September 2009 - Posts
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Yesterday’s session was full of noise. On the surface, we had the
backward-looking macro data releases: MBA weekly Mortgage Applications
at -2.8% vs. 12.8% (neutral in my view), the ADP Employment change at
-254,000 vs. -200,000 consensus (positive), GDP QoQ annualized at -0.7%
vs. -1.2% consensus (positive), personal consumption at -0.9% vs. -1%
consensus (positive), Chicago Purchasing Manager at 46.1 vs. 52
consensus (negative). Thus, early in the session, we were in
risk-taking mood. On top of this, the Department of Energy’s weekly
release of inventory data showed that gasoline inventories had fallen
by 1.66 million barrels, while the market was expecting an increase of
about a million. Oil, on the news, hit $70+/bl, from $66+ at open. Yet,
none of this was enough to get us to close higher in equities. Why?
While we have the positive data on the surface, deep underneath, we
have the uncertainty over interest rates beginning 2010. Early in 2010,
quantitative easing policies will be ending in the countries that
implemented them and it will be up to the fiscal policies to take the
lead.
As we have endlessly discussed here, the unique feature of this
financial crisis of 2008 is the coordination in monetary policies.
Monetary policy is easy to coordinate. There is only one head of a
central bank in each country and all of them can meet at Jackson Hole,
or Bretton Woods to plot against the value of our monetary assets. They
can carry out balance sheet transfers overnight, they can surprise us
with untimely comments, they can side with bankers to keep rates
inordinately low, etc. Coordinating fiscal policies is however a
different issue. It is simply impossible to coordinate them.
In the past two weeks, we have seen an explosion of research
debating the future exit strategies. I have my personal opinion.
However, it is an evolving creature and for the sake of clarity, I
prefer to defer its exposition until further developments prove me
right or wrong. In the meantime, we are going to witness volatility in
the forex markets, on benchmark curves (today we saw an important
steepening move in Treasuries), in swaps and agency debt while gold
should quietly strengthen. It is also true, we may attribute some of
these changes to the fact that we are trading at month and quarter end.
Below, I show the last seven trading sessions in the gold market
(source: Bloomberg). You can see how gold sold off last Thursday, on
the news that Robert Mundell urged politicians to implement the
convertibility of the Euro vs. the USD. We commented the implications
of this proposition two days ago (ref. “A Thought on a convertible Euro” www.sibileau.com/martin/2009/09/29 )
and concluded that such convertibility is not feasible on political
grounds and that the late sell-off in gold should be seen as an
opportunity. Gold is 1.8% up since then. Was it a mere coincidence?
The comments expressed in this
website and daily letters are my own personal opinions only and do not
necessarily reflect the positions or opinions of my employer or its
affiliates. All comments are based upon my current knowledge and my own
personal experiences. You should conduct independent research to verify
the validity of any statements made in this website before basing any
decisions upon those statements. In addition, any views or opinions
expressed by visitors to this website are theirs and do not necessarily
reflect mine. My comments provide general information only. Neither the
information nor any opinion expressed constitutes a solicitation, an
offer or an invitation to make an offer, to buy or sell any securities
or other financial instrument or any derivative related to such
securities or instruments (e.g., options, futures, warrants, and
contracts for differences). My comments are not intended to provide
personal investment advice and they do not take into account the
specific investment objectives, financial situation and the particular
needs of any specific person.
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Below, I show two charts (source: Bloomberg). On the left, we can
see the 3-mo Libor – Overnight Index Swap spread. As we repeated
countless times, in the past, we were confident that the rally in
stocks and credit was going to continue as long as we saw this spread
compress. We followed it from its 83+bps level at the end of April to
its 2009 low of 10.29bps, reached on September 18th. Since then, the
trend has been unequivocally from the lower left to the upper right. On
the 22nd, we turned neutral on equities. To the right, we can see the
change in the US yield curve, from Sep 21 to date. It is visibly
flatter.
Are we witnessing a retreat, a flight-to-safety? The USD index
(DXY), which indicates the general international value of the USD has
risen from 76.42 to 77.08. It is not much, but it is a signal and since
September 18th, the DXY seems to be very correlated with the 3-mo Libor
– OIS spread. I do not want to make straightforward conclusions out of
the 3-mo Libor – OIS spread, because there are excessively many parts
moving around in the rates space lately, which diminish the predictive
power of the trend. One of them, for instance, is the speculation (ref.
Bank of America’s Global Rate Focus report, Sep 25/09) that in 2010, as
part of its exit strategy, the Fed will need to take on $500BN in
reverse repo transactions. This volume is too high, when compared with
the average $219BN in Treasuries, Agency and MBS, which suggests a huge
crowding out effect on Commercial Paper, out of which Libor is based.
Thus, depending on how near and how violently the market forecasts the
reversal move take place, the recent trend highlighted in the charts
above may or may not continue. The impact on the equities and forex
markets is noticeable. The impact on credit, not so much.
Corporate credit seems to be enjoying the benefit of some sort of
inertia. The flow of cash out money funds and into credit has not
stopped, as investors keep crowding the boat in search of whatever
yield is left to take. I do not blame them. After all, that was the
purpose of the quantitative easing policies. The hope that this flow of
capital will trigger a wave of investments is perhaps a long way from
materializing. However, the flow is the necessary condition. It is not
a sufficient, but a necessary condition.
In conclusion, the trend in the 3-mo Libor – OIS spread, Treasuries,
the value of the USD and, last but not least, the political changes
taking place in Europe and the Middle East continue to make me
comfortable with my position on the sidelines. If the aforementioned
trends show continued strength, I will have no choice but to turn
bearish…
Lastly, the Fed bought yesterday $3.BN in Treasuries (May/12- Nov/13
maturity range), leaving only $7BN to complete its $300BN purchase
plan. It seems it was yesterday when I first wrote that I was convinced
the Fed would upsize this program. Was it successful though?
The comments expressed in this
website and daily letters are my own personal opinions only and do not
necessarily reflect the positions or opinions of my employer or its
affiliates. All comments are based upon my current knowledge and my own
personal experiences. You should conduct independent research to verify
the validity of any statements made in this website before basing any
decisions upon those statements. In addition, any views or opinions
expressed by visitors to this website are theirs and do not necessarily
reflect mine. My comments provide general information only. Neither the
information nor any opinion expressed constitutes a solicitation, an
offer or an invitation to make an offer, to buy or sell any securities
or other financial instrument or any derivative related to such
securities or instruments (e.g., options, futures, warrants, and
contracts for differences). My comments are not intended to provide
personal investment advice and they do not take into account the
specific investment objectives, financial situation and the particular
needs of any specific person.
A rare congruence of factors has taken place in the last 24 hours,
allowing Treasuries to gain (flatter yield curve) the USD to weaken,
and US stocks to gain a bit of what was lost last week. As I mentioned
yesterday, there is a lot happening these days, a lot of moving parts
at a very fast pace, which is shifting the tectonic plates rather
swiftly.
To begin with, I have to side with the notion that the waves
touching North America yesterday were generated out of Japan and
Germany (i.e. Menkel’s victory) during the weekend, and augmented by
the winds of the European Central Bank on Monday.
It’s true, the announcement of Xerox Corp. reaching an agreement to
buy Affiliated Computer Services for $6.4BN and Abbott Laboratories’
plan to purchase Solvay SA did also add to the winds. From Japan, we
seem to have had a short-cover move in the JPY/USD carry trade. I like
this explanation. It makes sense in my view. It was suggested yesterday
by UBS’ Rates Team.
The short-covering is a bullish trade on the Yen, positively
affecting Treasuries. It might look like a flight-to-safety trade, but
the fact that both Europe’s and North American indexes finished higher
rejects this thesis. We should get confirmation of this if we see the
yesterday’s rally extending to Asia in overnight trading.
Yesterday too, M. Trichet went public with Euro-bearish comments, in
support of the USD. Among those, he said that “now is not the time to
exit”, that “rates are appropriate” but above all, that “ a strong
dollar is extremely important”. One has the sense that there is a lot
of propaganda going on lately, as Bank of Canada’s Governor Carney also
addressed the public (in Ottawa) to show once more his unease with a
strong Canadian dollar.
