Tag Archives: debt

>Spain backtracks on China investment claim


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What fools they look like, but then again, this is nothing new for Zapatero

Spain backtracks on China investment claim

By Miles Johnson in Madrid
Published: April 14 2011 13:57 | Last updated: April 14 2011 13:57
The Spanish government has been forced into an embarrassing reversal after claims that Spain had secured up to €9bn in investment in its troubled savings banks from China were denied by Beijing.
Spanish government officials said an “error of communication” had led to claims that China Investment Corporation, one of the country’s sovereign wealth funds, was considering the €9bn investment after José Luis Rodríguez Zapatero, Spain’s prime minister, met Chinese leaders this week.
“China has said it will continue to buy Spanish government debt, and is interested in participating in the restructuring of the savings banks, but it is too early to name specific amounts of investments,” the Spanish government said.
Mr Zapatero is on an official visit to China and Singapore to meet Asian investors to promote Spain’s government debt and financial sector.
A CIC official earlier told Reuters that reports in the Spanish media of the investment were false. CIC is known to no longer have available funds to invest abroad, and the €9bn ($13.5bn) figure would dwarf its largest previous investment which was a $5bn stake in Morgan Stanley made in 2007.
The admission of error came as Spain’s central bank was finalising its approval of plans submitted by the country’s regional savings banks, known as cajas, to raise new capital to meet a €15bn shortfall that has shaken investor confidence in the stability of the Spanish economy.
The previously little-known and privately held cajas were left gasping for new capital after loans made during Spain’s property bubble began to sour and its economy fell into recession.
Tough economic reforms led by Mr Zapatero’s socialist government, including freezing civil service pay and slashing Spain’s budget deficit, have helped the country partially regain the confidence of financial markets after some investors had started to view Spain as being at risk of following Greece, Ireland and Portugal into taking European Union rescue funds.
The interest investors demand to hold Spanish government debt over German bonds has fallen sharply since the start of the year.
On Thursday, however, after the confusion over Chinese investment in the cajas and ahead of the finalisation of their own capital raising plans, the spread between Spanish and German 10-year debt rose by 9 basis points to 190bp.
Spain’s outreach to China for investment comes after the prime minister of Qatar said in February that his country would invest €300m in Spanish banks after expressing confidence in the Spanish economy during a visit to Madrid.
Since then there have been no further details about which institutions Qatar would invest in, nor what form any investment would take.

Copyright The Financial Times Limited 2011.

FT.com / Europe – Spain backtracks on China investment claim

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>Financial Times: Goldman made multiple trips to Fed window


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Goldman made multiple trips to Fed window 
April 01 2011 1:38 AM GMT


By Justin Baer in New York

Goldman Sachs turned to the Fed’s discount window on multiple occasions following its conversion to a bank holding company at the height of the financial crisis
Read the full article at: http://www.ft.com/cms/s/0/ea97d2f6-5bee-11e0-bb56-00144feab49a.html

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>Bolivarian Arbitrage The Devil’s Excrement


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 Bolivarian Arbitrage The Devil’s Excrement

I- The Question

I have been getting some emails asking about why it is that the PDVSA bond issued last week, the so called PDVSA 2022, has a price that is so much below the identical Global 2022 Venezuela bond issued by the Republic last summer.

II.-Bonds in general

But to understand why this is relevant, let me start at the beginning: Typically, when a country or a company issues a bond, it has a price and a yield to maturity which depends on the perceived “risk” associated with the issuer. Such a bond is simply a promise that I will pay the annual payments, the coupon, and at maturity, the day the bond ends, you will get 100% of the nominal or face value of the bond.

III.- Venezuela’s bonds and risk

Venezuela currently is perceived as being high risk, in fact, very high risk. There are two reasons for that, one is simply political, the feeling that one day Hugo may wake up and decide not to pay the country’s debt. The second one is that Venezuela has been issuing more and more debt and at some point this can’t go on, the country has to pay at maturity, as well as the increasing annual or coupon payments to the bond holders, which are already near US$ 5 billion per year.

As this risk has increased over the last few years, this coupon has gotten higher, meaning that the country or PDVSA has to pay more to convince someone to buy your bond. As an example, in 2009, PDVSA issued bonds maturing in 2014,2015 and 2016 with coupons around 5%. That means that if you hold $100,000 of the bond PDVSA has to pay you $5,000 per year and then at maturity give you back your money.

IV.- How Venezuela issues bonds

This is where things get complicated. Because of exchange controls, these bonds are not issued internationally, where they would trade very close to each other, but instead are sold to Venezuelan individuals or companies for Bs. That is, you pay so many Bolivars for each dollar face value of the bond at Bs. 4.3 per US$, but you know based of the coupon, that the bond will not trade at 100%, but at a lower value.

