Global Market Commentary From Russ Certo

From Gleacher's Russ Certo

Good morning.  Markets last week were dominated by developments with rogue leaders Chavez and Gadhafi. Loyalist forces firing on protesters in Tripoli sent crude up 6.5 dollars on the week to $104 a barrel and gold to $1443 an ounce.  Gasoline prices set a February record, averaging $3.21 a gallon.  10 year note yields backed up 8 basis points and surprisingly a cadre of Asian equity bourses rallied near 4%, Europe was mixed and feeble gains were made on the week in U.S.

With the exception of a swift short covering rally ahead of any prospective weekend geopolitical developments on Friday, global interest rates were ebbing higher on commodity price and general inflation themes.  Further, rates reacted to ECB president Trichet suggesting that interest rate increases at its next meeting were possible. 

Equally weighing on rates was what Chairman Ben Bernanke DIDN’T say.  He generally seemed in contempt of higher commodity prices and stayed the party line on finishing the full $600 billion in monetary stimulus called QE2.  Actually, the Chairman is beginning to stray from the party as other members Federal Reserve policy makers are signaling they favor an abrupt end to $600 billion in Treasury purchases in June, jettisoning their prior strategy of gradually pulling back on intervention in bond markets.  “I don’t see a lot of gain to reverting to a tapering approach,” Atlanta Fed President Dennis Lockhart told reporters on Thursday.  Philadelphia Fed President Charles Plosser echoed similar sentiments. 

With regards to U.S. monetary policy we live in a world of opposites.  Less is more and more is less.  The long end of the Treasury market would like to see “Biofuel” Ben, nickname for his liquidity provisioning impacts on commodity markets worldwide, actually be a protector of price to ensure that the paltry and rudimentary semi-annual fixed income coupon payments that one receives for 30 years can purchase the same amount of cotton, sugar, gold, wheat, corn, or S&Ps without being diluted. 

What Ben didn’t say sent the U.S. dollar index near record lows, something inconceivable given the traditional safe haven status of the reserve currency during times of global uncertainty like oil shocks and new world order.  The Euro, of all things, seemed to be the beneficiary of flows, breaching a new recent high of $1.40.  They have a banker that may at least be contemplating tighter policy.  And that is why the long Treasuries couldn’t maintain a bid for most of the week. 

Less vigilance by the Chairman is more inflation and less of that insurance policy for those fixed cash flows.   In a climate such as this where the Chairman doesn’t appear to be steadfast in following his mandate of promoting stable prices,  the bond vigilantes and Treasury dealers are likely to make sure they get compensated for the risk of underwriting  record supply of Treasury issuance like this week’s refunding.  Kindly note there is an important article in this morning’s WSJ discussing Bernanke, the next FOMC and metrics required for the Fed to begin tightening.

Committing precious capital in the underwriting process where the head of the central bank is aspiring to create inflation can be onerous.  This is precious capital indeed given regulators demands on speculative activities like buying hundreds of billions of securities of an entity that is trashing its balance sheet and is deliberately being depreciated by the Chairman of the central bank.    An aside from watching the auction process this week is March 15th,,  a date to watch closely as the FOMC meets and it will have to make plans for the near conclusion of the Fed’s QE2 purchases.  What’s next?

Interestingly, the TIC flows illustrate recently less of a desire for many overseas players to own such Federal debt.  Even with increased reserves a stable percentage dedicated to the asset class is LESS on a relative basis versus monies being allocated to more effective storehouses like HARD asset commodities or perpetual assets like equities, which may even benefit from a little inflation. 

Mind you, the Treasury only has 20 primary dealer players at the roulette table and most of them are FOREIGN  banks.  Not sure if this years deferred bonus and compensation season may act as a distraction as traders have one eye on the corner office to see if they are also being compensated to step up to the plate and aggressively participate in this auction process activity.  Is the risk worth the possible deferred reward?

How did the U.S. Treasury become so vulnerable and dependant to the aorta of a small bevy of lifeline dealers, most of which are foreign and all of which are being berated for taking risk in this regulatory regime?  Just maybe they will aspire to be adequately compensated in their onerous role as a partner to the Treasury and Chairman by requiring a few more basis points concession this week.

I have a prescription for this underwriting game and a way to franchise this Treasury product.  The Fed should hike the discount rate 75 basis points.  This would be symbolic in a sense but maybe long rates would appreciate some austerity at the helm.  Just maybe this would have a neutral impact with mortgage rates driving housing formation.  Long intermediate rates COULD benefit.  Recall, more is less and less is more.  Higher front end rates could even trigger a consumption boom.  I sequester the analytic and strategy community along with the press corps to determine how much of consumer discretionary spending is tied up in low yielding ZIRP policy bank Cds and other money market genre?

Let’s do a quick study of demographics to see how many retirees are living on a fixed income and what marginally higher rates in passbook saving accounts would do to discretionary spending.  This very large demographic IS living or trying to live on a paltry fixed income at the moment and any increase in income will likely trigger greater consumption because, well, grandma needs gas, food, and cotton sweater.  That’s the ticket, higher short rates to illicit an income feedback cycle so people have more discretionary income to consume INSTEAD OF BORROWING. 

All the anecdotes are pointing to how to deal with this low interest rate ZIRP challenge.  Weekend WSJ ran a piece on where to put your cash now given bank savings accounts average money market rate of 63 bps.  Banks are making longer-term CDs more attractive, crossing 3% mark!!!!!  Oh goody.  Not sure that will help me pay for the 10% gain in cotton this week.  Investors are pouring cash into floaters.  Let’s hike those rates.  

