ratings
  • Market participants keep a close eye on the outcome of the confidence vote in the Italian Parliament. In latest news, according to ANSA, Berlusconi has enough votes to win the confidence vote

Guest Post: Big Trouble Brewing

I do not toss around the idea of a market crash lightly. If you've been following me long enough, you know that only in very rare instances do I issue a cautionary Alert (I've only issued four since my website launched in 2008), and I am generally not given to hyperbole. Let's be clear: I'm not issuing an Alert at this time. But I am concerned that a materially adverse disruption to the financial markets is increasingly likely in the near future. Perhaps a definition will be helpful as we begin. A 'market crash' is an event where there are no bids to meet a wall of selling. The actual amount of the percentage decline is less important to note than the amount of chaos, or loss of control, that a given market experiences. Some like to say that a market downdraft requires a decline of 10%, or maybe even 15% or 20% (or more), in order to qualify as a 'crash.' For me, the key factor is not so much the amount of the decline, but the pace of the decline. With perhaps a quadrillion US dollars of hyper-interconnected derivatives outstanding -- that's the notional value, but who really knows what the real number is? -- an orderly market is essential for knowing whether or not the counterparty to one's trade is solvent. During periods of intense price swings in the market, such things are simply not knowable, and spawn the fear and paralysis that really define a market crash.

Geopolitical Risk in Middle East and China Currency and Trade War Risk Supporting Gold

Support is at $1,600/oz, $1,580/oz and below that strong support is seen at the lows reached on September 26th of $1,532.70/oz. Market participants are divided as to whether this is consolidation prior to a resumption of the bull market, whether a further sell off takes place or whether a bear market has commenced. Strong physical demand being seen internationally, but especially in Asia, would suggest that gold may have bottomed and the bull market is set to continue in the traditionally strong autumn and winter months. The fundamental factors that have driven the gold market in recent years - macroeconomic, monetary, systemic and geopolitical risk – also suggest gold’s bull market is set to continue. Geopolitical risk is seen in the bizarre alleged plot by the Iranian revolutionary guard to use a purported Mexican drug dealer to assassinate Saudi Arabia's ambassador to the United States.

Daily US Opening News And Market Re-Cap: October 11

  • Market participants keep a close eye on the outcome of the EFSF ratification by the Slovak parliament. In the latest news, Slovak lawmakers have adjourned the EFSF session until 2pm local time
  • The Troika Commission said Greece will miss its 2011 target, however it will get the new aid tranche when the Eurogroup and IMF approve results of their review, most likely in early November
  • According to sources, haircuts of 40%-60% on Greek bonds are under consideration, however the debate is over whether the haircut should involve the ECB and EU governments
  • ECB's Nowotny and Trichet said that the EFSF will not be leveraged with ECB funds
  • Strength in the USD-Index weighed upon EUR/USD, GBP/USD and commodity-linked currencies

Frontrunning: October 11

  • New bankruptcy ripples may emerge in tough economy (Reuters)
  • Europe’s banks may get €200bn bailout (Independent)
  • US to unveil criteria for picking “systemic” firms (Reuters)
  • China Props Up Bank Shares (WSJ) as reported yesterday
  • Europe warned of systemic crisis over debt (Reuters)
  • US Voters Will Weigh Ballots Focused on Budgets, Higher Taxes (Bloomberg)
  • Regulators stand up for new capital rules (FT)
  • Jobs Panel Pushes Help for Start-Ups (WSJ)
  • Dutch favour tough stance for Eurozone (FT)
  • BIS Report Aims to Debunk Banks’ Criticisms on Capital Rules (WSJ)

Frontrunning: October 10

  • Belgium to Buy Dexia’s Consumer Unit for $5.4B (Bloomberg)
  • New $1.4 Trillion U.S. Stimulus Is in Sight: Douglas Holtz-Eakin (Bloomberg)
  • Banks to be forced to boost liquid assets (FT)
  • Trichet Reminds U.S. Euro Built to Last (Bloomberg)
  • White House Aims to Lure More Foreign Investment (WSJ)
  • Fannie and Freddie debt fuels anxiety (FT)
  • Merkel and Sarkozy set euro deadline (FT)
  • ‘Time short’ for eurozone, says Cameron (FT)
  • Former PBOC Adviser: China To Continue Tight Monetary Policy (WSJ)

Market Developments This Week Very Gold Bullish; Bears Focus on Price, Not Value

The continuation of ultra loose monetary policies and new rounds of QE is supportive of gold in all currencies. Negative real interest rates mean that there continues to be no ‘opportunity cost’ to own gold which is a key driver of gold’s bull market. In time, quantitative easing will be seen for what it is - bailing out banks and financial institutions and a form of currency debasement. Developments in gold and wider markets this week are bullish. There are continuing signs of very significant demand in the Middle East, India, Vietnam and China. There are reputable reports of shortages of gold bars in Hong Kong, Singapore and Vietnam, of shortages of silver bars in India and delays in delivery and rationing of silver coins internationally. The CME decision to increase the amount of gold accepted as collateral and the LCH. Clearnet decision to allow gold bullion to be used as collateral shows the financial system is increasingly seeing gold as an asset on a par with cash and bonds.

Market Snapshot: Did Credit Just Capitulate?

Another day, another 12 swings of greater than 0.75% in S&P futures as volume slid to the lowest in a week and second lowest in two weeks. Credit and equity markets stayed largely in sync (as they have for the last few days - with slight beta-adjusted underperformance of credit) until around lunchtime and then a funny thing happened to investment grade credit. At around 12:30ET, the most liquid credit index, IG17, gapped tighter as ES and HY reversed briefly off the highs and then IG did not stop - compressing 3-4bps more into the close - notably outperforming HY and ES (its far higher beta cousins). At the same time, the less liquid but hugely levered (and exposed to correlation traders, tail-, and jump-risks), IG9, cracked very notably tighter (from our runs around 15bps) to 147bps. IG9 had held up as markets rallied but this move's magnitude and velocity suggest more than just some hedge adjustments and while the rest of the risk assets we cover were all levitating, this 'capitulation' stands out among them. Dollar weakness of course helped fuel the equity strength and commodities and PMs pushed on all day with gold the most subdued.

Market Snapshot: Reaction To Trichet - We Are Not Impressed

Out of the gate, credit and equity markets seemed happy that Trichet was offering CBPP2 and a Euro-TLGP II program in Oct/Dec but that quickly subsided (what no rate cut?) as rather surprisingly the market realized for itself - with little cajoling from us - that while short-term roll risk was reduced, capital still remains a 'problem' as the seemingly known (haircuts/exposures) unknowns and we assume unknown unknowns (contagion impact) remain tangible and this does nothing solve the underlying problem of insolvency. We were pleasantly taken aback by this reaction (and not in a Schadenfreude manner) but more simply that the market is 'getting it' - kicking the can by extending more and more credit (as Peter Tchir alluded to earlier) simply has its limits - and perhaps we are there.

Summarizing The ECB's Press Conference Disclosures

Update: "a word out of line" - Trichet says not appropriate to leverage the EFSF... Not what the market wanted to hear.

On one hand, the ECB keeps Germany happy with no rate cut, on the other, he promises as much liquidity as possible (but probably not enough - see below) and paints a very bleak picture of the economy in the period ahead.  Bottom line: no recapitalization from the ECB, but the central bank will make rolling of existing debt as easy as possible, and allow insolvent European banks to pledge any assets they have for cool cash.