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Gloves Off

Kirsten O'Farrell — Wed, 06 Oct 2010 22:06:00 GMT

here’s a lot of expectation surrounding the International Monetary Fund and World Bank meeting this weekend in Washington. The currency war sparked by global efforts to recover from the Great Recession and its repercussions should be the main discussion as governments around the globe increasingly try to use exchange rates as a domestic boost to growth.

On Monday a direct warning was sent by Charles Dallara, Institute of International Finance managing director, that the world’s leading economies must come to some sort of agreement on a currency pact or face more counter-productive protectionism. He called for a more sophisticated version of the 1985 Plaza Accord to compliment an exchange rate understanding.

Tuesday, shortly before the Bank of Japan surprised the world (although we shouldn’t have been surprised) with an interest rate cut to a range of 0.00% to 0.10% from 0.10% and threw quantitative easing on the table, the IMF sent a similar message about using exchange rates to solve domestic problems. Dominique Strauss-Kahn, head of the IMF, warned that, “translated into action such an idea would represent a very serious risk to global recovery…Any such approach would have a negative and very damaging longer-run impact.”

The dual warnings encapsulate what should be the topic of foremost concern this weekend as officials from economies around the world convene to discuss measures to be taken to help the climb out of a troubled global economic state.

Yesterday, equity markets displayed their raw sensitivity to data and events leading up to the November 3^rd Fed meeting by cheering at the BoJ’s move and then at a better than expected ISM Non-Manufacturing number (53.2 versus expected 52.0). More than just a bright spot, the ISM number had some fortunate timing and proved a theory about the dollar. Good US data leads to optimism and equity bids, putting pressure on the dollar as it equates to the risk trade, or dollar carry while the obvious bad US data puts pressure on the dollar because it raises expectations of further quantitative easing. The BoJ’s announcement of its “comprehensive monetary easing” policy was intended to put pressure on the Yen but at the same time raised expectations of further US QE and sent the dollar south. This was then compounded by the ISM release.

Expectations were also helped by some Q&A in the WSJ with Chicago Fed President Evans who said, "We need more accommodation. A lot of people respond that their take on monetary policy depends on the data coming in from here on out. For me, the data have spoken very clearly. As I stared at the forecast even before the August FOMC meeting, I had come to the conclusion that things were very different than what I had been expecting in previous meetings. This is a far grimmer forecast than we ought to have. So yes, I'm in favor of more accommodation."

But there’s still a lot of questions surrounding the seemingly imminent policy change here and what a point Philly Fed President Plosser makes in his opposition to QE2. The Fed has faced much criticism for sending the wrong message. In an interview with the Financial Times he said, “I think that before we can engage [in further QE] we need to be very clear about what it is we’re trying to do, how we’re going to go about doing it, how we’re going to measure whether we’re effective at it or not, and how we’re going to communicate that.” I think the latter is the most important. Along with Evans, George Soros happens to disagree. I wonder what trade he’s got on that favors further QE.

Plosser voices concern over further easing By Robin Harding in Washington Published: October 4 2010 06:17 | Last updated: October 4 2010 06:17 http://www.ft.com/cms/s/0/1087d124-cf5d-11df-9be2-00144feab49a.html

America needs stimulus not virtue By George Soros Published: October 4 2010 21:52 | Last updated: October 4 2010 21:52 http://www.ft.com/cms/s/0/61a77634-cfeb-11df-bb9e-00144feab49a.html

This morning’s ADP private sector employment numbers disappointed the tape by clocking -39K versus an expected build of 18K but even though it gave equities a breather it was in line with most expectations for the private payroll forecast within Friday’s Non-Farm report as ADP tends to miss by around 76K. Tomorrow we get the Monster Employment index, Weekly Jobless, and Treasury issuance announcements. Then at 1:30 Hoenig speaks. I’m looking forward to hearing what the lone dissenter has to say. He kind of has Plosser on his side now.