Why?

Because Venezuela would have to pay coupons of 14-16% for the bond to trade near 100% if issued in US$ directly. Instead, what the Government or PDVSA do, is to set a lower coupon, knowing that the bond will trade below 100%. Thus, if you are a Venezuelan and you pay say Bs. 4,300 per $1,000 of a bond that should trade around 70%, you buy it, sell the bond for 70% of its face value (You get $700) and then you are simply buying dollars at Bs. (4,300/700) or Bs. 6.14 per US$.

Since exchange controls are so strict now, people love these bond issues, because other than what the foreign exchange control office sells you at Bs. 4.3, there is no way for an individual to buy dollars as it is completely illegal to do so since last May. The same applies to companies. If the Government does not give them dollars for imports, they have to either use their own money or simply stop importing, it is illegal to buy foreign currency other than from the Government.

V.- The Venezuela Global 2022 bond

Last summer, Venezuela issued a bond maturing in 2022 (It actually matures in three parts, one third in each of 2020, 2021 and 2022) with a coupon of 12.75%. This is a very high coupon, very few companies or countries in the world issue at such high coupons. Even worse, these bonds trade at a discount in order to equilibrate with what investors expect from Venezuela. Last week, for example, this Global 2022 bond, as it is called, was trading at 88% of its face value just before PDVSA announced its bond. At that price it was yielding around 15.3%. The difference between coupon and yield is that coupon is what you get paid every year over the face value, yield to maturity is what your annual return will be if you keep the bond until it matures.

VI.- The PDVSA 2022 bond

And here is where the Bolivarian arbitrage and the topic of this post begins. You see, this week PDVSA announced an issue of a bond also maturing in 2022, also having a coupon of 12.75% and also having maturity in three parts in 2020,2021, 2022. That means the two bonds are identical. Given that PDVSA and Venezuela are so inter twinned, you would think they should have very similar prices and very similar yields. Right? Well, yes and no, because of all of the artificialities in the Venezuelan economy due to the controls, at the beginning of the trading of a bonds this does not happen. In time they will be very close, but it will take time.

In fact, last Thursday when the PDVSA 2022 began trading, it was being sold at 74% of its face value, while the Global 2022, essentially the same risk, same yield, same coupon, was trading at 86.4%, a full 12.4 points above the new PDVSA 2022 issue. Illogical. right?

VII.- The Bolivarian Arbitrage

You would think these two prices would become the same immediately, but they don’t. This is the Bolivarian Arbitrage, the subject of this post and the question I have been getting from readers: Why are they different, why doesn’t the gap close immediately? How can it make sense for Venezuela to be yielding 15.7% (same coupon, higher price of 86.4%), while an identical bond from PDVSA yields almost 19% (same coupon, lower price of 74%)? Aren’t markets “efficient”?

The answer is that this exists because of the dynamics of the bond sales by the Government and the banks. Eventually, the difference will close, but it will take time. Here is why:

Companies don’t want to buy the bonds, they want to get the dollars when they get the bonds and sell them. So, they go to a local bank and say: I will place an order with you, of say US$ 50 million, if you can guarantee a price for each dollar such that no matter what amount I get, the price will not change.

For the bank this is not easy. The client could be assigned zero of the bonds or it could be assigned the 50 million, the rules are never clear and vary from bond to bond. So, suppose that the bank expects the new bond to have a fair value of 82%, that means that each dollar costs (Bs. 4.3/0.82)=Bs. 5.24, but the company wants a guaranteed price, so you say I will pay you 70% for the bond, no matter how much you are assigned. This means, for the company, that the dollars will cost Bs. 6.14. This is a great deal in a country where there are no dollars to be had, so if your objective is to get dollars cheap, you are not very sensitive to the price, between not having access to any dollars or paying Bs 6.14 per US$, it is still a bargain. In fact, I bet most companies would pay even higher values, if they could get all they wanted.

VII.-Why the Government wants to sell cheap dollars

And here is another distortion. The Government knows that people would pay more, but it does not want to sell the dollars at a more expensive price (offering a lower coupon) because it wants to keep inflation down. Thus, it prefers to give away the dollars cheap, than to have the political risk of higher inflation. (Although in the end it is not as important for inflation as the Government thinks, it is mostly financing capital flight)

VII.- How local banks affect the international markets

But now, the bank has a problem. If six customers show up, each asking for a US$ 50 million guarantee of purchase, then the bank has undertaken US$ 300 million of risk, which could be dangerous. So, the bank measures how much risk it can take and starts selling these bonds in the international markets at say 74%, like the first day of the PDVSA 2022. It guarantees it will make a four point profit and lowers the size of its risk.