These comments bring uncertainty and over the weekend, I could read
a few different theories on the potential next moves in interest rates.
This brings me to my point today. Yesterday, I briefly mentioned that
Robert Mundell had suggested before a crowd in Hong Kong that the
USD/EUR exchange rate should be fixed (http://www.bloomberg.com/apps/news?pid=20601083&sid=aczBO8TH0OpA).
The move towards a convertible Euro would certainly evaporate the
uncertainty we suffer these days. As soon as these comments hit the
news, gold sold off last Thursday. I show the chart for the price of
gold (in USD/oz, source: Bloomberg) for the last five trading sessions.
Can we say that Mr. Mundell’s comments triggered the big move to the
downside on Thursday? I am never too sure but the timing is perfect.
The sell off started between 8:48 and 8:57am, exactly coincident with
the release of Mr. Mundell’s comments, at 8:53am. You decide. But the
sell off would be consistent with a thesis held at “A View from the
Trenches”, first proposed on April 21st: “…when there is global
coordination of inflationary monetary policies, gold cannot be a safe
and lucrative asset. When inflationary monetary policies are not
globally coordinated, gold is a safe and lucrative asset…” (www.sibileau.com/martin/2009/04/21 )
There is a lot to opine on this suggestion. But I can remember my
days at the Universidad de Buenos Aires, when students and professors
endlessly debated the wisdom of the USD/Argentine Peso convertibility.
The main lesson was that under convertibility, central banks forfeit
the right to act as lenders of last resort. This is the reason behind
the Austrian School of Economics’ support of the gold standard. If
central banks cannot provide liquidity in a crisis, the banking system
will be conservative, because Banks will be on their own.
Thus, what is the conclusion one can make here? Would the Fed and
the ECB give up their powers in the name of stability? It seems too far
fetched to me. If these banks wanted to keep their powers, they would
need a supra-national bank to back them. Can you imagine the IMF
playing out this role? I can’t.
What is one to make out of this? If the idea is good but doesn’t
seem feasible, the late sell off in gold should be seen as an
opportunity…
The comments expressed in this
website and daily letters are my own personal opinions only and do not
necessarily reflect the positions or opinions of my employer or its
affiliates. All comments are based upon my current knowledge and my own
personal experiences. You should conduct independent research to verify
the validity of any statements made in this website before basing any
decisions upon those statements. In addition, any views or opinions
expressed by visitors to this website are theirs and do not necessarily
reflect mine. My comments provide general information only. Neither the
information nor any opinion expressed constitutes a solicitation, an
offer or an invitation to make an offer, to buy or sell any securities
or other financial instrument or any derivative related to such
securities or instruments (e.g., options, futures, warrants, and
contracts for differences). My comments are not intended to provide
personal investment advice and the
Please, click here to read this article in pdf format: www.sibileau.com
A week ago, we went on record with our neutral call on equities (see www.sibileau.com/martin/2009/09/22 ). The three points we made played out as anticipated: Lack of clarity on exit strategies, dispersion in (global) monetary answers and political instability increasing. By now, both the first and last points should be self-explanatory (see: www.sibileau.com/martin/2009/09/23 ). The second point, the dispersion in the monetary policy answers is the one that worries me the most. There will be an exit strategy and regardless of how difficult it may be to get clarity on it, eventually that clarity will come. There will be political instability, but it will only (for now at least) indirectly touch the markets. On Friday, for instance, the joint statement made by the US, UK and France at the G20 meeting on Iran lifted the price of crude from $65+ to $67 (statement released at 8:53am ET, the strength was sold with violence…). However, the dispersion in monetary policies is an open-ended question. We don’t know how many countries may decide to abandon the coordination ship. We ignore what they will do if they abandon it, and we have no knowledge of the time when all this will happen.
But the process has started. It started with the United Kingdom. Last year, one thought it would be triggered by Iceland, or the Baltic nations dragging Sweden along, or Poland dragging Austria or Latin America dragging Spain. Today is the United Kingdom, and it is not hypothetical. It is a fact. The housing and banking problems have been rather serious there and although the UK has so far been in my opinion the most proactive and ingenious country in this crisis, the fact is that its currency is undergoing a speculative run. Moreover, it can get worse, because the market has heard from the Bank of England’s Governor Marvin King himself that interest rates there are likely to stay low for longer than anticipated. The Pound Sterling is therefore on its own. Perhaps that is a good thing, as it will prevent the growth of further imbalances. Ultimately, the answer relies on the side of fiscal policy. The situation with the Pound Sterling worries me not because the currency has depreciated against other currencies, but against gold, along a clear definite path. If gold becomes a visible refuge, the technical damage will have been done and the temptation to run against other currencies will grow exponentially.
In the late ‘20s, the situation with the UK was very similar. I dug into a few documents I had and found an interview The Economist held with Jacques Rueff (http://en.wikipedia.org/wiki/Jacques_Rueff ). It was published on June 1965, and entitled “The Role and the Rule of Gold.” The entire interview was reprinted in Jacques Rueff’s book “The Monetary Sin of the West”, MacMillan Co., New York, 1971, Part III. Its online version can be found at (www.mises.org/books/monetarysin.pdf ). I show below, a critical part of that interview, which I find contemporaneous:
The Economist: One of the countries that saw the biggest constriction imposed by the gold standard was, of course, Britain—which held no foreign exchange in its reserves. And, as we have always recognized, Britain at this time suffered precisely because of the harsh and inflexible disciplines of the gold standard, which you now want to restore
Jacques Rueff: Let me tell you that you touch a point on which I have quite a few personal recollections. In 1930, I was financial attaché in the French Embassy in London, and in that capacity, I was responsible for the deposits of the French Treasury with British banks. They were the direct result of eight years of the gold-exchange standard, because we had kept the pounds sterling in London, as my colleagues in New York had kept in the American market the dollars that had been pouring into the French Treasury from 1927 onward. Then, in 1931, the failure of the Austrian Creditanstalt caused successive waves of repatriations; and it was this collapse of the gold-exchange standard that, without any possible doubt, transformed the depression of 1929 into the Great Depression of 1931.
The Economist: While you are on this historical episode, what would your comments be on the very widespread view that it was to a substantial extent French pressure on London at that time, through the withdrawal of sterling balances that was in part responsible for the general collapse later on?
J.R. Let me tell you that, unhappily for the world, the French pressure did not exist, or was so mild that it had no effect. There is a very interesting document from this period, a letter from Sir Austen Chamberlain, who was then Foreign Secretary in London, to M. Poincaré, who was Prime Minister and Finance Minister in France; it must be of 1928. Sir Austen said, “We know that you are entitled to ask gold for your sterling, but in the frame of the close friendship between Britain and France we ask you, so as to avoid trouble for the City of London, not to do that.” And we were, I must say, weak enough to comply with this request and not ask for gold. The fact that I had such important sterling deposits in London shows that we did not use this right to ask for gold. The adjustment, which would hardly have been felt if carried out on a day-to-day basis, was not made, and we had the fantastic boom of 1927, 1928, and 1929. This explains the depth of the collapse and of the depression, because the adjustment was so long delayed.
The comments expressed in this website and daily letters are my own personal opinions only and do not necessarily reflect the positions or opinions of my employer or its affiliates. All comments are based upon my current knowledge and my own personal experiences. You should conduct independent research to verify the validity of any statements made in this website before basing any decisions upon those statements. In addition, any views or opinions expressed by visitors to this website are theirs and do not necessarily reflect mine. My comments provide general information only. Neither the information nor any opinion expressed constitutes a solicitation, an offer or an invitation to make an offer, to buy or sell any securities or other financial instrument or any derivative related to such securities or instruments (e.g., options, futures, warrants, and contracts for differences). My comments are not intended to provide personal investment advice and they do not take into account the specific investment objectives, financial situation and the particular needs of any specific person.
