Archive for January, 2010

« Older Entries

Notes From Underground: Russia is the bear in the China shop

January 31, 2010

Former Treasury Secretary Hank Paulson’s book, “On the Brink: Inside the Race to Stop the Collapse of the Global Financial System”, attempts to explain why he should be praised and not buried.The question is whether it his book should be classified as fact or fiction.

We won’t be reading it, but we found the leaked excerpts that shed light on the Russians’ attempt to manufacture chaos through a selloff of Fannie Mae and Freddie Mac bonds more than interesting. The plan included persuading the Chinese to join but they declined. By the end of 2008, it appears that the Russians had sold off their GSE bonds and freed up dollars to rebalance their reserves.

Our readers know that we watch the Russians with eyes wide open for they have a proclivity to foment discord when they believe it works to their advantage. This tale from the perils of Paulson sets the board for some intriguing market movements with the events that happened over the weekend.

China is very upset with the Obama administration for announcing a $6.5 billion arms deal with Taiwan. This is not a new deal but part of what the Bush administration had initiated back in 2001. It should also be noted that this is not offensive weaponry but rather Blackhawk helicopters and Patriot Missiles. The Chinese have flexed their financial muscles, saying that they will review their purchasing of commercial aircraft and other large high level capital goods.

Boeing is nervous as are other high tech manufacturers. Interestingly, Europe announced this weekend, at the behest of Spain, that the EU was contemplating lifting their China arms embargo. We do not fault the Obama administration for honoring a previous U.S. commitment, but we warn that the trains are set in motion and they must be stopped before we are launched into an all-out trade war. An export-hungry Europe may try to benefit at the expense of Boeing losing orders. The U.S. must not respond by announcing restrictions on Chinese imports or vent its frustration at Europe. The world economy is much too fragile to embark upon playing tit-for-tat games when it comes to world trade. Let us hope that cooler heads find a way to prevail before the trains are too close to the battle lines.

A final note: We look at an article from today’s London Telegraph. Lord Turner, chairman of the Financial Services Authority (FSA) of Britain, signaled that there needs to be a heavy regulatory framework for foreign exchange carry trades. He believes carry trades serve no useful social purpose. This daft Englishman has imperialist written all over him. The carry trade is probably the most important element in the global financial system, for it tends to do the work of central banks. The U.K.’s better position is due to the fact that the carry trade was responsible for depreciating the POUND while the EURO was rallying, giving the British a trade advantage relative to its European trading partners.The recession in Britain would have been far more severe had the POUND not depreciated so severely as it was used in the carry trade game. Lord Turner’s idiocy is a main reason why there will be no global financial regulation and in this we should rejoice.

Tags:, ,
Posted in Currency | 4 Comments »

Back to the Futures – CNBC.com

January 29, 2010

Back to the Futures – CNBC.com.

Posted in Debt Market | 1 Comment »

Notes From Underground: 11:22 CST-the Swiss National Bank intervenes on the EUR/CHF crossrate

January 29, 2010

The stress in the European Union has made the Swiss Franc a haven, the SNB said not so fast. With the EUR/CHF trading at its lowest level since March of 2009, the SNB said we will not let EURO weakness bleed into making Switzerland the recipient of the angst that is developing in the financial system.

So far the effects have been short-lived as the cross is well off its high. But this being the end of the month and liquidity somewhat shallow, we would not be surprised to see the SNB make another run. The Swiss are letting it be known that they are unhappy with the present policy of benign neglect on the Greek debt problem. We will be watchful as the market will test the SWISS RESOLVE! Let the games begin.

Tags:
Posted in Currency | Leave a Comment »

Notes From Underground: The GDP was better then expected … I guess we know why the equity markets performed so well in the last quarter

January 29, 2010

Today we received the first look at fourth-quarter GDP in the U.S. The initial report stated growth registered 5.7% in the last reporting period of the year. The consensus was 4.7% so the result was demonstrably better with inflation well-contained. As the Wendy’s ad may have asked: Where are the jobs?

If job growth doesn’t begin soon these growth numbers will be inconsequential as we enter the 2010 political season. If the equity markets can’t generate a strong rally off of this data, we will be assured that the market has been fully priced to positive growth and other variables are most certainly in play. Our readers are aware that we believe that there are always other elements in play, which is way markets are dynamic in nature. Our job is to sift through the mess and see if  we can find some nuggets to profitably trade.

