Notes From Underground: No Surprises This Monday

Even as the rumors of a massive IMF intervention to support Italy faded into the New York close the equity were buoyed by the robust start to the HOLIDAY SHOPPING SEASON. Increased sales and no bad news from Europe left the risk on (deleveraging halted) for at least another day. The 2/10 Italian curve aided the rally as the curve MOVED 50 BASIS POINTS AND CLAWED BACK TO A POSITIVE SLOPE. IN YESTERDAY’S BLOG IT WAS NOTED THAT THE 2/10 CURVES OF THE SPANISH AND ITALIAN DEBT MARKETS WERE NOW AN IMPORTANT INDICATOR OF DEBT STRESS AND FEARS FOR THE ECONOMIES OF THOSE ON THE PRECIPICE OF CRISIS.

Every time the markets edge back from the brink of disaster, the EUROPEAN POLICY MAKERS go into rumor denial. This is no way to run an economy on the verge of collapse as it is time for the EUROCRATS AND GLOBAL KINGPINS TO GET AHEAD OF THE CRISIS RATHER THEN ALWAYS GOING INTO REACTION FUNCTION MODE. The ECB CAN’T AND WILL NOT DO IT ALONE.

Yesterday’s London Telegraph had an interesting piece by the highly regarded Ambrose Evans-Pritchard titled, “SHOULD THE FED SAVE EUROPE FROM DISASTER?” Pritchard’s main point is that if the Germans wish to continue the battle of FISCAL REPRESSION leading the world into a global recession and possibly depression, it is incumbent upon the FED to act as the world’s lender of last resort. Money supply figures revealed that the velocity of money is slowing and coupled with the push for fiscal austerity equals economic destruction.

Pritchard cites comments from Myron Scholes and Brad DeLong that the FED is able to buy foreign bonds. In Bernanke’s famous November 2002 speech, “Deflation: Making Sure It Doesn’t Happen Here,” Bernanke stated: “The Fed can inject money into the economy in still other ways. For example, the Fed has the authority to buy foreign government debt. Potentially, this class of assets offers huge scope for Fed operations, he said. “Professor DeLong believes that the Feral Reserve needs to buy up every single European bond owned by every single American financial institution for cash.”

There are many ways for the FED to accomplish this, especially as it is sitting on BILLIONS OF EURO received in SWAP ARRANGEMENTS WITH THE ECB. There is a major problem for the FED in aiding the bailout of Europe. The FEDERAL RESERVE is going to suffer the “slings and arrows” of U.S. legislators as it has been revealed that the FED played the bagman for the largest U.S. banks in aiding them through the crisis of 2008-2009. The FED was loath to reveal how much money it made available to large Wall Street banks. Bloomberg News forced the public disclosure about the vast amounts on money made available at zero rates and enabled the banks with horrible collateral to be saved, and, in the end, turn a sizable profit.

The FED can argue that it kept the financial system afloat, but that is not going to be an easy sell to a citizenry desiring the jailing of Wall Street executives for malfeasance. The fact that the FED had to be sued in court to release the information is a major problem for Bernanke. The FED faces a compounded problem because the BANKS turned a sizable profit with the FED‘s benevolence and sat by as the Bankers distributed the profits in sizable bonuses.Bernanke will catch heat from Ron Paul and others for failing to speak out against such LARGESSE, rather than for urging the banks to increase their capital bases. THE FED BAILOUT OF EUROPE MAY BE A SOUND ECONOMIC IDEA BUT THE POLITICS ARE GOING TO BE UGLY.

***A reader wrote a note about the JGB‘s and the terrible-looking chart. Nice Z man and a hat tip to you. It certainly appears the Japanese debt market is being sold and it is doing it with the YEN beginning to weaken. For several days, even when the market was in risk-off mode, the YEN failed to attain its haven status. The market is definitely beginning to sense that something in Japan is changing. The BOJ and Ministry of Finance are very concerned about the YEN strength hurting Japanese growth and as the Koreans warned last week, hollowing out Japanese manufacturing. TONIGHT, THE JAPANESE UNEMPLOYMENT RATE INCREASED TO 4.5% FROM 4.1% (consensus was 4.2%).