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Yesterday we had the announcement of the FOMC decision. Nobody was
surprised, the target range for the federal funds rate was left where
it was, and the extension in (and slowing down of) the mortgage-backed
securities and agency-debt purchases to March 2010 had been expected.
However, the intraday volatility was still there.
At 10:30am, the Dept. of Energy released crude oil inventory data. The
consensus had been for a decrease of 1.4mm barrels. Instead,
inventories grew by 2.9mm. This immediately triggered a sell off in
crude and the typical flight-to-safety trade that appreciates the USD.
Oil thus lost 3+ dollars, as it fell from $71.65 to $68.35.
The healing process in credit continues, with issuances coming to
market in full fashion. Another positive sign yesterday was the weekly
MBA Mortgage Applications index: +12.8%, from previous -8.6%. The
refinancing wave keeps strong, but I still hold firm to my neutral
stance on equities. It is neither bearish nor bullish. I am just
neutral, with cash on the sidelines, waiting for things to crystallize
before I make my next move. As I wrote yesterday, the political action
generates a volatility that makes me uncomfortable.
To make my point more graphic, I am including this morning a chart
(see below left, source: Bloomberg) showing the reaction in the
Treasuries (white line) market to the Fed’s decision of letting things
the way they are. You would think continuity deserves indifference, but
that was not the case. In fact, the S&P500 plunged at close,
closing -1.01% at 1,060.87pts.
Naturally, I read the typical macro reports on what happened
yesterday. I was surprised to see a huge divergence of opinions.
Therefore, mine will contribute to the confusion. For instance,
according to some analysts, volatility decreased. In my view,
volatility ended higher, touching the swaps (see chart above, right,
showing the last 10 days for the 2-yr swap and compare to what happened
yesterday) and agency markets, as investors have to reinterpret the
outlook with very limited information. The outlook is also seen from
different angles. Some think that the fact that the programs are coming
to an end signal that we are better off. To me (yes, I know, I am
always a bit negative!), one can interpret the situation as follows:
The fact that the Bank of England last week insinuated the probability
of having lower bank deposits rates and yesterday the Fed announced the
extension of its agency-debt purchase program until March 31, 2010
means that:
1. - It’s true, liquidity triggered a recovery, otherwise central banks would have already stopped injecting liquidity,
2. The recovery is still not self-sustainable, otherwise we would
not be insinuating lower bank deposit rates or purchase program
extensions. Another proof of that is the lack of details on an exit
strategy. In fact, Bank of Canada Governor Mark Carney said last
Tuesday that “…That growth that we are seeing is largely the result of
policy: monetary policy, fiscal policy, the measures to stabilize the
financial system….We have a ways to go before we are really going to
see true growth, self- sustaining private sector growth.”. Thus, I rest
my case! (A confesion de parte, relevo de prueba!)
This fragility, this weakness, led in my view to profit taking in
the last hour yesterday. Now, to be fair, we should ask ourselves what
is it that we would like to see, to convince ourselves that the
recovery is in fact self sustainable. An exit strategy by central
banks? No, in fact, I believe that it will only come after there is
proof of such sustainability. What then? Capital expenditures! I will
believe in this recovery the day I start seeing issuances in the bond
markets not to refinance bank debt or other short-term debt, not to
finance equity purchases, but to fund plain, old-fashioned capital
expenditures.
The comments expressed in this
website and daily letters are my own personal opinions only and do not
necessarily reflect the positions or opinions of my employer or its
affiliates. All comments are based upon my current knowledge and my own
personal experiences. You should conduct independent research to verify
the validity of any statements made in this website before basing any
decisions upon those statements. In addition, any views or opinions
expressed by visitors to this website are theirs and do not necessarily
reflect mine. My comments provide general information only. Neither the
information nor any opinion expressed constitutes a solicitation, an
offer or an invitation to make an offer, to buy or sell any securities
or other financial instrument or any derivative related to such
securities or instruments (e.g., options, futures, warrants, and
contracts for differences). My comments are not intended to provide
personal investment advice and they do not take into account the
specific investment objectives, financial situation and the particular
needs of any specific person.
Please, click here to read this article in pdf format: www.sibileau.com
I want to start today’s comments reiterating my neutral call on
equities. This is on equities only, not on credit. Credit is undergoing
a different dynamics. Again, my call is different from that of the
bears out there. I do not have a bearish call. My call is based on my
uneasiness with the following issues:
1. - No clarity on exit strategies. As an update, Bloomberg reported
yesterday afternoon that the Fed has started talks with dealers on
using reverse repos. This program would increase the supply of
Treasuries, in conjunction with a rising federal fiscal deficit in the
US. Unless there demand picks up, interest rates will increase
(Treasuries sold off), with a huge crowding out effect on other asset
classes. There is also the logistical side of it, as the Fed could
bypass the dealers and transact with money funds directly. There will
be dislocations. On the other hand, if there is demand for the
increased supply of Treasuries, it will be at the expense of equities.
Therefore, the equity market faces a real challenge.
2. - Recent dispersion in monetary policy answers. We are in a
global world and it is not enough to see good actions carried out by
only some governments. The recent developments in the UK are flagging
some cracks in the front. While the world is discussing exit
strategies, last week the Bank of England’s Governor King said he was
considering lowering the interest rate banks earn on deposits. The GBP
sold off on the news and finished the week 3.2% lower vs. the Euro.
What is worse, the sterling lost big time against gold. As we said on
Monday, we don’t want to see gold become a reserve asset. But when it
does, it will not be instantaneously against all currencies. No, it
won’t. It will first start rising against a weak currency, and then it
will spread like a cancer to the rest of the global currencies. Right
now, we see the tumor in the GBP. Let’s hope it doesn’t spread.
3. – Political instability is increasing. One gets the sense that
the world is rapidly fracturing into right and left again. We did not
have that in 2008 and unity was critical to save us from a run against
the financial system. That unity is not there anymore. On top of this,
we face the developments in Iran. My feeling is that the world is
misreading the problem here. As much as the market does not believe in
inflation until it sees a jump in the CPI, I get the impression the
market does not see a conflict in the Strait of Hormuz, until it
happens. And when it happens, it will be too late.
Thus, please note that my call is not bearish based on fundamentals.
The sell-off of 2008 and the rally of 2009 were never about
fundamentals. It was, is and will be about liquidity. Liquidity has to
spread via asset acquisitions carried out by Central Banks. When the
asset mix changes, liquidity suffers, volatility increases, and I want
to sit on the sidelines. Politics determines the asset mix. Politicians
(I include central bankers under this category) arbitrarily decide what
and when they will buy Treasuries, mortgages, bank’s capital, etc.
Lastly, I thought I would include a chart of the S&P500 (source:
Bloomberg), since I started writing and measure it against my
recommendations. My initial call on Mar 19/09 was bullish (“A View from
the Trenches” was sent via email in those days) on the Treasury
Purchase Program announcement. On June 3rd, I turned neutral and
remained neutral until August 4th. The reasons behind can be reviewed
at: www.sibileau.com/martin/2009/06/03 and www.sibileau.com/martin/2009/08/04 .
As well, during this period, I wrote many times against those who
believed the end was near. Yesterday, I turned neutral again.
The comments expressed in this
website and daily letters are my own personal opinions only and do not
necessarily reflect the positions or opinions of my employer or its
affiliates. All comments are based upon my current knowledge and my own
personal experiences. You should conduct independent research to verify
the validity of any statements made in this website before basing any
decisions upon those statements. In addition, any views or opinions
expressed by visitors to this website are theirs and do not necessarily
reflect mine. My comments provide general information only. Neither the
information nor any opinion expressed constitutes a solicitation, an
offer or an invitation to make an offer, to buy or sell any securities
or other financial instrument or any derivative related to such
securities or instruments (e.g., options, futures, warrants, and
contracts for differences). My comments are not intended to provide
personal investment advice and they do not take into account the
specific investment objectives, financial situation and the particular
needs of any specific person.