What is the risk? Well, the bank could have the opposite problem, that all customers are given nothing and then it has to go buy the bonds that it promised to deliver. Or that prices will go down because oil goes down or too many bonds hitting the market.

The problem is that these are huge issues for the markets, US$ 3 billion. To give you an idea, two weeks ago Petrobras issued the largest corporate bond in Brazilian history, a US$ 6 billion issue. PDVSA has issued US$ 9.15 billionsince last November! Thus, there is an over supply of PDVSA bonds and when the bank tries to sell US$ 100 million, there are only buyers at a low price, if there is no bargain, there are no big buyers.In time, prices will go up as the bonds leaving Venezuela are absorbed by the international markets.

This is the Bolivarian Arbitrage, another artifact of the distortions and complicated schemes the Government has built in around the exchange controls and the large and frequent issuance of bonds. These type of arbitrage has allowed many people in the past few years to make a lot of money, it was just not as obvious to the average person because the bonds were never identical like this time.

VIII.- Making money with the Bolivarian Arbitrage

Let me give you an example. Suppose you had a Venezuela 2010 bond in 2009 which you bought at 70-75% in the middle of the world financial crisis. In August of 2009, that bond was back up at 94% when PDVSA announced a Petrobono 2011 with no coupon. This 2011 bond came out at around 64%, you could have sold the 2010 and bought the Petrobono 2011. Then, PDVSA issued the PDVSA 2014, which was sold at around 56% when the Petrobono was already at 82%. Then, you could have sold the PDVSA 2014 at around 63% to buy the Global 2022 at 76%. In that sequence, ignoring interest, you would have made over 100% profit in less than two years and now you are ready to make some more money again, switching to the PDVSA 2022.

IX.- The risk of playing this game.

The risk, obviously is that one day you will not get paid if Venezuela decides not to pay and the bond will drop to around 30-35% of its face value, the so called recovery value. (That is why some people buy the long dated bond, which trade around 45%) You will lose a lot of money, in fact, you will lose all your gains. Of course, everyone assumes they are so smart that if that ever happens or comes close to happening, they will have no Venezuelan bonds in their portfolio by then. They did not expect Russia to default in the 90′s or Argentina in the new century. They both did.

Of course, that is what markets are about. Some think oil is going to soar. Others that the Government will change. Many that Venezuela can do this for a few years without defaulting. Everyone has a different opinion on it.

In the meantime, they will continue riding the Bolivarian Arbitrage.

X.- Why this is so crazy.

But this whole thing is absolutely crazy and it should not be this way. Venezuela’s risk premium is high because of the constant supply of bonds to the market and the non-transparent way in which things are done. If the Government set up a road map every year telling markets exactly how much it will issue and in roughly which part of the year, the risk premium would go down, the debt would not be as costly. Instead, after telling investors for weeks there would be no issuance in the first few months of the year, PDVSA surprised them with this bond. A road show abroad by the Government once in a while to explain its finances, would also not hurt either.

Additionally, there is no justification for the overvaluation of the currency in these sales. Venezuela has high inflation because monetary liquidity keeps going up and up while productivity goes down and down. It is the classic inflationary set up. But instead of attacking the real causes of inflation, the Government decides to sell these dollars cheap to those that have access to them. It is in the end a subsidy to the well to do and to foreign investors, who are as happy as can be investing in yields that are impossible to find anywhere else in the world.

But it is a crazy scam that will one day come back and get us. It is the Bolivarian Arbitrage.

http://devilsexcrement.com/

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Debt Factoids on Our National Debt Are Puzzling – And Scary – Seeking Alpha


If you’re interested in the subject of our national debt, there is a new must read report from the Congressional Budget Office (CBO) on the topic. It includes some odds and ends that I found interesting.
We know that there is a law called the debt ceiling. We also know that we will (again) hit that limit early in 2011. Many think that this will be a line in the sand fight with the new Congress. Phooey. According to the CBO report, suspending issuance of maturing cash management bills in the supplementary financing program will cost $200 billion; suspending flows and redeeming securities in government accounts, $124 billion; from the civil service retirement fund, “at least” $200 billion; from the exchange stabilization fund, $20 billion; and swapping debt with the federal financing bank, $15 billion. Total: $560 billion.

Conclusion: If there is to be a fight over the debt limit, it could be a long one.
The CBO is speaking with forked tongue in this report. A critical issue: How do we define what debt is at the federal level?