Again, our eyes turn to Europe as the noise coming from the policy markers becomes more confusing and is causing great volatility. We have heard so many experts tell us about what can take place under EU rules, but the more they talk the less they seem to know. Investors and traders should be careful as so much of what is put out in the media is just subjective opinion and not grounded in reason. The outcome of the Greek situation will be that Germany will provide the funds while it extracts a terrific political profit.

We watch to see if Axel Weber is named the next ECB head for that would be a significant event and would signal that Germany is in fact in a bargaining mood. The contagion of the Greek situation is causing stress in the PIIGS as rates continued to move higher all week (although they have narrowed a bit today). The problem for Europe is that a NEGATIVE FEEDBACK LOOP is developing. Why? As the spread differential between German debt and the peripheries widens, it means that the competitive positions of the PIIGS relative to the European growth engines continues to deteriorate. That is why the vicious cycle has to be stopped. The more Greece has to spend to finance its debt, the greater stress on its budget. The same applies to Spain and Portugal.

Yesterday we noted that the Chinese created more stress in the European debt markets by announcing they had no interest in the Greek government paper. Yu Yongding, a member of CASS, the highly regarded Chinese think tank, said,

“It is unreasonable for an economist to support a diversification away from an unsafe asset class to a much more unsafe asset class.”

The Chinese consider the Greek debt unsafe because they don’t trust the data coming from Greek officials. Is that the WOK calling the rotating spit black? Creating even more uncertainty for the Europeans, the British finance chief, Alistair Darling, mudded the debt situation even more. Darling inanely pointed out that the Greek situation was a problem for those in the European currency and not a problem for those not in the currency. This idiotic statement by the Exchequer will certainly come back to haunt the Brits.

Interestingly, the EURO/Pound cross should have been sold off as the Brits absolved themselves of responsibility. But that in fact is not what happened. The EUR/GBP cross instead rallied–and yes we are aware that the cross has been sold hard of late and the technicals appear terrible–but we did notice this price action. If Britain will not move to aid the UNION in crisis, why do they even pretend they wish to be a full political member. One day the Europeans will force the Brits to call the question on where they truly stand on the UNION. The Brits will not be able to have the best of both worlds: free market access while being able to float their currency as needed.

When it comes to Europe and the mess it is in, we wish to offer a quote we learned from our friend Bernard Connolly. It tells us a great deal about the European political entity and it comes from a 19th and early 20th century Italian Prime Minister, Giovani Giolitti: “The Law is something we apply to our enemies. For our friends we interpret it.”

Tags:, ,
Posted in Currency, Debt Market | Leave a Comment »

Notes From Underground: Why we owe the Greek Government a debt of gratitude

January 28, 2010

The State of Union address is over and the spin has begun. We heard a great deal but are concerned that there was little mention of how to curb the growing debt problem. It was great to hear that the President is desirous of the reinstallment of pay-go rules. This means that no tax cut or new spending program can preceed unless it is offset by spending cuts or tax increases. This was a budget tool that showed great success in the later Clinton years but funding two wars and the Bush tax cuts put it to bed. We are skeptical that this Pay-GO will see the light of day as the Liberals in Congress are already up in arms about defense spending, which is not included in the discretionary spending freeze.

Budget battles stand to be drawn out, bloody affairs as the partisan lines are drawn. As the Greek/European budget crisis plays out, we see how devastating the results of fiscal malfeasance can be. Greece is already being forced to pay very high rates relative to its neighbors for its continued profligacy. One other point that Obama raised also piqued our interest. Job growth was going to be promoted by exports. How will this come about? Export subsidies to U.S. businesses, tariffs on imports, or a concerted effort to depreciate the DOLLAR? It is one thing to promote exports but it is quite another to lay out a plan on how it is to occur, especially in an administration so beholden to union support.