Please, click here to read this article in pdf format: www.sibileau.com
The week started with the Japanese markets closed, and I have the
sense there is a bit of anxiousness out there. There are multiple
issues shaping the outlook on capital markets, which may be an
indication that it will be difficult for the equity market to keep
rallying from here. Thus, friends, for the record, on September 22nd 2009, “A View from the Trenches” turns neutral on equities.
Do I mean the S&P500 will fall? Do I mean that the S&P500 cannot keep rallying? Not necessarily. Let’s see…
I do not think that the S&P500 will
sell-off because the market will grow impatient on macro stats, or
lower-than-expected revenue or earnings or even increased probabilities
of default. No! I do not share the rationale of the bears. As we have
been writing lately, I believe Central Banks still have a lot of
firepower in their hands to stop a run for cover. My fear is that
precisely the same Central Banks may screw up with the unwinding of
their existing liquidity programs. In fact, no matter how softly they
unwind them, the impact on relative prices in the foreign exchange,
rates and credit markets will affect equities. On political grounds,
then, the S&P500 can sell off. This differentiates my scenario from that of the bearish voices on the street.
For the same reason, I do not think equities can keep rallying on
fundamentals alone. (For the sake of honesty, I note that some months
ago, I held the same view on the potential for equities to shoot
higher. I was wrong then, because the self-feeding mechanism of lower
spreads, more refinancings and lower jump-to-default risk was a
virtuous spiral that got us where we are now. I underestimated the
secondary effects of liquidity!) However, maybe I am right this time.
My view is that the equity market would need some policy measure that
would bring clarity, confidence to the picture. So far, I cannot think
of any.
Therefore, two main 2009 themes that we have extensively discussed here come to mind:
1. - We are in the middle of an inflationary process and inflation
never brings growth. As we wrote countless times, the stagnation is
caused by the uncertainty in relative prices. Inflation is non-neutral,
affecting certain prices first, and other prices later and in the end,
when everybody realizes it is there to stay, inflation is evident
through CPI readings. For those who still believe in the CPI mystique,
I offer this comparison: As much as you cannot claim that a baby is not
alive yet when you see a mother pregnant, you cannot claim inflation
has not arrived yet because consumer prices and wages have not
increased. Trillions of debt have been monetized, lifting the equity,
credit and fixed income markets. The pregnancy started months ago and
we are going to have that baby! In the meantime, the changes in
relative prices and outlooks are still significant.
2. - All shocks have been exogenous so far, driven by politics. Therefore, we must pay attention to all things political.
The details on an exit strategy from Central Banks are still unclear.
Yes, it’s almost October and nobody really knows what the next steps
are going to be. However, while equities stagnate (hence we are
neutral), in the interest rates and credit markets, the situation is
different. Speculation is rampant on the impact of the run-off of the
Supplementary Financing Program, the end of the Mortgage Purchase
Program (expected to be extended) and the Treasuries Purchase Program
on curves, liquidity, and spreads. Perhaps the liquidity aspect of
these changes is the most critical. I will not describe it here,
because it is all rumors so far, but promise to elaborate on it once we
have more details. In the meantime, the bottom line is that liquidity
will be negatively affected and some kind of panic may arise, which
will (if it is not already doing so) negatively touch equities and
commodities, strengthening the USD.
In Credit we had the launch of Series 13 yesterday, in the CDX North
American indices. I will have more to say about the macroeconomic
implications of the current levels (CDX IG13 closed at 91/92, IG12 at
98.75/99.75) and above all, curves in the credit space. But we can
safely say that increasing fiscal deficits worldwide and a steep credit
curve with 50%+ of issuances maturing within a couple of years is close
to what Paul Krugman warned us about: The postponement of the end of
the world.
Yesterday, we wrote about the recent USD denominated sovereign
issuances in developed markets. We did further research and came across
a September 18th note on the subject by Bank of America’s Rates team.
It appears that approximately $13.6BN has been issued by European
governments in September alone. I asked an informed analyst whether
these issuances have actually been hedged against currency risk, but I
was not given a clear answer back. However, my understanding is that
the interest rate risk would not be eliminated. As we wrote yesterday,
one wonders if giving up seigniorage in exchange of a few bps upfront
is a sound policy. How big is $13.6BN? Not that much, if we think about
them as a single event in time. However, if the trend picks up, it will
be significant.
The comments expressed in this
website and daily letters are my own personal opinions only and do not
necessarily reflect the positions or opinions of my employer or its
affiliates. All comments are based upon my current knowledge and my own
personal experiences. You should conduct independent research to verify
the validity of any statements made in this website before basing any
decisions upon those statements. In addition, any views or opinions
expressed by visitors to this website are theirs and do not necessarily
reflect mine. My comments provide general information only. Neither the
information nor any opinion expressed constitutes a solicitation, an
offer or an invitation to make an offer, to buy or sell any securities
or other financial instrument or any derivative related to such
securities or instruments (e.g., options, futures, warrants, and
contracts for differences). My comments are not intended to provide
personal investment advice and they do not take into account the
specific investment objectives, financial situation and the particular
needs of any specific person.
Please, click here to read this article in pdf format: www.sibileau.com
Today’s is unfortunately a short letter, as I have had a very busy
week and even busier weekend. Nevertheless, below I describe what I
believe was and will be a very relevant theme during the last and
coming weeks: Central banks coordination.
I’ve been trying unsuccessfully to edit a handwritten draft I wrote on this subject, but here is a main point:
In a global world with fiat money, if monetary policies are
coordinated, it is perfectly possible to see a certain mathematical
set, a certain path, of foreign exchange crosses compatible with
increasing demand for consumption and investment goods. In formal
notation:
There exists a set (usd/cad, usd/eur, usd/rmb,…., cad/nok,….., fx i/fx j) where: delta (C + I) / delta t > 0
This is Bernanke & Friends’ plan to get us out of this mess (For
those interested in the details, this framework was first suggested by
Patinkin, using a Walrasian model of a monetary economic system and
including the net wealth effect). The key for this undetermined system
(it is undetermined because multiple different foreign exchange crosses
or price relationships can potentially satisfy this recovery process)
to succeed is that there must not be a “deflator” for the main fiat
policies. In statistics, a deflator is a value that allows data to be
measured over time in terms of some base period usually through a price
index in order to distinguish between changes in the money value of GNP
which result from a change in prices and those which result from a
change in physical output (http://en.wikipedia.org/wiki/Deflator
). As such, it can also be used as a reserve asset. Gold therefore is a
perfect deflator. Thus, if you believe my thesis, the key is that gold
does not become a reserve asset.
This means that it is not possible to see multiple paths for delta
(C + I) / delta t > 0, when people challenge central banks and
change the set (usd/cad, usd/eur, usd/rmb,…., cad/nok,….., fx i/fx j)
for the following set:
(usd/Gold, cad/gold, gbp/gold, eur/gold,….Fx i/gold)
For gold not to become a reserve asset, central banks have to coordinate a way to slowly debase their currencies in synchrony.
This is what they are starting to do. China has been leading the way,
followed by Canada. China started the process with its swaps of
Agencies for Treasuries. Canada followed with the decision to issue
USD4BN in federal government bonds, which were going to fund its
capitalization portion in the IMF. But last week, we saw a firm
confirmation of this process with the announcement by Germany.
Last week, Germany decided to issue a $4 billion 3-year in the USD.
This would be the first time it borrows in USD, since 2005. Other
European nations have also approached the USD market (Spain, Belgium
and Austria).
The excuse is that the cost of raising USD is lower than raising
Euros. However, when governments can enforce fiat money upon its
citizens but choose not to issue debt in their own currencies, they are
not being efficient. In other words, these nations as well as Canada
are giving up their right to seigniorage (http://en.wikipedia.org/wiki/Seigniorage
). And there is no way you will ever convince me that a few bps
differential between interest rates can make up for the cost of giving
up this valuable right!
The real reason behind this that the political class of the world
seeks to coordinate a global bid for the USD, to prevent gold from
becoming a reserve currency. Politicians do not want the set:
(usd/Gold, cad/gold, gbp/gold, eur/gold, …. , Fx i/gold) to become a
reality. They do not want their deficits to be killed by the rigorous
benchmark gold represents.