At this point it doesn’t seem like Friday’s employment data, or any sort of agreement discussed at the IMF meeting are going to influence whether or not we will see more QE but I’m curious to see if expectations change. The question is as much how much and when as it is what message is sent. Now with the currency war acknowledged, while we have been demonizing everyone else for intentionally devaluing their currencies, we have to make sure we don’t come across as hypocritical, lest our message with more QE look like a tired effort to say “In your face, Yen and Renminbi!” Then we can surely expect China to pull the trigger and start diluting our treasury prices with their holdings, pushing yields the Fed has worked so hard to push down back up. Sure enough, there are headlines just out about Wen warning that forced revaluation of the renminbi could be disaster for the world. Get ready for more of them fightin’ words.

Siberian Dollar

Kirsten O'Farrell — Thu, 30 Sep 2010 19:18:00 GMT

A cold windblew in China’s direction from the US House of Representatives last night. TheHouse voted yesterday on a bill put forth by the Ways and Means Committee whichdubbed China a “currency manipulator.” The name-calling is not new but the gutsto say it out loud is. The watered down version, called the Ryan Murphy bill,that passed the House vote is legislation that would allow the US to imposetariffs on imports based on estimates of currency undervaluation. Its intentionis to punish China for not allowing its currency to rise in accordance withnatural market forces, although the language is broad enough to apply to otherAsian countries.

So, in thecurrency markets we have a brewing an international war, as pointed out byBrazilian PM, Guido Mantega. It’s a race to devalue, which not everyone can winat once because currencies, unlike any other asset, are valued solely based oneach other, making it impossible for them all to fall. They affect other assetprices for sure but as a market they stand alone.

The problemscaused for the US export and manufacturing businesses by China’s currencymanipulation are not new but they are exacerbated by movements to do the sameby Taiwan, Brazil, South Korea, and most importantly, Japan, who recentlydumped Yen to buy $20B. The chatter surrounding the Murphy bill today is allabout how we went about this in the wrong way and this will cause tradetensions and ultimately hurt ourselves by making Chinese goods more expensive.The other side of the coin, however, is that we kind of don’t really have achoice. If other central banks are now coming to the table to fight we have totake aim at the perp who does the most harm.

The bill muststill pass through the Senate, which is not likely to happen before mid-termsand the market is not pricing in trade tensions but if it does pass and thepenalties come to fruition, there is the possibility we can at least expectsome form of retaliation by China. This usually entails some kind of threat to changethe balance sheet levels of dollar-denominated assets.

The US,Japan, and GB are likely to orchestrate more direct currency intervention or wewill see the value of our currencies depressed as a result of furtherquantitative easing. If other central banks take either of these tacts itincreases the likelihood of the latter happening in the US at the next meeting.

The brewing concernabout currency manipulation is likely to me the main topic at the IMF/WorldBank Fall meeting next weekend. The G7/G20 finance ministers and centralbankers will have an opportunity to meet there. This comes after the Bank ofJapan meets on Monday and Tuesday, the Bank of England meets on Wednesday andThursday, and the ECB makes post-meeting comments on Thursday as well.

The G-20Summit is in Korea November 11-12. We’ll see if they come to some sort ofcompromise.

We have a bigweek for data coming up. Non-Farm Payrolls, for which we got the last batch ofSeptember data this morning (Initial unemployment claims dropped 16K to 453K, alarger than expected drop), are the most watched but leading up to Friday’snumber we have other employment-related data, ISM Non-Manufacturing Index,Factory Orders, and Wholesale Inventories, post-employment. Sorry no chartstoday. Stay tuned.

Wait, now Rahm Emanuel is resigning too? I was still thinking about how much I was going to miss Larry Summers...