While on the subject of debt, we wish to recommend a piece in today’s Financial Times by the dynamic duo of Kenneth Rogoff and Carmen Reinhart. These are two of the better academics in that they synthesize the theoretical and the practical. In this opinion piece, they warn against governments playing the yield curve by shifting debt duration to the front end where they pay cheaper rates. The problem with the DEBT load is that it eats up a big chunk of discretionary spending as rates go higher, creating havoc with all types of governing plans. The more of the budget that is used to pay interest on the DEBT, the less to spend on healthcare,education and trade promotion. This is the problem that Greece and all profligate societies confront. As Rogoff and Reinhart state:

“Although most governments still enjoy strong access to financial markets at very low interest rates,market discipline can come without warning.” They continue, “soon they will also wake up to the fiscal tsunami that is following. Governments who have convinced themselves that they have done things so much better than their predecessors had better wake up first. This time is no different.”

This wake up call will surely resonate now that the Greeks have put the issue center stage. The fact that the Chinese are questioning whether to bare gifts of money to an ailing government and the impact that Chinese wavering has had on global markets it is important to monitor all debt markets for the significant role they play in setting trading strategy. We must remember: Markets are dynamic and not static. The fundamentals that drive them are always in flux. Debt is back to on the frontline.

Tags:,
Posted in Debt Market | Leave a Comment »

Notes From Underground: Greasing the skids when Greece is skidding

January 27, 2010

The German/Greek 10-year spread widened out considerably today. As we noted yesterday, we were wary of the Greek situation in that the spread failed to narrow even with a very good auction with the bid to cover 4-1. Today’s crushing of Greek debt has put pressure on the EURO and EURO crosses. Even the Italian, Spanish and Portuguese debt levels widened from 7-10 basis points versus the German. This is going to be very problematic as the other PIIGs are now going to be attacked. Markets are like water in that it seeks out its lowest levels and removes all the flotsam and jetsam in its way.

As we write, the FED announces that rates are unchanged and will be so for an extended period. The MBS buying program will end March 31 as anticipated, but this is of little consequence now that Fannie and Freddie have been NATIONALIZED and provides the administration with a slush fund of gargantuan proportions. We also saw the 5-year Treasury auction go very well with a strong bid to cover, but we caution that this variable can be subject to further review.

In addition to the Greek situation, it seems that the Chinese are growing suspect about a large purchase of Greek debt, even with a steep premium. The Chinese have been open in their desire to rebalance reserves away from the DOLLAR, but even they are getting cold feet. (Even though EURO-based Greek debt is yielding 6.73% on 10-year duration.) This is what created the huge selloff in the Greek market but this just confirms the point that the Chinese are becoming aggressive traders and will play the market to their advantage. The days of being the novice in the game is over! We warned weeks ago that the trading arena would become more difficult as the central banks become more aggressive and better participants. Also, a tip of the hat to Fed member TOM HOENIG for voting his principles. As it has often been implied by others, consensus is the last hiding place of cowards.

Tags:, ,
Posted in Debt Market, Federal Reserve | 2 Comments »

Notes From Underground: Will the last person at Davos please sweep out the stables?

January 26, 2010

All we can do is ponder why Davos is in the limelight again. This self-absorbed group is meeting of under the banner of the World Economic Forum again to discuss the problems of the global financial system. If we took a roll call, we would find that most of the attendees were the meglomaniacs who got us into this mess. Yes, we know that Nouriel Roubini and other doomsters are there to ensure some debate. But as always their views provide the comic relief of court jesters. Maybe these leaders of industry and all-right thinking will find new ways to look for aid from world governments after their ill-thought out plans go awry. Adam Smith himself warned of “Kapitalists” and their acts of subterfuge emanating from cocktail parties. Enough is enough, but we wished to put an end to the nonsense that is reported out of this Potemkin village of intelligent thought.

The news was all Asia today as the Chinese moved again to raise the reserve requirements to curtail the loan activity that is feeding 10.7% GDP growth. To put it in perspective, these small, incremental moves appear to be shot across the bow at international investors than to be any serious attempt to halt Chinese growth. The policy makers of China have yet to follow some other emerging countries down the path of taxing investment inflows, but they are certainly aware of the impact the huge amount of foreign direct investment is having on their economy. We will be on the alert to see if these incremental moves have any impact. If they fail we will probably see some type of moderate exchange controls.