This is indeed going to be a long and tiresome war. Get ready!
The comments expressed in this
website and daily letters are my own personal opinions only and do not
necessarily reflect the positions or opinions of my employer or its
affiliates. All comments are based upon my current knowledge and my own
personal experiences. You should conduct independent research to verify
the validity of any statements made in this website before basing any
decisions upon those statements. In addition, any views or opinions
expressed by visitors to this website are theirs and do not necessarily
reflect mine. My comments provide general information only. Neither the
information nor any opinion expressed constitutes a solicitation, an
offer or an invitation to make an offer, to buy or sell any securities
or other financial instrument or any derivative related to such
securities or instruments (e.g., options, futures, warrants, and
contracts for differences). My comments are not intended to provide
personal investment advice and they do not take into account the
specific investment objectives, financial situation and the particular
needs of any specific person.
Please, click here to read this article in pdf format: www.sibileau.com
Let’s be upfront: Yesterday’s session was all about a run on the
USD. In an emerging market or developed country whose currency lacks
international weight, a run against that country’s currency is
expressed in terms of devaluation vs. an international currency. This
is the case in Latin America, when the pesos lose against the USD. But,
when the currency run takes place against an international currency, it
may be expressed as a devaluation against equities, corporate bonds,
treasuries (ironically), gold and yes, other currencies as well. This
is what is happening this week. This is what was reinforced today,
after bullish economic data releases: The CPI index, Industrial
production, Capacity utilization and last but not least, the NAHB
Housing Market index. Also relevant, the Department of Energy weekly
inventory data showed a higher than expected drop in crude oil
inventories (4.729k vs. 2.5k) and gasoline (547k vs. 700k).
All this obviously allowed equities to shoot higher, with
speculators throwing their chips on natural gas, cement, etc. In terms
of our liquidity metrics, the 3-mo Libor – OIS spread is now at
11.29bps, as if nothing would have ever happened here. Volatility
dropped as well and we saw the CDX IG12 index closing at 97.5/98.5,
losing 5.5bps.
Interestingly and in line with the trend, Bloomberg reported
Venezuela’s Chavez announcing that China will invest $16BN in the
Orinoco. If this is the case, the run against the USD is really, really
in full force. The People’s Bank of China will ultimately be lending
(=getting rid of) its US Treasuries to a joint venture with PDVSA,
Venezuela’s state-run oil company. Thus, the flight out of the USD
takes the most unusual forms, although we should not be surprised, as
this reminds us of the outflows of capital from the Middle East to
Switzerland and from there further to Latin America during the ‘70s. We
all know how the story ended. These US dollars are being spread all
over the planet and will end up providing depreciating incomes to
salaried workers in commodity-based markets…Il n’y a que les pauvres
qui partagent! Gold thus looks increasingly like a symbol of liberty in
a world held hostage by central banks.
The market for corporate credit seems to be getting back to normal.
We are starting to see more and more M&A deals, which will
ultimately crystallize into a spiral of issuances to fund new capital
expenditures programs. As we suggested in yesterday’s letter, the
corporate credit market is sailing on a course that will lead to a
direct collision with the rates (=government debt) market (Anyone wants
to guess who will sink first?). Academics call this the “crowding out”
effect, which if acute, can lead to something called the “Olivera
effect” (http://en.wikipedia.org/wiki/Olivera-Tanzi_effect ), in honor of Julio H. G. Olivera.
The market is already becoming aware of this, but from another
perspective. The market is concerned about the course rates are taking.
Analysts are trying to forecast interest rate paths, quantitative
easing policies, interest rate futures …Bank of America’s US Rates team
published an interesting note on this subject, that touches on the
political aspects of this problem (“SFP: A lull, not an end”, September
16th, 2009). The political side of this in the United States is
represented by the need the Treasury currently has to wind down the
Supplementary Financing Program, in order to meet its debt ceiling
constraints. The Treasury will have to receive authorization from the
Congress to increase its borrowings. How much more? The report suggests
that AT LEAST $4 EXTRA TRILLION may be required to finance the sum of
the fiscal 2010 deficit ($1.5 Trillion), social security plans ($0.5
Trillion) and an explicit guarantee (not funded, but which counts
towards the ceiling) on outstanding Agency debt ($1.7 Trillion). Until
we have certainty about the political support for this, we may bet on a
sell off in long end Treasuries and Agency debt. This is the
perspective on interest rates’ sailing course. But what about the
sailing course of corporate credit?
I think that we must not lose sight over the fact that perhaps the
two factors that drove credit spreads tighter so far are: a)
Quantitative easing policies (=creation of liquidity) and b)
refinancings (=maturity swaps), where borrowers issued long term debt
to repay short term debt. Both factors have a mutually reinforcing
dynamics, but the first factor is not sustainable and the second one
can only lead to a good port if the issuers of debt manage to recover
their liquidity within the timeframe they just bought with their
refinancings. The first factor is not sustainable because it requires
political stability internally and globally, a manageable fiscal
deficit and coordination of supply among central banks to prevent gold
from becoming a reserve currency.
The second factor is perhaps the most underestimated, in my view.
Firms will have to work hard to regain the liquidity they lost, but in
the upcoming stages of this inflationary process, we will see giant
distortions in relative prices, including foreign exchange crosses, and
increasing difficulties on the labor side. Usually, these factors lead
to bankruptcies (loan losses) even before interest rates rise.
The comments expressed in this
website and daily letters are my own personal opinions only and do not
necessarily reflect the positions or opinions of my employer or its
affiliates. All comments are based upon my current knowledge and my own
personal experiences. You should conduct independent research to verify
the validity of any statements made in this website before basing any
decisions upon those statements. In addition, any views or opinions
expressed by visitors to this website are theirs and do not necessarily
reflect mine. My comments provide general information only. Neither the
information nor any opinion expressed constitutes a solicitation, an
offer or an invitation to make an offer, to buy or sell any securities
or other financial instrument or any derivative related to such
securities or instruments (e.g., options, futures, warrants, and
contracts for differences). My comments are not intended to provide
personal investment advice and they do not take into account the
specific investment objectives, financial situation and the particular
needs of any specific person.
Please, click here to read this article in pdf format: www.sibileau.com
In the last 24 hours, I think the markets may have focused on two things:
1.-Stronger than expected retail sales and Producer Price Index (PPI) figures for August, released at 8:30am
With the news, the 30yr on-the-run Treasury plunged 1% and the
immediate assault upon the USD began. I don’t know about retail sales,
but when I realized this morning that the PPI ex-Food & Energy
year-over-year was up 2.3%, I was very impressed. The past 12 months
since August 2008 were one of the worst in our history since the Great
Depression, with Lehman falling, Citigroup’s share price plunging to 99
cents, the S&P500 losing a decade of accumulated value,
foreclosures, etc., etc…and yet, the index managed to be up? I don’t
care here about the absolute figure, for these are usually not precise.
I care about the trend, and the trend is up. Where will this index be
once the recovery is in full force? The market seemed to ask the same
question this morning and acted swiftly. No prisoners were taken.
2.-President Obama’s speech in Pittsburgh and Bernanke’s declaration that recession is “likely over”.
I confess I did not here Obama’s speech entirely. However, I believe I
heard enough (in particular his thoughts about his healthcare plan and
its corresponding financing) to go back to my Bloomberg screen and
confirm that the USD continued to be under assault. No surprises here…
In the end, the S&P500 closed higher (in terms of USD, of
course!) at 1052.63 (+0.31%), the CDX IG12 at 103/104bps and Treasuries
managed to bounce back at the end, helped by a $2.05BN purchase by the
Fed. Short rates endured best. The day also witnessed a heavy corporate
bond issuance, which brings me to my next point:
At the beginning of May, we addressed the renaissance that was taking place in the debt markets (www.sibileau.com/martin/09/05/07
). If today we are still uncertain about the strength and pace of the
economic recovery, back then we were in complete and hopeless darkness.