WSJ: Blaming China Won’t Help the Economy

ByANATOLE KALETSKY

Published: September 26, 2010

http://www.nytimes.com/2010/09/27/opinion/27kaletsky.html?_r=1&scp=1&sq=blaming%20china&st=cse

FT: Currency wars

By James Mackintosh

Published: September 28 2010 22:43 | Last updated: September 282010 22:43

http://www.ft.com/cms/s/0/7610475e-cb45-11df-95c0-00144feab49a.html

FT: Intervention: The genie hasescaped from the bottle

By Peter Garnham

Published: September 27 2010 17:38 | Last updated: September 272010 17:38

http://www.ft.com/cms/s/0/50ea3302-c9c6-11df-b3d6-00144feab49a.html

The Great Hesitation

Kirsten O'Farrell — Wed, 22 Sep 2010 21:46:00 GMT

We have to accept the bad that goes along with the good concerning recovery. Earlier this week the National Bureau of Economic Research declared the end of the recession we are recovering from now to be June of 2009, totaling 18 months, the longest postwar recession to date. But just because the recession was “over” doesn’t mean the struggling was over. I recently heard the recovery since called the “Great Disappointment” because the economists who said recovery would be slow and painful were proven right by, among other things, recovery of output levels, or GDP. Output took only three quarters to exceed its most recent peak after both 16-month postwar recessions, 73-75 and 81-82, while after four quarters of recovery this time around output is still 1.3% below 2007 levels.

That leads me to the next point. Recovery is not happening at the rate Fed members would like, at least that’s the interpretation we are supposed to get from yesterday’s FOMC statement. I say “supposed to” because the Fed knows what reaction it will signal with its carefully worded statements. We haven’t forgotten that Bernanke and Co. admittedly sent the wrong message in the last statement with the announcement of reinvestment of maturing MBS, and then reversed the message with his Jackson Hole speech. Regardless, the widely held interpretation of the statement is that the Fed is transitioning toward a new round of QE and we can all but expect the Fed to add to its balance sheet, barring any significant signs of strength out of upcoming data. This also means the markets will be exceptionally sensitive to data leading up to the November 3^rd meeting. Specifically, the language that signaled this is the change from “employ its policy tools as necessary,” to “prepared to provide additional accommodation” regarding support of economic recovery.

The Fed also changed its mention of levels of inflation in a way that anticipates easing by noting that already low inflation measures “are currently at levels somewhat below those the Committee judges most consistent” with its mandate and that “inflation is likely to remain subdued for some time.” In this regard some believe the Fed has already done too much, as illustrated by skyrocketing gold, not to mention record highs in other commodities. Cotton is at a 15 year high and Corn at a 2 year high, to name a few that feed into food-related inflation numbers. Without direct mention of inflation, the Organisation for Economic Co-Operation and Development alludes to action already taken as being a hindrance to the recovery lost in the recession with this statement; “It is likely that the financial crisis and response have raised the cost of capital for the foreseeable future and thus lowered potential output.” Even if inflation levels are not in a desirable range right now, doesn’t adding to the balance sheet and printing more money add to the imminent inflation problem we are seeing signs of already? Correct me if I’m wrong. A little inflation is good but the intention is to ignite the economy with inflation as a bi-product. Not the inverse. More easing seems a more than a little redundant.

A while back I heard some chatter about the how the Fed might not act at the November 3^rd meeting because it’s the day after elections and that would be too much of a shock to the markets. They don’t seem to be concerning themselves with this timing factor but it might prove to be the explanation if nothing is done at the next meeting. I have my suspicions that the administration pressures this easing bias because not enough jobs have been created (has anyone pointed that out yet or is it too far out there?) but I’m drooling to see how the markets react to the elections. Having a Fed meeting the next day might put a damper on that, however. Concerning the effect of further quantitative easing on the Fed’s balance sheet and consequently its ability to act versus restrained growth, it’s a question of what’s worse. And to that I don’t have the answer.

I’ll leave you with charts of the Fed’s balance sheet and of Non-Farm payrolls versus NBER Recession Dating courtesy of SM Research.