There are so many components to the puzzle. I give the CBO an A+ for this position:

CBO believes it is appropriate and useful to policymakers to include Fannie Mae’s and Freddie Mac’s financial transactions with other federal activities in the budget. The two entities do not represent a net asset to the government but a net liability — that is, their impact on the government’s financial position is a negative one.

So how does CBO actually account for F/F? It gets a D- for this:

Neither CBO nor the Administration currently incorporates debt or MBSs issued by Fannie Mae (FNMA.OB) and Freddie Mac (FMCC.OB).

That’s interesting. They say they “should” do it, but they don’t. Who makes that decision?

The Administration’s Office of Management and Budget (OMB) makes the ultimate decision about whether the activities of Fannie Mae and Freddie Mac will be included in the federal budget.

The White House decides which categories of debt are included when determining what constitutes debt? That is convenient. When did that happen? We are not talking chicken scratch here. The good folks over at the Fannie and Freddie have piled up $6 trillion in debt. We would blow out the debt ceiling set by Congress by over 40% if that came on the books. So it stays off the books. But the debt is staring us in the face. Funny system.
This also caught my eye:

Payments of interest from the FFB to the Treasury have been less than $1 billion annually in recent years but are projected to increase (to as much as $6 billion) because of higher loan activity (particularly by the Department of Energy’s Advanced Technology Vehicles Manufacturing program and the Rural Utilities Service). As of September 30, 2010, the FFB portfolio totaled $60 billion.

Hello, what is this? For interest to rise at the FFB from $1 billion to $6 billion, it would have to imply that there is at least a four- or five-fold increase in the balance sheet. This means that there is a plan to grow the FFB by $250 billion. Who is going to be the beneficiary of that? That is a hell of a lot of money. Is the FFB going to fund a solar build-out? The existing portfolio of Department of Energy loans:

Another (minor) data point of interest: The federal government has a number of trust funds that are used as accounting vehicles to store up IOUs from the government. The principal accounts and current holdings:

Social Security Trust Fund…….2.6t
Civil Service Retirement Fund…0.8t
Military Retirement Fund………0.3t
Medicare……………………….0.3t
All others…….…………………0.6t

Total:…………………………..4.6 trillion

These funds are all anticipated to grow over the next decade. One has a growth rate that is way out of whack with the others:

The Military Retirement Fund is growing at three times the rate of the others. The raw numbers are $282 billion for 2010 and $1.012 trillion for 2020. That’s a 10-year increase of $730 billion (a 350% increase). What is that about? Are we planning on a new war, or have we just not accounted for the retirement costs of the military properly over the past decade or two? I suspect (hope) it is the latter.
We have all seen a form of this chart elsewhere. It is nothing to be proud of. Yes, there are a few countries in worse shape than us. But Italy, Greece and Belgium are now making front-page news with their debt. And the U.S. will have a different outcome than Japan.

This chart of trust fund assets is central to our problem. Notice that these funds are scheduled to grow by more than $2 trillion. It sounds nice that the nation has trust funds where money is squirreled away someplace safe — money that can be used to pay bills (Social Security) when they come due over the next 20 years.

But there is no money in the trust funds. They have IOUs that obligate future taxpayers to come up with the cash when needed. The trust funds have nothing to do with “savings” in the traditional sense.
This has been going on since 1983, when Greenspan created the accounting gimmick and the huge surpluses that followed. The fact is we do have future liabilities, and there have been some savings set aside for that. But the money has been spent on funding past deficits. So, really, there are no savings.
I am not sure there is a fix to this problem. I do know that the bills on this are coming due in the next five years or so. I don’t think we will make it another 10 years without having to confront this problem.

Debt Factoids on Our National Debt Are Puzzling – And Scary – Seeking Alpha

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Bernanke on CBS’s ‘60 Minutes’ – Real Time Economics – WSJ


Need a Real Sponsor here

Bernanke on CBS’s ‘60 Minutes’

Federal Reserve Chairman Ben Bernanke appeared Sunday evening on CBS’s “60 Minutes” to discuss the state of the economy, the central bank’s controversial $600 billion bond-buying plan and the financial crisis. Following are excerpts from the interview with CBS’s Scott Pelley, as released by the network:
Q: The major banks are racking up profits in the billions. Wall Street bonuses are climbing back up to where they were. And yet, lending to small businesses actually declined in the third quarter. Why is that?

A: A lot of small businesses are not seeking credit, because, you know, because their business is not doing well, because the economy is slow. Others are not qualifying for credit, maybe because the value of their property has gone down. But some also can’t meet the terms and conditions that banks are setting.
Q: Is this a case of banks that were eager to take risks that ruin the economy being now unwilling to take risks to support the recovery?