Back then, we wrote that: “… issuers’ fundamentals have not improved,
let alone bottomed. We may understand the issuers’ reasons for settling
at any cost, but how do we explain investors’ appetite for these
issuances? Are investors being compensated for the risk taken? …” We
then suggested that: “…If the market believes issuers can pay these
coupons, the expectation is they will sell assets, restructure or
increase prices. Selling or restructuring requires that management have
a strategic view, and I find it hard to believe there is a solid
understanding of what the future keeps for us. If I am right, the
recent steepening of the yield curve may be indicating that inflation
expectations are to take a leading role, bringing REAL interest rates
down….”
My opinion was that the US Treasuries’ curve had to steepen. And
steepen it did, particularly fuelled by the negative convexity needs of
mortgage investors. Thereafter, both the self-feeding recovery process
via expectations and central banks’ hypocritical assurances that
“liquidity will be there” but “there is also an exit strategy”, gave
back some perspective to an anxious market, and allowed for some bull
flattening movement. Months went by and we have made it to September
with equities, credit and rates all rallying at the same time. As
someone suggested, one of them has to be wrong…Or not. We have been
explaining how, thanks to international coordination of monetary
policies, with central banks swapping assets among themselves and the
threat of a powerful IMF thwarting any currency run in emerging
markets, the world can reach this state of dynamic equilibrium among
debt, equities and rates. In a simple words, their rally is nothing
else than a slow and steady flight from the USD.
But the consequences of the May renaissance are now visible and
challenge the prospect of an easy exit strategy. According to
Bloomberg, this wave of refinancings in 2009 deferred all the tension
to the future, with 52% of the high yield bond and bank debt maturing
between 2012 and 2014, exactly when everyone expects central banks to
have started their respective exit strategies, with abrupt increases in
interest rates and fiscal savings (if you believe them)!
Will activity have picked up so much that earnings at the companies
that are today refinancing, carrying out acquisitions or financing
capital expenditures will justify refinancings at high yields? You can
bet most banks will have no choice but to lend to these companies, in
the hope that defaults are pushed further out the curve. But if they do
not succeed, will governments not step in again? At what (reputational)
cost? Would it not be much, much simpler to merely accept the fact that
we will live with two-digit inflation?
The comments expressed in this
website and daily letters are my own personal opinions only and do not
necessarily reflect the positions or opinions of my employer or its
affiliates. All comments are based upon my current knowledge and my own
personal experiences. You should conduct independent research to verify
the validity of any statements made in this website before basing any
decisions upon those statements. In addition, any views or opinions
expressed by visitors to this website are theirs and do not necessarily
reflect mine. My comments provide general information only. Neither the
information nor any opinion expressed constitutes a solicitation, an
offer or an invitation to make an offer, to buy or sell any securities
or other financial instrument or any derivative related to such
securities or instruments (e.g., options, futures, warrants, and
contracts for differences). My comments are not intended to provide
personal investment advice and they do not take into account the
specific investment objectives, financial situation and the particular
needs of any specific person.
Please, click here to read this article in pdf format: www.sibileau.com
The week started on a positive tone, with plenty of optimistic
outlooks, new trading recommendations, updated views on every market as
well as the political front. Before we can add anything, let me mention
that yes, I did notice that almost every market analyst on Monday
attributed Friday’s sell-off to President Barack Obama’s imposition of
tariffs (starting at 35%) on tire imports from China. The decision
backed a United Steelworkers union complaint.
Thus, after reading the news, I wondered why I would have not seen the
connection between the new tariffs and the sell off I commented on
yesterday’s letter (www.sibileau.com/martin/2009/09/14).
Yesterday, I browsed the Bloomberg News application and found out that
the announcement had first been officially released on Friday at 9PM
Easter Time. Yet, Friday’s sell off was triggered at 11AM, right after
the Fed purchased Agency debt. Furthermore, the sell off was
significant and in EVERY relevant market: FX (vs. USD), oil, equities,
credit, etc. How could an announcement on new tariffs that affects only
$1.7BN in imports (as reported by Bloomberg) have caused a worldwide
sell-off ten hours earlier? On the other hand, the complaint had been
already filed in April of this year, and the Obama Administration had
until September 17th to make a decision. Perhaps I am wrong, but I find
it way more likely that a worldwide sell-off be caused by a sudden
change in the outlook on quantitative easing policies than a tariff
announcement on a trade of $1.7BN per year on rubber tires. However, I
perfectly understand the negative reaction on Monday morning to this
announcement, which challenges the cornerstone of policy response
during this crisis, namely international coordination.
Now, why am I confident the outlook may have changed? Yesterday, and in
line with my comments, Richmond Fed President Lacker speculated the Fed
may not end up purchasing the entire $1.25Tr of Mortgage-backed
securities, during a speech at the Risk Management Association of
Charlotte, North Carolina (It was not explicit in his speech, but a
reputable analyst at an also reputable investment bank reported this as
having been “commented”. For transparency, I let the reader decide. The
speech can be found at: http://www.richmondfed.org/press_room/speeches/president_jeff_lacker/2009/lacker_speech_20090914.cfm)
Proceeding now to review yesterday’s action, I think one word says
it all: Liquidity! Yes, the 3-month Libor – Overnight Index Swap spread
reached a lower low, at 11.85 bps, as 3-mo Libor hit 29.5bps! As we
wrote on September 9th (www.sibileau.com/martin/2009/09/09 ): “ …going
forward I don’t think liquidity will have the power to fuel the rally
to new highs, as the law of marginal returns kicks in, but at least
forms a formidable wall against any rebellion…”. We had a
rebellion on Friday, but liquidity ruled and we saw the S&P500
again reach for the 1,050pts and the CDX IG Series 12 touch 105-106bps.
This macroeconomic backdrop has forced a multitude of analysts to
update their forecasts. At “A View from the Trenches”, we don’t have to
do so, for we understand that there is nothing more practical than a
good theory. Thus, after having read at “Human Action” (1949) from
Ludwig Von Mises (highly recommended) and Gottfried Haberler’s, “Money
and the Business Cycle” (1932) a long time ago during our time at the
University of Buenos Aires, we wrote back on April 14th (our first
letter) that: “…We
will keep reading the bearish comments from those who see a bear market
rally in stocks, as they single out all the horrifying figures of the
real estate, labor, retail, etc. markets. There is nothing wrong with
those figures, but this is not a bear market rally. It’s just the
“relative” inflation Gottfried Haberler wrote about 77 years ago… In
conclusion, as long as the Fed and all the other central banks keep
flooding buckets with liquidity and feed us with daily announcements,
we can see prices NOT falling…” In the meantime, most analysts at
the major investment banking firms are unanimously constructive or
“cautiously optimistic”, given the success of the quantitative easing
policies worldwide.
I would like to continue writing here, but I am afraid I will have
to defer to upcoming letters. But there is a lot more to say to this
new stage we are in. To begin with, a recent wave of M&A activity
is telling me we are about to enter stage 4 of the inflationary
process, as I first laid out exactly five months ago, on April 14th (www.sibileau.com/martin/2009/04/14).
If this wave is solid and the Iranian threat does not become a reality
and/or politicians do not destroy what they have achieved so far, we
may see a surge in capital expenditures, we may get closer to a rise in
intermediate/capital goods and energy prices, and finally see the
famous CPI numbers tell us that inflation is with us to stay. It takes
time, but we are patient, particularly when we profit from patience.
Finally, an interesting development is taking place in interest
rates and credit curves, which I intend to address shortly. In the
meantime, for reference if you are interested, you can read about the
origins of such development on our letter from May 7th (www.sibileau.com/martin/2009/05/07).
The comments expressed in this
website and daily letters are my own personal opinions only and do not
necessarily reflect the positions or opinions of my employer or its
affiliates. All comments are based upon my current knowledge and my own
personal experiences. You should conduct independent research to verify
the validity of any statements made in this website before basing any
decisions upon those statements. In addition, any views or opinions
expressed by visitors to this website are theirs and do not necessarily
reflect mine. My comments provide general information only. Neither the
information nor any opinion expressed constitutes a solicitation, an
offer or an invitation to make an offer, to buy or sell any securities
or other financial instrument or any derivative related to such
securities or instruments (e.g., options, futures, warrants, and
contracts for differences). My comments are not intended to provide
personal investment advice and they do not take into account the
specific investment objectives, financial situation and the particular
needs of any specific person.