US takes stock of the ‘Great Recession’

By Robin Harding in Washington

Published: September 20 2010 20:50 | Last updated: September 20 2010 20:50

http://www.ft.com/cms/s/0/e1fea3ce-c4ed-11df-9134-00144feab49a.html

Destroying King Dollar Is Not the Solution

Published: Wednesday, 22 Sep 2010 | 4:40 PM ET By: Larry Kudlow

http://www.cnbc.com/id/39313137

To Everything, Turn

Kirsten O'Farrell — Wed, 15 Sep 2010 16:25:00 GMT

In what is historically the worst month for stocks, equity indexes are putting on a good show. So far for the month of September, the Dow is up 5% and the S&P, 6%. But there’s some noise beneath the surface. Of the many factors at work here, technical and fundamental, two could inflict the most influence, or at least put us on shaky ground: Fed action and mid-term elections. Yesterday’s price action means markets are starting to realize this, having been positive for most of the session and then ending up right back where they started. Uncertainty is back.

In the period between the last Fed meeting on August 10^th, until Bernanke’s Jackson Hole speech on August 27^th, stocks fell by 6.5%. This was a direct result of digestion of the announcement to reinvest maturing mortgage-backed securities to mean that the economy was in worse shape than we thought and needed more help. It was an invitation to speculate on how much more and what kind of further quantitative easing might come from the Fed. Admittedly, the move sent the wrong message, which Fed members had feared might happen. The Jackson Hole speech did damage control as did the release of minutes from the meeting and since then stocks have rallied by over 5% and bond yields have stabilized somewhat. Based on that, and further positive economic releases, I didn’t think further QE was on the table, at least not unless “the outlook were to deteriorate significantly,” but there have been several analyst calls for renewed proactive QE and lower rates. A Bloomberg article released Monday has Goldman and Pimco forecasting that the Fed will resume easing by the end of the year. Some think the possibility is already baked in, in Eisenhower era low yields. I strongly disagree that this is a possibility and I heard someone call this the “nuclear option.” It will not help the job market, nor will it help the housing market, the thorns in the side of recovery. What it will do is inject fear into the markets and diminish Fed effectiveness, as illustrated by the result of the last meeting. That being said, the options on the table if they were to take further action are worth noting because of each one’s effect on the markets. They are purchasing additional longer-term securities, altering the Committee language in regard to the extended period, and lowering the interest paid on excess reserves. The meeting is on September 21^st. More to come leading up to the meeting.

My other favorite market churner is mid-term election. All over the news today is the number of upsets within party lines. People want change on the local level and on the federal level that will be reflected exponentially. The push is towards more business-friendly and market-friendly policies including the extension of tax-cuts and increased incentives for business spending. As a result we saw more winners come out of so-called “extremist” ideals. I will go deeper into this issue and its effect on the markets in days to come. However, allow me to point out another good point made by James Mackintosh. “Since 1946, equity returns during gridlock have been lower than when the president’s party controls Congress. During gridlock, the S&P 500 has averaged 14.8 per cent in the two years after the new Congress or president takes office, against 19.9 per cent without gridlock. Conversely, bonds have produced much better returns…” However… “The average return when a Democratic president faced gridlock was almost 17 per cent, against less than half that when a Republican faced gridlock. Stopping Dems pushing for big government seems to be good for markets. In fact, though, what matters is not gridlock but whether elections are presidential or midterms. Average returns in the final two years of a president’s term are far higher, at 17.1 per cent, than the 4.8 per cent in the first two. Adjust for this, and there is only a small gap between the parties.”

I dare say if recent election results foreshadow the regime change markets hope for, we aren’t going to need any further quantitative easing. Precocious in this judgment I may be, it’s history that I am basing this on. Timing is everything.

Please respond with your thoughts and questions and stay tuned.

Should markets hope for US gridlock?

By James Mackintosh - Published: September 10 2010 01:51 | Last updated: September 10 2010 01:51

http://www.ft.com/cms/s/0/07cef4f0-bc6a-11df-a42b-00144feab49a.html

Yields Fall to Eisenhower Low in Pimco View of the Fed

By Liz Capo McCormick - Sep 13, 2010 1:41 PM ET

http://www.bloomberg.com/news/2010-09-12/treasury-yields-decline-to-eisenhower-low-in-pimco-bofa-view-of-fed-easing.html

Yellow Light

Kirsten O'Farrell — Wed, 08 Sep 2010 18:07:00 GMT

I don’t believe in coincidence, but let me point out the corny irony of a positive jobs report heading into this year’s Labor Day weekend. James Mackintosh put it perfectly in yesterday’s FT Short View where he points out that “as the armies of unemployed watched those with jobs take a break, at least they could see market confidence in job creation rising and fear of a double-dip recession receding.”