Japan’s efforts at YEN intervention has had no success. With the JGBs and the YEN both weakening in tandem, it is time to be alert to a fundamental change in the market. Whip out the technicals and look at DOLLAR/YEN resistance levels and JGB support levels to be prepared for any real indication of a change in market sentiment. The answer may soon find itself in the NIKKEI for it has been a dismal performer this year, down 20%. The EUR/YEN CROSS, WHICH CAN GENERALLY BE A GOOD PROXY FOR THE JAPANESE PICTURE, is no longer as the EURO is subject to every financial headline. Remember, it is month-end Wednesday and year-end in a month. LIQUIDITY, WHERE FORE ART THOU?

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8 Responses to “Notes From Underground: No Surprises This Monday”

  1. Danny Says:

    If markets go risk-on for the rest of the year does that imply JGB’s and Yen get sold off along with every other asset that had been playing the role of safe haven? If so, how does one draw a point of distinction between a risk-on world vs. a fundamental shift in the market’s assessment of the Japanese macroeconomic future?

  2. yra Says:

    Danny–this is a good question and will be answered later.But this is the dynamic that will make the next year very interesting as the algo’s break -down and new relationships are established.Remember that markets are DYNAMIC and not STATIC and good traders always adjust to changing relationships.

  3. vortex Says:

    Morning Yra,

    As you touch base on the Pritchard story and the FED backstop. I would like to get your thoughts on the following Opinion from a ZH poster named Mediocritas. I learned from Jim that it is only a man’s opinion although I would really appreciate your take on it. Especially since from your comment here Iam asking myself what would be more politically damaging bailing out EU or facing an accelerating downward slope in economic activity in an election year?

    Best regards

    Sun, 11/27/2011 – 20:08 | 1919165

    Assuming the trans-atlantic euro + eurodollar QE3 happens the way I (we?) think it will, briefly:

    – Fed pumps eurodollars into Europe via asset swaps with Europe-exposed banks holding USD-denominated “assets” (meaning overpayment for shit, meaning future inflation)

    – ECB eases with euros, exactly the same as the Fed’s QE1, just in Europe and denominated in euros. ECB ends up with an expanded balance sheet full of overvalued Eurotrash debt. Banks laugh all the way to next bubble. Extent likely limited by German resistance and political quagmire.

    – Fed supports ECB by pumping euros into Europe by depleting its own euro reserves, then increasing the limit on its swapline with the ECB and pulling more euros that way. It will be considered “safe” because USDs created to enable euro creation via swap will remain domiciled in Fed and ECB accounts. Euros will be used to acquire Eurotrash debt in support of the ECB (which may be hamstrung). Aim will be to eventually swap eurotrash debt back to the ECB in exchange for euros which will then be swapped back for USDs to zero the swap-lines. Net effect, ECB does QE1 with Fed help, Fed has a clean set of books. Major problem is transient risk. If the ECB blows up while the Fed has eurotrash on the books -> big, big trouble. Either way, investors in the US will be spooked.

    The numbers here will be big, real big. (QE1 + QE2) * 2 I would guess, minimum. Assuming it goes down something like this, then I believe that QE3 may stall the current crisis, only to replace it with another. I suspect it will deal a fatal blow to the USD. Being the world reserve currency, eurodollar holdings exceed dollars, creating a unique risk for the USD. As the US economy continues to degrade and political / social system continues to implode, QE3 pushes the risk dial to 11/10 meaning it’s only a matter of time until nations start dumping dollars and trading directly in other currencies. A flood of repatriating eurodollars is the death of the USD.

    It’ll be a hard sell to chop the USD but it will be the only way to stabilize the world economy in the aftermath. The eurodollar component of the USD will have to be excised (to become SDRs) and the remaining USD inflates into the gutter, or “stability” is encouraged by moving to the Amero. The latter option was considered plausible by the elites I’m sure, until recently. Now, it’s a damn near impossible sell given the disaster of the euro currency union.

    Of course, the US may elect to “protect” itself and let Europe tank, but “protect” is a relative term not an absolute one.

    Long term, there really is only one solution. Massive political overhaul, worldwide and an entirely re-invented financial system. There will be war preceding it. Highly optimistic that we eventually come out of it healthy.