A: We want them to take risks, but not excessive risks. we want to go for a happy medium. And I think banks are back in the business of lending. But they have not yet come back to the level of confidence that –or overconfidence –that they had prior to the crisis. We want to have an appropriate balance.
Q: What did you see that caused you to pull the trigger on the $600 billion, at this point?

A: It has to do with two aspects. the first is unemployment The other concern I should mention is that inflation is very, very low, which you think is a good thing and normally is a good thing. But we’re getting awfully close to the range where prices would actually start falling.
Q: Falling prices lead to falling wages. It lets the steam out of the economy. And you start spiraling downward. … How great a danger is that now?

A: I would say, at this point, because the Fed is acting, I would say the risk is pretty low. But if the Fed did not act, then given how much inflation has come down since the beginning of the recession, I think it would be a more serious concern.
Q: Some people think the $600 billion is a terrible idea.
A: Well. I know some people think that but what they are doing is they’re looking at some of the risks and uncertainties with doing this policy action but what I think they’re not doing is looking at the risk of not acting.
Q: Many people believe that could be highly inflationary. That it’s a dangerous thing to try

A: Well, this fear of inflation, I think is way overstated. we’ve looked at it very, very carefully. We’ve analyzed it every which way. One myth that’s out there is that what we’re doing is printing money. We’re not printing money. The amount of currency in circulation is not changing. The money supply is not changing in any significant way. What we’re doing is lowering interest rates by buying treasury securities. And by lowering interest rates, we hope to stimulate the economy to grow faster. So, the trick is to find the appropriate moment when to begin to unwind this policy. And that’s what we’re going to do.
Q: Is keeping inflation in check less of a priority for the Federal Reserve now?

A: No, absolutely not. What we’re trying to do is achieve a balance. We’ve been very, very clear that we will not allow inflation to rise above two percent or less.
Q: Can you act quickly enough to prevent inflation from getting out of control?

A: We could raise interest rates in 15 minutes if we have to. So, there really is no problem with raising rates, tightening monetary policy, slowing the economy, reducing inflation, at the appropriate time. Now, that time is not now.
Q: You have what degree of confidence in your ability to control this?

A: One hundred percent.
Q: Do you anticipate a scenario in which you would commit to more than 600 billion?

A: Oh, it’s certainly possible. And again, it depends on the efficacy of the program. It depends, on inflation. And finally it depends on how the economy looks.
Q: How would you rate the likelihood of dipping into recession again?

A: It doesn’t seem likely that we’ll have a double dip recession. And that’s because, among other things, some of the most cyclical parts of the economy, like housing, for example, are already very weak. And they can’t get much weaker. And so another decline is relatively unlikely. Now, that being said, I think a very high unemployment rate for a protracted period of time, which makes consumers, households less confident, more worried about the future, I think that’s the primary source of risk that we might have another slowdown in the economy.
Q: You seem to be saying that the recovery that we’re experiencing now is not self-sustaining.

A: It may not be. It’s very close to the border. — it takes about two and a half percent growth just to keep unemployment stable. And that’s about what we’re getting. We’re not very far from the level where the economy is not self-sustaining.
Q: [On calls to cut the deficit]

A: We need to play close attention to the fact that we are recovering now. We don’t want to take actions this year that will affect this year’s spending and this year’s taxes in a way that will hurt the recovery. That’s important. But that doesn’t stop us from thinking now about the long term structural budget deficit. We’re looking at ten, 15, 20 years from now, a situation where almost the entire federal budget will be spent on Medicare, Medicaid, Social Security, and interest on the debt. There won’t be any money left for the military or for any other services the government provides. We can only address those issues if we think about them now.
Q: How concerned are you about the calls that you’re beginning to hear on Capitol Hill that would curb the Fed’s independence?
A: Well, the Fed’s independence is critical. The central bank needs to be able to make policy without short term political concerns. In order to do what’s best for the economy. We do all of our analysis, we do all of our policy decisions based on what we think the economy needs. Not based on when the election is or what political conditions are.
Q: Is there anything that you wish you’d done differently over these last two and a half years or so?