As if to confirm that hesitation is the name of the game equity markets retreated and the curve re-flattened back to pre-NFP levels. The fundamental explanation was renewed European banking system concerns after a Wall Street Journal analysis suggested Europe’s banks stress tests understated some lenders’ holdings of potentially risky government debt. During the European session equities sold off sharply, there was an increased widening in European sovereign debt spreads, and notable increases in default swaps in the European banking sector. The safe-haven bid overseas caused a flattening in the treasury curve that was mimicked during our session.

This alone, however, doesn’t give me the sense that markets have lost their positive undertone. We knew a lot of analysts have been preparing to poke holes in the European stress tests. Jean Claude Trichet said yesterday in an interview with Maria Bartiromo, “Basel III is a work in progress,” giving the impression that the news is a mere temporary setback. It doesn’t make me want to put on a Euro-steepener yet but it does make me want to explore one here. Last week we saw steepening as the transfer into stocks took life out of the rally in the long end. The addition of a better than expected 67K private sector jobs topped off the optimism that had gained steam last week, or at least, squashed a lot of the pessimism. Although yesterday’s retreat may have created opportunity, to put one on this week would be a bit premature as treasury price pressure should get an assist from supply. But as equities embrace underlying positives, bear steepening is inevitable. The Beige book’s release today will help set the tone for this month and the next Fed meeting, as well as July trade balance tomorrow and wholesale inventories Friday.

If not for the European situation markets may have paid more attention to new proposals from the Obama administration. The first is a $50B infrastructure spending program, which will likely fail to win Congressional approval and the second is tax write-offs for corporate investment. Could that be correct? Tax write-offs? Although there was more spending proposed in the same breath, this is the first of late of this type of inspiration to business growth we have seen from the current administration. As Larry Kudlow points out, it’s not that businesses are not profitable that jobs are not being created. It’s that they’re as hesitant as you and I amidst all the uncertainty regarding regulation and taxes, which is hindering projection and thus innovation and progressive growth. http://www.kudlowsmoneypolitics.blogspot.com/ http://www.cnbc.com/id/39039492

As we approach this year’s elections we may well see more of this type of pro-business proposal. The democratic majority knows it needs to get a grip if it wants to have any chance for life on the other side of elections. Although minutes and data make clear that recovery has slowed there are still an abundance of bright spots littered throughout the economic atmosphere including key elements of demand, consumer spending and now maybe, just maybe, business investment. I’ve been saying for a while that we’re right where we are supposed to be, growing, but not like we’ve just broken through a start gate. That in and of itself would inspire fear. All we need now is for our government to recognize that stability will arise from the freedom to know they are not going to get slammed with regulation and taxation. Then we can expect a little progress.

For James Mackintosh and the Financial Times “Short View:”

http://www.ft.com/cms/s/0/b2d50cce-ba33-11df-8804-00144feabdc0.html

Kevin Williamson: Another Stimulus, Another Bailout:

http://www.nationalreview.com/exchequer/245745/another-stimulus-another-bailout

The Lost Summer

Kirsten O'Farrell — Wed, 01 Sep 2010 22:19:00 GMT

It’s hard to tell whether today’s rally is an explosion of return to risk that investors have been waiting for or just a technical bounce and short cover coming off month-end selling that ended the worst August in nine years. I tend to lean toward the latter. Initially, today’s equity rally was fueled, in part, by positive data out of Asia, where the Chinese PMI snapped a three months losing streak with a rise from 51.2 to 51.7 pts. The Australian GDP rose by 1.2% in the Q2, beating the market consensus of +0.9%. A solid performance of the Asian economies provides optimism about the global economy, should the conditions in the US economy still wane, which also offers a realistic reason for yields to rise, other than just based on a transfer into equities. Then the real catalyst came when the August ISM Manufacturing Index beat expectations, clocking 56.3 versus market expectations for 52.8.

