Notes From Underground: The Good, the Bad and the Ugly (or Another Spaghetti Western)

It is very difficult to find the GOOD in the global financial world, while the BAD and UGLY abound. The GOOD could be “found ” in low interest rates on BONDS and NOTES in the U.S. Yet when you scratch below the surface, the fundamental reason for a 3% 10-YEAR NOTE is nothing to crow about. Poor employment data and the fear of a credit crisis in EUROPE is forcing investors to find shelter in the debt instruments of the U.S., even as the Washington budget circus captures the headlines. The subtext of the GOOD is that the EUROPEAN DEBT DRAMA almost cratered the global equity markets but support was found for the EQUITIES and ITALIAN BONDS when the ECB purportedly intervened in the DEBT markets by buying Italian and Spanish debt.

As my readers know,the ITALIAN BOND FUTURES RELATIVE TO THE GERMAN BUND is a very good window to the market sentiment on EURO DEBT in real-time. This spread has had tremendous volatility this week as I warned on Sunday evening and it stands to become even more volatile. The Italians listed a BOND FUTURE on Eurex almost two years ago and because it is the only other EURO BOND listed in the futures it is attracting all the hedgers and speculators who utilize it as a proxy for the EURO DEBT CRISIS. For speculators without access to the CDS and other swaps instruments, the ITALIAN BOND FUTURES is the only instrument that provides a way to trade the credit turmoil.

Also part of the GOOD was the rumor that surfaced mid-day, hinting that the European finance ministers and the ECB were working on a TRILLION EURO TARP-TYPE program. The rumor appeared to be the result of a statement by William Buiter, a former member of the Bank of England, who opined that the ECB would do whatever is necessary to create financial stability in Europe. The immediate issue is the Italian BOND AUCTION on THURSDAY, in which the Bank of Italy will issue 74 BILLION EUROS of BONDS of various duration. Buiter maintains that the ECB will have to be a major buyer to assure that it is not a FAILED AUCTION, for the consequences of a failure would create turmoil across the entire financial spectrum.

The BAD is to be found in America and Europe. The FOMC released its minutes from the June 21-22 meeting and, like a whore, provided delights for everyone at a price. Inflation Hawks found some board members willing to begin the exit from the QE2 stimulus even if unemployment did not begin to dramatically improve and inflation proved to be INTRANSITORY. “Several participants observed that the necessity of reallocating labor across sectors as the recovery proceeds as well as the loss of skills caused by high levels of long-term unemployment and permanent separations, may have temporarily reduced the economy’s level of potential output. In that case, the withdrawal of monetary accommodation may need to begin sooner than currently anticipated in financial markets.”

Of course because we are dealing with a room full of economists there has to be the “other hand” (Harry Truman always desired a one-armed economist). There was much discussion about the weakness of the U.S. and  the potential problems from peripheral Europe that could cause the FED to aggressively pursue further stimulative action, which the pundits immediately discerned to be a possible QE3. The FED has placed a great deal of the recent weakness on the Japanese disaster and Bernanke wants to believe that the supply disruptions from the tsunami will be transitory. However, in two different places, the FED was unusually worried about Europe and its effect upon the U.S. economy.

“Moreover, the recovery remained subject to some downside risks, such as the possibility of a more extended period of weak activity and declining prices in the housing sector, the chance of a larger-than-expected near-term fiscal tightening, and potential financial and economic spillovers if the situation in peripheral Europe were to deteriorate further.”  In a further mention, the FOMC goes on to say, “Meeting participants also noted that an escalation of the fiscal difficulties in Greece and spreading concerns about other peripheral European countries could cause significant FINANCIAL STRAINS IN THE UNITED STATES.” (emphasis mine)

There you have it: Now we are left to wonder how BAD the situation in Europe becomes before Bernanke and Geithner offer verbal and financial support to a very volatile European situation. The yield curves of the peripherals are in deep inversion signalling a very deep recession: Greece negative 1150; Portugal negative 362; and Ireland negative 334.

Needless to say, with all the turmoil around the globe the FED is sure to maintain “EXCEPTIONALLY LOW LEVELS FOR THE FED FUNDS RATE FOR AN EXTENDED PERIOD.” Also deemed to be in the BAD camp was a late move by MOODY’S to DOWNGRADE IRELAND to JUNK STATUS. This was certainly no surprise but it squelched an attempted rally by the U.S. markets and the EURO currency was immediately sold. Risk-on; risk-off.

There is so much UGLY that is beginning to look like the Lina Wertmuller film, SEVEN BEAUTIES. The winner of the UGLY contest, though, has to be the European bank stress tests that are due during the next few days and weeks. Is there any possibility of the truth emerging as to the genuine financial position of European Banks? How do you really value the sovereign debt on the books of the large lending institutions?

In a BLOOMBERG article on the stress tests,  a ZKA CENTRAL CREDIT COMMITTEE SAID, “Given the tense situation which already exists in money and capital markets, we believe publishing the results with the present level of detail would exacerbate the sovereign-debt crisis.” The entire DEBT CRISIS has been complicated by the continued lies and half-truths of the European financial and political elite. Does it get any UGLIER than that? Lies, damn lies and financial stress tests.



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