Please, click here to read this article in pdf format: www.sibileau.com
Let me begin by saying that last Friday’s action in the markets was very interesting. This is a view that I don’t think analysts would share. But nevertheless, I am willing to go on record here describing what I think took place on Friday, ignoring the fact that nobody else has made a comment on it. The chart below (source: Bloomberg) depicts the spread between the 5-yr Fannie Mae issue and its 5-yr benchmark (on-the-run Treasury). As you can see, this spread broke to the upside in two occasions on Friday: At 2am and at 11am Eastern Time:
Here’s what I think unfolded at 11am: The Fed was to buy Agency debt and by 11am, they had bought $2.8BN out of $6.2BN (45% hit ratio). The largest purchases were $761MM of FHLB 3.625% Oct/13, $492MM FNMA 5% Apr/15 and $485MM FNMA 2.75% Mar/14. Right after this, all the risk trades started to unwind: Crude oil, gold (commodities) fell; equities fell, Treasuries continued to appreciate, the USD gained vs. the CAD and the EUR and I even heard of some violent moves to short the CDX HY index (i.e. the credit default swap index for high yield names). Below and in this order, I show the charts for 1) Crude oil, 2) S&P500 index and 3) Canadian dollar vs. USD, so you can get a better picture of my point:
What happened?
I think the market had been waiting for the Fed to include on-the-run issues in its Agency debt purchases, which closed at 11am on Friday. Why is this relevant? A week before, Bank of America’s Rates team (Global Rates Focus, “Caution and Prudence”, September 4th, 2009) had suggested that the Fed would include on-the-runs to speed up its purchases and ensure that it reaches the $200BN ceiling of its Agency debt purchase program. The report also noted that the correlation between agency debt and swaps had been decreasing, forcing dealers to use on-the-runs to hedge off-the-runs exposure. What does this all mean? It means that it could explain why the on-the-run spread between Agency debt and Treasuries (first chart above) shows the jump at 11 am, as on-the-run Agencies are sold (spread widens) to hedge the off-the-run exposure affected by the Fed‘s purchases. However, what are we left to think about the sell-off in the rest of the markets? I think there is a little bit more to this story, than the consequences of hedging needs by some Agencies dealers here. Let’ see:
Axioms:
1. The Fed needs to hit its $200BN purchase ceiling in Agency debt.
2. At the current pace, it can only hit this ceiling if it buys on-the-runs
Thesis:
If the Fed does not buy on-the-runs, it is not in a hurry to hit the $200BN ceiling = The ceiling will not be reached = This is the beginning of an exit strategy = The Fed may not increase interest rates soon, but in order to avoid a further depreciation of the USD, the Fed intends to slow down or even not provide all the liquidity it had previously promised.
Demonstration:
If the exclusion of on-the-runs means that the Fed is unwinding its liquidity programs, the markets should sell off and the USD should appreciate.
As you can see, the chart above, in my view constitutes the proof of my thesis: The markets actually did sell off in violent fashion right after 11am. I must say (warn you) that I read and reread the standard market closing commentaries and not a single one of them seemed to have paid attention to this. I leave to the reader to judge the reasonableness of this conclusion (feedback welcome).
But if I am right, here are a few conclusions to take away:
1. Considering all the positive economic data releases that we saw last week, the sell off makes it very clear that the financial situation is still really weak worldwide.
2. We are not seeing a recovery but a bubble. Bubbles live off liquidity and die when liquidity is withdrawn.
3. All investments should be made in very liquid instruments
4. If you paid close attention to the first chart, you will have noticed that the first jump in the spread between Agencies and Treasuries occurred after 2 am…This is very suspicious to me. Did a Central Bank in Asia know already that the Fed was not going to buy on-the-runs and swapped for Treasuries?
5. If the answer to question no. 4 is positive, we are seeing a serious and strong coordination among central banks = Gold will face real challenges to break to the upside.
The comments expressed in this website and daily letters are my own personal opinions only and do not necessarily reflect the positions or opinions of my employer or its affiliates. All comments are based upon my current knowledge and my own personal experiences. You should conduct independent research to verify the validity of any statements made in this website before basing any decisions upon those statements. In addition, any views or opinions expressed by visitors to this website are theirs and do not necessarily reflect mine. My comments provide general information only. Neither the information nor any opinion expressed constitutes a solicitation, an offer or an invitation to make an offer, to buy or sell any securities or other financial instrument or any derivative related to such securities or instruments (e.g., options, futures, warrants, and contracts for differences). My comments are not intended to provide personal investment advice and they do not take into account the specific investment objectives, financial situation and the particular needs of any specific person.
Please, click here to read this article in pdf format: www.sibileau.com
The week is passing by and yesterday I did not see any noteworthy
changes to the ongoing trend of more liquidity (3-mo Libor - OIS spread
now below 13bps), central bank intervention (i.e. the Bank of Canada
bought C$500MM in another repurchase agreement), stocks sneaking higher
(S&P500 at 1033.37, +0.78%), corporate credit (CDX IG12 at 113bps,
HY12 at 89 11/16, mid) and emerging markets sovereign risk tightening.
There was also some profit taking in gold post-Barrick news, but in
general and in particular in fixed income, the session was flat. On the
news, the Mortgage Bankers Association’s weekly mortgage application
index was reported 17% higher, as mortgage rates make record lows. The
refinancing and new purchase applications increased to 23% and 10%
respectively (this week), suggesting a recovery in the housing market
(This is in line with the negative convexity trades in Treasuries we
were suggesting weeks ago and the bull flattening move a week ago).
I would leave things here, but perhaps there are two additional points to make:
1) One has the feeling that central banks are bracing for an
increase in intervention, be it only vocal (i.e. Fed’s Evans speech
yesterday), indirect (i.e. China’s efforts to tighten credit expansion,
the rising role of the IMF) or explicitly direct (i.e. the Bank of
Canada’s repurchase agreements). On the latter, I thought I would
include the chart below (in CAD per 1 USD), corresponding to the last
few sessions (source: Bloomberg). In it, you can see how the general
trend is for the CAD to appreciate as well as the impact of these
transactions (announced at 10:30am), which send the CAD lower vs. the
USD. Individually, these interventions may or may not be effective in
the long-term. However, we are in a global world, and they are
coordinated, and in my view, on aggregate, they influence the shape of
this global asset inflation (also known as recovery).
2) One cannot help to sense that the political events of the last
weeks are starting to have some unwanted influence. Call me crazy if
you like, but I am willing to put some weight on them behind the latest
appreciation in gold. What am I talking about? I am talking about the
developments in Iran, Venezuela, Poland, the east Baltic states and the
US (i.e. health care reform). I sense an increasing polarization
between left and right in the world that rarefies the air. There was no
such thing last year, when every politician was willing to discuss a
safety net for deposits and there is one now, where atomic weapons,
military expansion, alliances and potential trade wars are at the table.
The comments expressed in this website and
daily letters are my own personal opinions only and do not necessarily
reflect the positions or opinions of my employer or its affiliates. All
comments are based upon my current knowledge and my own personal
experiences. You should conduct independent research to verify the
validity of any statements made in this website before basing any
decisions upon those statements. In addition, any views or opinions
expressed by visitors to this website are theirs and do not necessarily
reflect mine. My
comments provide general information only. Neither the information nor
any opinion expressed constitutes a solicitation, an offer or an
invitation to make an offer, to buy or sell any securities or other
financial instrument or any derivative related to such securities or
instruments (e.g., options, futures, warrants, and contracts for
differences). My comments are not
intended to provide personal investment advice and they do not take
into account the specific investment objectives, financial situation
and the particular needs of any specific person.