Either way, today’s rally, if not completely decimated by the close of trade tomorrow, sets us up for a pull-back if NFP disappoints or even doesn’t beat expectations with the rigor that ISM did today. You all know I don’t use equity markets as a gage of anything, let alone the state of recovery, so I’m going to turn your focus back onto the grander macro-economic picture. This is in spite of the chatter going on that today’s rally signals the reversal of the short equity, long treasury trade that has worked all summer. I’m not saying that’s not the case but as I’ve said before, one day does not a recovery make.

It was easy to poke holes in the hope that yesterday’s better than expected data. S&P Case-Schiller Home Price Index rose 1.0% in June after a 1.3% rise in May but that was dismissed as having been masked by the home buyer tax credit, which I agree with. The surprise rise in the Conference Board’s Consumer Confidence Index which unexpectedly rose to 53.5 in August from 51.0 in July can be dismissed as it remains at more depressed levels than previous recoveries. Any hope given the markets by either data piece yesterday was shot down after the release of the FOMC minutes, which generally speaking, clued us in to both the reality that growth had softened somewhat more than members had anticipated and that members would only consider large scale asset purchases if the economy weakened “appreciably.”

Regardless, those looking for clues of a Japanese lost decade rerun coming off the Jackson Hole meeting, mixed but unpleasant data, dismal Fed Minutes, and the worst August in nine years got a bit of a reprieve in today’s rally and data. Even if those doomsayers are right about deflation they still might be wrong. As “hindsight is 20/20” sounding as it may be, I like James Mackintosh’s point this morning in FT’s Short View that “Japan’s experience suggests economies can function perfectly well with entrenched deflation.” (This statement must be footnoted with his insert that economist Andrew Smithers points out that ageing population effects data and Japanese GDP per person of working age rose at more than double the rate of Germany, faster than that of the UK, and close to that of the US while on paper GDP rose only half the level of the US in the 2000’s.) I would never imply that a deflationary scenario is imminent; I just think market disappointment coming off the minutes that more government intervention is unlikely is misplaced.

We may very well get some more confirmation that we’re not in such bad shape by Friday’s non-farm payrolls number. I think it will be short-lived though. My crystal ball tells me we’ll continue to see a mixed bag of data, we’re not out of the woods yet, and equities will continue to get gitty every chance they get. Either way, it’s September now, the excuse of quiet, low-volume, unpredictability is in the rearview, and now it’s time to step it up and go back to work.

The August ADP National Employment report showed a 10,000 decline in private sector payrolls. According to Stone and McCarthy Research, this is consistent with expectation of a 50K increase in the Bureau of Labor’s private sector measure. However, they point out that we must remain mindful that in recent months the ADP reading has been weaker than BLS. Stay tuned.

A bit silly, but interestingview:

http://www.zerohedge.com/article/michael-pento-says-fed-will-buy-stocks-and-real-estate-its-next-attempt-create-inflation

Not the Size of the Wave

Kirsten O'Farrell — Thu, 19 Aug 2010 01:17:00 GMT

As diligent traders, investors, or even spectators, we are taught not to take too seriously the price action and market movement that takes place in the quieter late summer months. Still, even with this in mind, what the bond market is trying to tell us cannot be ignored. As I drown myself in research regarding the subject, all the publications I read religiously seem to be trumpeting the same thing: the outlook for recovery is gloomier than we thought.

But how much can we ask for here? If deflation is the ultimate fear, as illustrated by, among other things, the flood of investors into treasuries which pushes TIPS into negative real yields, then why did equities not get the memo? Yesterday equities rallied on positive earnings reports from Home Depot, Walmart, Urban Outfitters, and Abercrombie, among others, coupled with potential M&A activity and better than expected data. Wholesale inflation pressures rose in July for the first time in four months with annual core prices jumping to 10 month highs of 1.5%, industrial production rose more than forecast by 1%, and even ABC consumer confidence rose to -45 from -50. We all know one day does not a recovery make and I tend to listen to bonds which see the macro forest for the trees and are telling us their bull trend is still intact.