A: Well, I wish I’d been omniscient and seen the crisis coming, the way you asked me about, I didn’t, But it was a very, very difficult situation. And– the Federal Reserve responded very aggressively, very proactively
Q: How did the Fed miss the looming financial crisis?
A: there were large portions of the financial system that were not adequately covered by the regulatory oversight. So, for example, AIG was not overseen by the Fed. … The insurance company that required the bailout, was not overseen by the Fed. It didn’t really have any real oversight at that time. Neither did Lehman Brothers the company that failed Now, I’m not saying the Fed should not have seen some of these things. One of things that I most regret is that we weren’t strong enough in in putting in consumer protections to try to cut down on the subprime lending problem. That was an area where I think we could have done more.
Q: The gap between rich and poor in this country has never been greater. In fact, we have the biggest income disparity gap of any industrialized country in the world. And I wonder where you think that’s taking America.

A: Well, it’s a very bad development. It’s creating two societies. And it’s based very much, I think, on– on educational differences The unemployment rate we’ve been talking about. If you’re a college graduate, unemployment is five percent. If you’re a high school graduate, it’s ten percent or more. It’s a very big difference. It leads to an unequal society and a society– which doesn’t have the cohesion that– that we’d like to see.
Q: We have talked about how the next several years are going be tough years in this country. But I wonder what you think about the ten year time horizon. Fifteen years. How do things look to you long term?

A: Long term, I have a lot of confidence in the United States. We have an excellent record in terms of innovation. We have great universities that are involved in technological change and progress. We have an entrepreneurial culture, much more than almost any other country. So, I think that in the longer term the United States will retain its leading position in the world. But again, we gotta get there. And we have some very difficult challenges over the next few years.
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Bernanke on CBS’s ‘60 Minutes’ – Real Time Economics – WSJ

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The MasterFeeds

MasterFeeds: Weekly Recap, And Upcoming Calendar


Weekly Recap, And Upcoming Calendar
– All Eyes On December 7 And The Irish Budget/European Bank Run – zerohedge.com
From Goldman Sachs
Week in Review

The European / IMF bail-out package for Ireland – announced one week ago – was somewhat smaller than expected at €85 bn and failed to calm market jitters spreading to other Euro zone periphery countries early in the week, most alarmingly to Spain and Italy. It was only with the ECB’s announcement that full allotment liquidity operations would continue through Q1 2011 and with a jump in ECB purchases of Portuguese government bonds on Thursday that stress in the Euro zone periphery abated somewhat.

United States labor market data were weaker than expected, with the unemployment rate jumping to 9.8%, even as the participation rate failed to rise from its very low level of 64.5%. The broadest measure of underemployment (U-6) remains stuck close to its peak level at 17.0%. After much market criticism of QE2, the weak state of the labor market in Friday’s data was seen as validating the Fed’s resumption of large scale asset purchases.

We published our global forecasts last week, as well as an initial batch of our top trades for 2011. The key feature of our forecast revisions is an upgrade to US growth to 2.7% in 2011 from 2.0% previously. This puts us slightly above consensus. On the back of this forecast revision, and with a view that the Fed will likely stay on hold through end-2012, our top trades have a decidedly pro-cyclical flavor. In FX, our top trade is short $/CNY via 2yr NDF.

Week Ahead

Central bank meetings Central banks will be meeting this week in Australia, Brazil, Canada, New Zealand, South Korea and the UK. We expect all of these meetings to keep policy rates on hold. Perhaps the most interesting meeting will be Brazil, where the central bank last week announced several measures to tighten domestic liquidity, perhaps indicating a shift to a more hawkish stance. We will be watching carefully for the minutes of the meeting, which will be published next week. In addition, it is also worth noting that this will be Governor Henrique Meirelles’ last Copom meeting, before his successor Alexandre Tombini takes over in January.

Euro zone crisis Following last week’s turbulence on the periphery, this week’s key event will be the Irish parliament vote on the 2011 budget, which is scheduled for Dec 7. A failure to pass the budget could quickly exacerbate tensions across the Euro zone periphery, by highlighting the political costs of needed budget cuts.

Monday 6th

Chile monthly indicator of economic activity (Oct) We expect this indicator to register growth of 6.0% yoy, above consensus of 5.8% yoy but down from 6.5% yoy in September.

Also interesting Taiwan CPI inflation for Nov, given our focus on food price inflation in EM

Tuesday 7th

Australia central bank meeting We expect the RBA to stay on hold at 4.75%, in line with consensus. Bank bill futures are pricing essentially a zero probability of a rate hike as well. We think the RBA will be confident about tightening monetary policy again from March next year, as the data flow should improve from what we see as a mid-cycle slowdown going into 2011.

UK industrial production (Oct) We expect IP to expand 0.3% mom, in line with consensus, after an expansion of 0.4% mom in September.