  4. yra Says:

    Vortex–what a post.After reading this for the third time ,this is a summary of every post of the final outcome of a banking system based on the idea that DEFLATION will not happen on our watch.As bernanke promised milton friedman–we will not make that mistake again,meaning that it is the ultimate 1937er.Yes ,the fact that the world’s policy makers have spent their time in a demand sustaining world of DEBT the bill has come due and it is not pretty.Europe is a credit bubbble gone awry and the now the implosion is taking place without a lender of last resort –well we can see the impact.The U.S. will not let Europe implode because it will not be good politics for the party in power and Mr.Geithner is all about saving the banks ;where ever they may be domiciled.The silence of the big domos means that something big is in the works–pay attention for the effort will be global.As I will blog tonight –the YELLEN speech yesterday which got traction read like the essay exam of a mid -level class in comparative economics—pathetic

    • vortex Says:


      For my personal education what is a domo 🙂 (sorry if this sounds dumb…

      Back to the point seems that we have a winner:

      For release at 8:00 a.m. EDT

      The Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank, the Federal Reserve, and the Swiss National Bank are today announcing coordinated actions to enhance their capacity to provide liquidity support to the global financial system. The purpose of these actions is to ease strains in financial markets and thereby mitigate the effects of such strains on the supply of credit to households and businesses and so help foster economic activity.

      These central banks have agreed to lower the pricing on the existing temporary U.S. dollar liquidity swap arrangements by 50 basis points so that the new rate will be the U.S. dollar overnight index swap (OIS) rate plus 50 basis points. This pricing will be applied to all operations conducted from December 5, 2011. The authorization of these swap arrangements has been extended to February 1, 2013. In addition, the Bank of England, the Bank of Japan, the European Central Bank, and the Swiss National Bank will continue to offer three-month tenders until further notice.

      As a contingency measure, these central banks have also agreed to establish temporary bilateral liquidity swap arrangements so that liquidity can be provided in each jurisdiction in any of their currencies should market conditions so warrant. At present, there is no need to offer liquidity in non-domestic currencies other than the U.S. dollar, but the central banks judge it prudent to make the necessary arrangements so that liquidity support operations could be put into place quickly should the need arise. These swap lines are authorized through February 1, 2013.

      Federal Reserve Actions
      The Federal Open Market Committee has authorized an extension of the existing temporary U.S. dollar liquidity swap arrangements with the Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank, and the Swiss National Bank through February 1, 2013. The rate on these swap arrangements has been reduced from the U.S. dollar OIS rate plus 100 basis points to the OIS rate plus 50 basis points. In addition, as a contingency measure, the Federal Open Market Committee has agreed to establish similar temporary swap arrangements with these five central banks to provide liquidity in any of their currencies if necessary. Further details on the revised arrangements will be available shortly.

      U.S. financial institutions currently do not face difficulty obtaining liquidity in short-term funding markets. However, were conditions to deteriorate, the Federal Reserve has a range of tools available to provide an effective liquidity backstop for such institutions and is prepared to use these tools as needed to support financial stability and to promote the extension of credit to U.S. households and businesses.

  5. yra Says:

    Danny–we are going to be moving to calling the risk on/risk off paradigm the leveraging /deleveraging market.The Japanese have been the recipient of deleveraging money as safety has been the key although after MF GLOBAL many people I know are rethinking about the safety of CASH and the Japanese have been the Cash story–I think that the Japanese are bothered by the impact of repatriation on the Japanese economy and will look to redirect investment through alternative ways besides YEN intervention which will be the catalyst for Mrs. Watanabe to redirect investment.For my money,going forward the Nikkei/JGB relationship may be the best indicator of any real seachange.

  6. MattW Says:

    With all the noise in the blogosphere, your postings always stand out and are very much appreciated. Lucid, thoughtful, and outside the box. It’d be great to see more frequency or even Twitter, although managing a prop business limits time I’m sure:) Thanks for the great work.

  7. yra Says:

    MattW–thanks for the kind words.This is not a blog for touting but the working thru of ideas which leads to trades.Every thing in the BLOG I act on and never act opposite.The trading world is dependent on the generating of good ideas and because the voice world has diminished good discussion is needed.I love it when thoughtful readers poke at the concepts because the give in take challenges everyone to think why the trade idea may be wrong–good readers make for good discourse and hopefully we all benefit

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