Maybe the prescription of a token rate hike would be consistent with the fact that U.S. retailers and auto makers posted higher-than-expected gains if February sales.  And that consumer confidence rose to a three year high this week.  Unemployment claims pointed to stronger demand for workers and the Fed’s Beige book showed the labor market improved recently.  And with payrolls showing jobs. 

In Friday’s payroll report, job gains appeared in nearly every industry.  Among the biggest were manufacturing, construction and business services.  But not so fast, the U.S. still has 13.7 million officially unemployed Americans, with 2.7 million more who stopped looking for work, which is the only reason the unemployment rate ticked lower on Friday, the labor force participation rate of people stopping to look for jobs. 

Nearly half of all workers without jobs have been out of work for at least six months.  This labor force participation rate above and why the unemployment rate has been falling  is because over the past year the number of working-age Americans not in the labor force dropped by two million people.  For reference, the U.S. economy need to maintain a pace of 190,000 net new jobs for at least the next 12 months merely to get the jobless rate back to 8%.  But we’ll take the recovery in the right direction for now. 

Housing?  State attorneys general have presented the nation’s five biggest banks with a list of demands that could drastically alter the foreclosure process and give the government sweeping authority over how mortgage servicers deal with millions of homeowners in danger of losing their homes.  This represents a “significant expansion of powers for the newly created Consumer Financial Protection Bureau” which is overseen by Elizabeth Warren, according to the NYT.  This package of proposals is backed by attorneys general, the consumer bureau, HUD, Treasury, Dept. of Justice and the FTC. 

The proposal spells out more detailed modification timelines such as banks having to acknowledge receipt of modification applications within 10 business days and other notifications and verifications.  The new plan would allow for any borrower who successfully made three payments in a trial modification to be given a permanent modification.  This current proposal, outlining a code of conduct, is designed to lay a foundation for more permanent changes in mortgage servicing practices that would outlast a separate call for banks to write down more than $20 billion in loan balances.

Of course, the current program, HAMP (Home Affordable Modification Program) was launched by the administration in 2009 and House Republicans are considering a bill this week to end the program.  This week’s new measure is an attempt at doubling up efforts.  HAMP is/was a largely voluntary program that was ushered in with great fanfare as a solution geared to abate housing foreclosures for over supposed 4 million homeowners.  The program has achieved less than 10% of its stated goal and “falls dramatically short of any meaningful standard of success” according to Neil Barofsky, the Special Inspector General for the Troubled Asset Relief Program (TARP).

In fact, HAMP has bottlenecked the entire modification and foreclosure process and the stakeholder interaction subsequent to this failed hallmark bill between government and mortgage players was likely was the catalyst to the robo-signing scandal.  One measure of HAMPs success, for example, is that on average loans that went through foreclosure in January had been delinquent for 507 days, up from 319 days two years ago according to Lender Processing Services.   HAMP perfectly illustrates the inefficient allocation of taxpayer funded government resources and why one should read the fine print in the new proposal.  I also recommend a must read from the WSJ, “Housing Market Masochism” which has a view.

It’s not just the WSJ that is skeptical.  The NYT carries some blistering interpretations as well.  They quoted Scott Garrett, an influential member of the House Financial Services Committee as saying, “I have deep concerns that an unconfirmed political appointee is making calls that affect the safety and soundness of our financial institutions.  This is another attempt by the administration to circumvent the rule of law and unilaterally implement its failed housing agenda at the expense of responsible homeowners.”  Ouch.

Also, there is a bastardization of the electronic mortgage registration system in the Sunday Times business section.  If you want to know any details about the controversial system MERS, read the exhausting piece in the link.  The upshot is that foreclosure process will continue to be complicated as the MERS system is being challenged in state and local courts as not being a valid owner of title.  Highlights the limitations and is a thorough piece.

I’m skeptical (not cynical) in light of a massive study of duplication this week from the nonpartisan Government Accountability Office which found that the Federal Government has 15 agencies overseeing food-safety laws, more than 20 separate program to help the homeless, 80 for economic development, and 47 for job training and development.  And this isn’t Wisconsin.

“It’s Time to Face Fiscal Illusion in NYT captures the fiscal debate which is educating Main Street regarding entitlement outlays and a call for austerity and how the President could frame the discussion before too late.  

In the debate over “draconian” budget cuts, Barron’s runs a nice piece on where the term “draconian” actually came from.  Draco, the Athenian politician of the 7th century B.C. changed Athenian law and “his laws created a better civil order in a place that was operating along the lines of modern Afghanistan or Somalia”.  How draconian is last week’s Federal budget, 27 centuries after Draco?  “In Search of a Modern Draco”.  Draconian budget cuts are what the nation needs.

Separately, Fed’s Hoenig this week chimed in on “Too big to fail” debate along with his conclusions of the implications of Dodd-Frank.  In the link, he suggests that advantages of large banks are GROWING since Dodd-Frank and there is an empirical study of bank funding advantages of 81 bps from banks with more than $100 billion in assets over those in the $10 billion to $100 billion range.  Importantly and in the spirit of inept policy community above, “the final decision on solvency is not market driven but rests with different regulatory agencies and finally with the Secretary of the Treasury, which will bring political considerations into what should be a final determination.”  Another must read article on tectonic shifts of government in markets and the implications.  Just to keep score and to elevate increasingly divisive opinions about regulatory structure and policy machinations within the Fed, Treasury and Executive office.



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