Irish parliament votes on 2011 budget

Chile CPI (Nov) We expect CPI inflation of 2.5% yoy, in line with consensus and up from 2.0% yoy in October. Consensus expects CPI excluding perishables and fuel to be flat mom, after a -0.1% mom drop in October.

Chile trade balance (Nov) We expect a trade surplus of $980 mn, below consensus which is looking for a surplus of $1,311 mn. Either way, there will be a big jump from October’s surplus of $215 mn.

Canada central bank meeting In line with consensus we think the Bank of Canada will remain on hold. Indeed, even though we upgraded our Canada growth forecast this week, we continue to believe that the Bank of Canada will remain on hold throughout 2011, as it looks over its shoulder at the Fed’s QE2.

Also interesting Philippines CPI for Nov, given our focus on food price inflation in EM

Wednesday 8th

Germany industrial production (Oct) We expect a strong print of 1.2% mom, slightly above consensus of 1.0% mom after a relatively weak reading of -0.8% mom in September.

Turkey industrial production (Oct) We expect a reading of 7.0% yoy, above consensus of 6.4% yoy, but down from 10.4% yoy in September.

Brazil IPCA inflation (Nov) Following the elevated reading for the IPCA-15, we expect IPCA inflation in November to be 0.92% mom, which is above consensus of 0.86% mom.

Brazil central bank meeting We expect the Copom to remain on hold at this meeting, in line with consensus. Last week’s reserve requirement hike and other measures could be seen as a shift to a more hawkish stance by the central bank, but whether or not this raises the probability of a hike this week depends on whether one sees this as a substitute or complement to a hike. Our economists think the latter and believe the probability of a rate hike has gone from something like 25% before last week’s measures to 45% now.

Thursday 9th

Australia employment report (Nov) We expect the unemployment rate to drop to 5.2% from 5.4% in October, in line with consensus, as we think the participation rate drops back from its higher level after last month’s jump. We think the strong trend of employment growth will continue. We are looking for +25k employment change, above consensus of +20k.

New Zealand central bank meeting In line with consensus, we expect the RBNZ to remain on hold this week.

South Korea central bank meeting We maintain our view of no rate hikes in the December and January Monetary Policy Committee meetings. We expect the next rate hike, 25 bps, to be in February 2011.

UK central bank meeting We expect the Bank of England to keep rates unchanged.

Brazil GDP (Q3) We are looking for growth of 0.5% qoq, above consensus of 0.4% qoq but below the strong pace of 1.2% qoq in Q2.

United States initial claims (Dec 4) Consensus expects initial claims of 425k, following 436k last week.

Friday 10th

China trade balance (Nov) We expect November export growth to accelerate to 27.0% on a yoy basis, from 22.9% yoy in October. Meanwhile, we believe import growth will rise to 26.0% yoy, from 25.3% yoy in October. This implies net exports will likely stay at a high level of around US$25.0 bn, slightly lower than US$27.1 bn in October. Our estimate for the trade balance is thus above consensus ($21 bn).

Turkey GDP (Q3) Consensus expects growth of 6.5% yoy, down from 10.3% yoy in Q2.

United States trade balance (Oct) We expect the trade deficit to narrow to -$40.5 bn, against consensus which expects the trade deficit to remain unchanged from the September reading at -$44.0 bn.

United States U. of Michigan consumer confidence (Dec) Consensus expects this preliminary reading to be 72.5, up from 71.6 for the November reading.


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Market Still Deluding Itself That It Can Escape The Inevitable Dénouement


 Until we face up to the reality of the economic landscape before us, we will be on the same path as Japan, 1987-present…

Market Still Deluding Itself That It Can Escape The Inevitable Denouement 
By Albert Edwards, Société Générale, London
 