The Japanese DEBT market was downgraded today to a negative outlook. The move had a momentay effect on the YEN, but as the risk off mindset resumed control of the market the YEN ended the day very strong versus all the major currencies. Now that the Japanese have stated their unhappiness with recent YEN strength, the markets will test the BOJ and Finance Minister Naoto Kan’s resolve. The Japanese will be cautious to do anything of major impact as the G7 meeting is very near and they don’t wish to be the odd one out at the meeting. Economically though, the deflation that persists in the Japanese economy cannot tolerate an appreciating currency. There is no easy solution at hand but the crown rests very uneasy on the head of the Japanese policy makers. Throw in the current strains with the U.S. over the military base on Okinawa and the intervention question is that much more difficult. (Note: the accompanying article was written by my son, Tobias.)

The trade story of the day is how well GOLD performed with the unwinding of so much risk. The risk-off algorithm has sent GOLD down every day that the equities and commodities have fallen. The early story was more of the same but GOLD resurrected itself and ended the day higher. This may be a mere one-off event but it has certainly caught our attention, and from a fundamental view, it makes perfect sense.

While the Bernanke confirmation and Scott Brown election has distracted the media, the problems of the global financial order continue. The Greek bond auction went very well yesterday in that bid to cover was almost 4 to 1. However, the 2-10 German/Greek spread barely budged, indicating that the ostensible problems will be there until there is some type of wealth transfer from Germany to shore up the Greek economy. It was interesting to see that 78% of the Greek auction went to foreigners. Some brave investors believe that Greece will not default and that they are getting a EURO-based investment and picking up an extra 300 basis points over German rates and even 200-plus over Spain and Italy.

In addition, Luxembourg Prime Minister and Finance Minister Jean-Claude Juncker protested that the EURO was too strong versus the YUAN and the DOLLAR. Between the difficulties in Japan, European uncertainty and the political machinations of Washington, no wonder the GOLD defied the correlations of the risk-based algorithms. Somebody is buying a stairway out of here!

Tags:, , ,
Posted in Currency | 1 Comment »

Notes From Underground: Jim O’Neill & the 5% Solution

January 24, 2010

We know, we know. The president’s threatened war on Wall Street is the supposed news of the week, but to us the proposal is so convoluted and fraught with political expediency that we have yet to really figure out its impact. We are on record as favoring the type of change that was put on the table and it has the right name: THE VOLCKER RULE. Barney Frank, who ought to have jumped on this, cautions that this could be a 3- to 5-year process. When one of the most “liberal” voices in the Congress says this, we know that whatever sausage grinds its way forward it will not have a lot of spice but will be a bland concoction. Next thing we will hear is that they are convening a “blue ribbon panel.” This Congress is running from its own shadow and is now terrified of making any type of mistake.

Word comes out tonight that Ben Bernanke will be confirmed by a bi-partianship majority. When Senator Chris Dodd warned of a stock market calamity if Bernanke was not reappointed, the Senate was as limp as Bob Dole without Viagara. Bernanke will be the Man and several senators will be able to vote in opposition and tell their constituents that they stood up to the Wall Street powers (knowing of course that he will be confirmed and their will be no pain). Does the Bernanke reappointment change anything going forward? WE don’t think so. The FED will be on hold for longer than most think, especially if the onslaught against Wall Street leads to a weakening equity market. Remember former FED member Rick Mishkin’s November Financial Times piece about good bubbles and bad bubbles? The strong stock market was viewed as a positive for the economy as it was not built on leverage. The stock market strength also went a long way toward relieving some of the Pension Fund stress that was playing havoc with corporate and government pension liabilities. This is no small matter in times of a “balance sheet recession.”

An issue we think is important is the need for the Treasury to have lifted the caps on Fannie and Freddie. The U.S. Treasury has been hard at work trying to get struggling borrower’s home equity debt reworked. This is going on hand-in-hand to get workouts done on first mortgages. Under the home affordable modification plan (HAMP), first mortgage holders are not willing to do principal reductions when second lien holders and other junior lenders are not willing to make cuts. In a Bloomberg article last week, BlackRock Inc.CEO, Laurence Fink, who oversees the world’s largest asset manager, called the government’s effort flawed “because of its treatment of second mortgages,which he said should be wiped out before first liens are touched.” If second liens were wiped off the balance sheet hit to JP Morgan Chase, Bank of America and Wells Fargo would be enormous. This is a very important issue and if not reconciled, the cost to Fannie and Freddie and thus the American taxpayer is going to be huge. If it is resolved to the holders of the first mortgages, the hit to the largest banks is going to be market shaking. Put this on your radar screens.