Please, click here to read this article in pdf format: www.sibileau.com
Gold has finally passed the $1,000/oz mark. I was a bit nervous on
Tuesday morning, but by noon, I had the feeling that the day would end
according to our main trend forecast. Let’s see…
The 3-mo Libor-OIS spread made a newer low, at 12.89bps as Libor is
now at 30.19bps. Thus, going forward I don’t think liquidity will have
the power to fuel the rally to new highs, as the law of marginal
returns kicks in, but at least forms a formidable wall against any
“rebellion”.
Do I think yesterday’s action was about risk seeking, away from the
USD, as it so smelled in early trading? Not really. Here’s why: If you
look at the chart below (Source: Bloomberg. For regular readers, this
is now a classic chart at “A View from the Trenches”) the spread
between 30-yr Treasury and S&P500 was erratic. It was only after
1pm, after the uneventful $5BN of Treasuries purchases by the Fed took
place that the random movements began to fade, with an inverse
relationship between equities and sovereign risk taking the driver’s
seat. The Fed bought Treasuries maturing between May/16 and Aug/19
(total purchases so far are at $281BN = only $19BN left to complete the
$300BN program!!!). After 3pm, with the announcement of the record drop
(by $21.6BN) in U.S. consumer credit, equities corrected but managed to
close higher (S&P500 up 0.88%, at 1025.39). Corporate credit gives
us another flag: The IG and HY indexes have been in range-bound trading
since mid August, and yesterday’s action only confirmed this
characteristic. Therefore, am I surprised that gold broke the
$1,000/oz? No. Do I think it is the start of a new phase for gold? I
will answer this from the other side of the coin. I read yesterday two
asset allocation reports based on macro outlook reports. They were both
bullish on equities. Regardless of the side they take, I think the
approach is mistaken. Macro stats should support nothing these days.
It is all about deleveraging/leveraging forces, which tells me that
central banks still hold too much power and makes me fear being a gold
bug. For example, with yesterday morning’s move in gold, the Canadian
dollar had made it to 1.0674 CAD/USD, only to go back to the 1.08+
CAD/USD. Why? The Bank of Canada intervened the market again, buying
C$1BN of securities in a 272-day repurchase agreement, announced at
10:30am.
In conclusion, I don’t see the rally in gold as a reflection of risk
appetite (asset inflation) and I don’t see gold strong enough to
withstand a potential killing move by central banks.
Last but not least, I noticed that after the announcement of the
fall in U.S. consumer credit, the CAD regained strength. A few days
ago, such news would have triggered a flight-to-safety and
USD-supportive trade. Yesterday, the market reacted different,
confining the bad news to the US market. This was news to me…
The comments expressed in this website and
daily letters are my own personal opinions only and do not necessarily
reflect the positions or opinions of my employer or its affiliates. All
comments are based upon my current knowledge and my own personal
experiences. You should conduct independent research to verify the
validity of any statements made in this website before basing any
decisions upon those statements. In addition, any views or opinions
expressed by visitors to this website are theirs and do not necessarily
reflect mine. My
comments provide general information only. Neither the information nor
any opinion expressed constitutes a solicitation, an offer or an
invitation to make an offer, to buy or sell any securities or other
financial instrument or any derivative related to such securities or
instruments (e.g., options, futures, warrants, and contracts for
differences). My comments are not
intended to provide personal investment advice and they do not take
into account the specific investment objectives, financial situation
and the particular needs of any specific person.
Please, click here to read this article in pdf format: www.sibileau.com
With Labor Day over, perhaps it has never been so clear that a new
phase in the capital markets story is being written. What are we
talking about? As I mentioned earlier, I am currently writing a small
research note describing a formal framework to analyze this story. In
the meantime, let’s borrow an approach from another science, namely
Biology. If my memory doesn’t fail, biologists cannot tell you what
“life” is, but they can describe a living being. Thus, while we wait
for a formal definition of the new phase, let’s describe the different
dynamics taking place in the markets. Let’s see…
With the first half of 2009 earnings releases behind, there is this
much certainty: There has not been any revenue growth so far and
results were acceptable thanks to cost cutting and the refinancing of
short-term in favor of longer term maturities. Without revenue growth,
unemployment will remain high and consumption weak. This obviously
impacts the housing market and may lead to further loan losses. These
concerns have merit, of course.
In addition, given the steady fiscal deficits, monetary easing
cannot stop, no matter what Bernanke and friends will tell you. Risky
assets have been (and continue to be) transferred from the private to
the public sector. They were (and continue to be) risky for a reason:
an important percentage of them were/are underwater or in default. The
final balance sheets to hold them were those of the central banks. They
were transferred from financial institutions to governments and from
governments to central banks. Therefore, their corresponding currencies
(the liability side of this equation) should be worth less than before
this exercise took place. But when you sell a devalued currency, you
must actually buy another one, unless you want to invest it in a
non-financial asset. The exchange away from currencies and into
non-financial assets began in earnest on March 18th of this year. At
this stage, the expected productivity from these non-financial assets
is thought to have matched their respective price appreciation. But
given the continuation (the immortality) of fiscal deficits worldwide,
it is clear that the devaluation of currencies will remain in full
force. Therefore, it begs the question of what currencies we are left
to invest in. The central bankers know this well and to thwart any
movement, they will exchange, swap, their respective assets to deceive
us. That is what has been happening since on August 18th, the People’s
Bank of China started to restrict credit expansion and unload, at the
same time, agency debt in exchange of Treasuries. The market took note
of it and decided to start buying gold.
After the Jackson Hole conference in August, it seems that there is
a silent agreement to strengthen the Chinese currency. The unwanted
consequence is the becoming of the USD into a carry currency. Can a
carry currency be a reserve currency at the same time? Only in those
countries where money has a history of being debased (i.e. Latin
America, etc.) at a higher speed. The concern therefore shifts from the
US to emerging markets. Emerging markets have slowly, over the past
years become more and more dependent of Chinese consumption. There is
nothing new here. Perhaps the new paradigm however is that while in the
past, US would lead the way, driving China and emerging markets
indirectly, it may now be China that leads the way, driving emerging
markets, dollar bloc currencies and the US simultaneously, in parallel.
I call this a paradigm, because it is not a reality, yet. But the
markets want to believe in that story, and we cannot fight the market.
What do we mean by “China” leading the way out? We mean that China’s
growth would be the key driver behind the “needed” increase in demand.
Politicians and a great majority of economists believe we need an
increase in demand, because deflation is considered something negative.
We can’t blame them; they’ve been educated under the Keynesian truth,
where the pricing system is not considered an essential mechanism to
transmit demand/supply signals, but a blurry reflection of “animal
spirits”.
What is the bottom line here?
The asset swaps among central banks can and will
continue, particularly among developed nations and with more difficulty,
between developed and emerging nations (here is where the IMF regains its lost
shine). An alternative way is to use an indirect approach, where China holds US
assets, for instance, and emerging markets’ central banks hold Chinese assets.
This has actually started.
On March 30th, for instance, the central bank of Argentina entered into
a 70BN Yuan currency swap with China. There are only two possible
outcomes: Inflation or deflation, which means we will be denied the
benefit of price stability. I (and the markets too) am inclined to
believe inflation will be the outcome. With inflation, we will continue
to see high unemployment and more defaults. The bomb has not been
defused and the explosion has only been delayed.
Normal
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The comments expressed in this website and
daily letters are my own personal opinions only and do not necessarily
reflect the positions or opinions of my employer or its affiliates. All
comments are based upon my current knowledge and my own personal
experiences. You should conduct independent research to verify the
validity of any statements made in this website before basing any
decisions upon those statements. In addition, any views or opinions
expressed by visitors to this website are theirs and do not necessarily
reflect mine. My
comments provide general information only. Neither the information nor
any opinion expressed constitutes a solicitation, an offer or an
invitation to make an offer, to buy or sell any securities or other
financial instrument or any derivative related to such securities or
instruments (e.g., options, futures, warrants, and contracts for
differences). My comments are not
intended to provide personal investment advice and they do not take
into account the specific investment objectives, financial situation
and the particular needs of any specific person.
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