The current situation reminds me of mid 2007. Investors then were content to stick their heads into very deep sand and ignore the fact that The Great Unwind had clearly begun. But in August and September 2007, even though the wheels were clearly falling off the global economy, the S&P still managed to rally 15%! The recent reaction to data suggests the market is in a similar deluded state of mind. Yet again, equity investors refuse to accept they are now locked in a Vulcan death grip and are about to fall unconscious.
The notion that the equity market predicts anything has always struck me as ludicrous. In the 25 years I have been following the markets it seems clear to me that the equity market reacts to events rather than pre-empting them. We know from the Japanese Ice Age and indeed from the US 1930’s experience, that in a post-bubble world the equity market merely follows the economic cycle. So to steal a march on the market, one should follow the leading indicators closely. These are variously pointing either to a hard landing or, at best, a decisive slowdown. In my view we are poised to slide back into another global recession: the data is slowing sharply but, just like Japan in its Ice Age, most still touchingly believe we are soft-landing. But before driving off a cliff to a hard (crash?) landing we might feel reassured when we pass a sign that reads Soft Landingand we can kid ourselves all is well.
I read an interesting article recently noting the equity market typically does not begin to slump until just AFTER analysts begin to cut their 12m forward EPS estimates (for the life of me I can’t remember where I read this, otherwise I would reference it). We have not quite reached this point. But with margins so high, any cyclical slowdown will crush productivity growth. Already in Q2, US productivity growth fell 1.8% – the steepest fall since Q3 2006.Hence, inevitably, unit labour costs have begun to rise QoQ. This trend will be exacerbated by recent more buoyant average hourly earnings seen in the last employment report. Whole economy profits are set for a 2007-like squeeze. And a sharp slide in analysts’ optimism confirms we are right on the cusp of falling forward earnings (see chart below).
OTBImage01
I love the delusion of the markets at this point in the cycle. It bemuses me why investors cannot see what is clear as the rather large nose on my face. Last Friday saw the equity market rally as August’s 67k rise in private payrolls and an upwardly revised July rise of 107kbeat expectations. But did I miss something? When did we switch from looking at headline payrolls to private jobs? Does the fact that government is shedding jobs not matter? Admittedly temporary census workers do mess up the data, but hey, why not look at nonfarm payroll data ex census? Why not indeed? Because the last 4 months run of data looks notably weaker on payrolls ex census basis than looking only at the private payroll data (ie Aug 60k vs 67k, July 89k vs 107k, June 50k vs 61k and May 21k vs 51k). But these data, on either definition, look dreadful compared to the 265k rise in April and 160k in March (ex census definition). If someone as pathologically lazy as me can find the relevant BLS webpage after a quick call to the BLS (link), why can’t the market? Because it is bad news, that’s why.
OTBImage02
August’s rebound in the US manufacturing ISM was an even bigger surprise. This is a truly nonsensical piece of datum as it was totally at variance with the regional ISMs that come out in the weeks before. The ISM is made up of leading, coincident and lagging indicators. The leading indicators – new orders, unfilled orders and vender deliveries – all fell and point to further severe weakness in the headline measure ahead (see chart above). It was the coincident and lagging indicators such as production, inventories and employment that drove up the headline number. Some of the regional subcomponents (eg Philadelphia Fed workweek) are SCREAMING that recession is imminent (see left hand chart below).
OTBImage03 OTBImage04
The real reason why markets reversed last week was that they got ahead of themselves. Aside from the end of 2008, government bonds were the most over-bought they had been over the last decade. And in equity-land the AAII two weeks ago recorded a historically low 20% of respondents as bullish (see chart above). These technical extremes will now be quickly worked off before the plunge in equity prices and bond yields resumes.
I am often asked by investors with a similar view of the world to my own (yes, there are some),whether the equity market will ever reach my 450 S&P target because of the likelihood that further Quantitative Easing will prevent asset prices from falling back to cheap levels.
Indeed we know that a central plank of the unhinged policies being pursued by the Fed and other central banks is to use QE to deliberately target higher asset prices. Ben Bernanke in a recent Jackson Hole speech dressed this up as a “portfolio balance channel”, but in reality we know from current and previous Fed Governors (most notably Alan Greenspan), that they view boosting equity and property prices as essential for boosting economic activity. Same old Fed with the same old ruinous policies. And by keeping equity and property prices higher, the US and UK Central Banks are still trying to cover up their contribution towards the ruination of American and British middle classes – (see GSW 21 January 2010, Theft! Were the US and UK central banks complicit in robbing the middle classes? – link).
The Fed may indeed prevent equity prices from slumping with any QE2 announcement. But this sounds a familiar refrain at this point in the cycle. For is monetary easing in the form of QE that different from interest rate cuts in its ability to boost equity prices? Indeed announced rate cuts in previous downturns often did generate decent technical rallies. But in the absence of any imminent cyclical recovery, equity prices continue to slide lower (see chart below). The key for me is whether QE2 can revive the economic cycle, not equity prices temporarily.
OTBImage05
In the absence of a cyclical recovery I cannot see how QE is any different in its ability to revive asset prices than lower rates in anything other than a temporary fashion. (Interestingly many of our clients think QE2 might give a temporary fillip to the risk assets but that the subsequent failure to produce any cyclical impact will cause an extremely violent reaction as investors lose faith in QE as a policy tool and Central Banks in general.)
If we plunge back into recession, do not place too much confidence in the Central Banks having control of events. As my colleague, Dylan Grice, said last week “let them keep pressing their buttons.” Ultimately they cannot fool all of the investors, all of the time.