Finally, we must respond to the news out over the weekend from Goldman’s chief European economist and top global macro analyst, Jim O’neill. We have respected Jim’s work for as long as we have traded, but the headline grabbing call of the Yuan being revalued by 5% in some immediate sense is worthless. Jim believes that the Chinese are succumbing to global pressure and will reval their currency (5%). If that is the case, Jim, give us some sense of its impact on global markets. Why do we say laughable? Because we don’t know what 5% means. We do know that when China wants to make an impact that moves hard and swift, go to your charts of Dollar/Yuan from January 1st,1994. The Chinese devalued the Yuan by 50%, from 5.8 to the dollar to 8.7 to the dollar–that was a significant statement. Oh, and it also happened to be the onset of NAFTA. 5% does not get our attention, unless of course we happen to be long.

Tags:, ,
Posted in Currency, Federal Reserve, Regulation | 4 Comments »

Notes From Underground: If We Ran the World

January 22, 2010

Just thinking in the big picture…

If we ran Goldman Sachs, we would file to return to being a partnership which would preempt the Obama “Volcker Plan.”  Then Goldman should partner with  Blackstone and /or other private equity firms to ensure that they had a ready pool of capital. This would allow Goldman to lever its theme of being the smartest guys on the street and remove the government from the equation. Notes from underground is always about thinking outside the box! More will be forthcoming but we think we have been ahead of this issue for years, so stay with us on this.

Meanwhile,we view this newest wrinkle in the landscape as incidental noise as this will be a long drawn out process. The cheap money will prevail  but there is no doubt that global capital is nervous!

Tags:,
Posted in Regulation | 11 Comments »

Notes From Underground: The Wheels of Politics Rotate Around Axel Weber

January 20, 2010

Tonight the Financial Times has two stories of major impact but do not lend themselves to an immediate trade. First, China tells some of its banks to stop lending. Think about that concept for a minute. Greenspan and Bernanke have both asserted ad nauseam that a central bank cannot prick a bubble. The Chinese have a much different take on that, in that they have recent memories of a top-down command economy. It is the Chinese political situation that renders much of the economic analysis worthless. In the realm of political economy, it is the Chinese centralized decision-making apparatus that makes it tougher to compare to the American-Anglo capitalist model. A statement such as the one cited above leads to a 3 1/2% decline in the Shanghai index, which leads to a selloff of the global markets. This is what makes the year going forward so very difficult.

The Chinese news is not the most significant story. The word from Europe tonight is that Axel Weber, the most anti-inflation hawk, will become president of the ECB when Trichet retires in 2011. We have pondered what price the Germans would exact for the bailout of the PIIGS. Now it seems as if we have our answer. The ECB is an 11-year-old institution and has never been led by a German. The first president was Wim Duisenberg,a Dutchman of strict monetarist credentials, but he was in fact a compromise in effort to keep the Bundesbank from openly controlling the Bank. To appease the disappointed French, the Dutch reached a compromise so that Dusienberg would serve half a term and Trichet, in a nod to France, would serve the second half of a full term. Most Europeans were fearful of the strict monetarism of the Bundesbankers (although Germans citizenry has never wanted to turn the control of their GELT over to others). Now that the Germans have the political and economic winds at their back, they appear to be pushing for control of European monetary policy during this time of great uncertainty.

German Chancellor Angela Merkel seems to believe that by pushing Axel Weber to the fore, she will get the German populace to buy in to a bailout of the PIIGS. It appears that the French are buying into this with the vice-presidency going to Vitor Constancio of Portugal who many consider a monetary dove. We believe this is very significant and if we are right, we should see spreads in the Greek debt markets narrow in anticipation of the Germans seen as providing DEBT RELIEF. So monetary control will be handed over to the mother of all Bundesbankers.

Oh, the wheels on the European politick go round and round but they will be rotating on a new AXEL.This is why the concept of 2+2=5 is a beautiful thing!

Tags:,
Posted in Debt Market | 3 Comments »

« Older Entries
Follow

Get every new post delivered to your Inbox.

Join 1,208 other followers