While the whole balance between deflation, disinflation, and inflation is generally elusive as to what is best for economic recovery and what we should trade on, I agree with both Hoenig and Kocherlakota that rates at zero to 25 basis points for too long could actually feed into a deflationary scenario. In spite of the most recent Senior Loan Officer’s Survey, we know it doesn’t inspire banks to lend to eachother. Right now bonds say deflation, equities don’t seem to care either way, and everyone and their dog wants to read into the FOMC action last week to reinvest maturing mortgage bonds into Treasuries. Was it enough? Is there more to come? If so, in how long? Are bonds rallying in response to this or is the real driver of the rally a further deterioration in growth expectations vs. deflation risks? One thing we can be sure of, as Larry Kudlow points out in his latest blog post, “Economic Lessons of the Summer Swoon (http://www.cnbc.com/id/38739767),” fiscal policy should NOT be the main driver of market action.

It is summer after all. Stay tuned.

FT Lex Column:
http://www.ft.com/cms/s/0c3ccb62-a9db-11df-8eb1-00144feabdc0,Authorised=false.html?_i_location=http://www.ft.com/cms/s/3/0c3ccb62-a9db-11df-8eb1-00144feabdc0.html&_i_referer=http://www.ft.com/intl/lex

WSJ: The Great American Bond Bubble:
http://online.wsj.com/article/SB10001424052748704407804575425384002846058.html

FT Short View:
http://www.ft.com/cms/s/0/9c304356-aa45-11df-9367-00144feabdc0.html

Larry Kudlow's Blog:
http://www.cnbc.com/id/38739767)

Macro Reality

Kirsten O'Farrell — Fri, 13 Aug 2010 15:26:00 GMT

I am biased. I believe if a trader is bred into fixed income he or she has the ability to see forest for the trees. If the trader is bred into the equity world he or she doesn’t even know that ability exists. Recent market activity supports my theory.

Yesterday equity markets had a reality check session following Tuesday’s release of the latest FOMC statement. In recent trade leading up to the release, risk assets had a sort of fantastic run in combination with the anticipation and other contributing factors like strong earnings reports. Tuesday’s Fed decision was to maintain its holdings in the System Open Market Account near $2.054 Trillion by buying longer-dated treasuries (specifically, by rolling over the agency debt and agency mortgaged backed securities). Just how much money is this? Courtesy of Stone and McCarthy Research: Most of the Fed's re-investable cash will come from principal payments associated with its MBS holdings, which total over $1.1 trillion. There is a lot of uncertainty associated with principal payments on MBS because of prepayments due to refinancing. Most estimates for MBS principal payments to the Fed are in a range of $10 to $15 billion per month.

The disconnect present between equities and fixed income before Tuesday’s release proved bonds to be right. Although the disconnect can be common in the early stages of recovery due to equities rising while inflation subsides and monetary policy continues to ease but we know it’s different this time for a few reasons. Among other things, the timing is off and policy action has been unconventional, so the disconnect something to pay attention to. Although I would’ve liked equities to be right because it would have made the simple steepener put on after the Humphrey Hawkins testimony work better in the short-run (maybe I shouldn’t remind you but I have to put it out there that I don’t profess to be right all the time), I also have to point out the false optimism that was present in equities. In this case the risk rally perpetuated not only as a result of positively surprising earnings reports but because of the speculation that the Fed would release more artillery in the form of quantitative easing to prevent further pull-back in recovery. Although the fact that the Fed stands ready to do whatever it takes to boost economic recovery can be read as a positive, there’s no question that the fact that it needs to do so is blatantly disappointing. Let’s be honest.

So ahead of the release, equities and treasuries both factored in more Fed action in their own ways. Equities rallied in the face of a disappointing jobs report (-131K vs. -65K forecast) because of the false reassurance that the Fed would do whatever it takes to inspire recovery. Yields, on the other hand, reflected the fresh economic disappointment by recognizing that the need for further Fed action represents weakness. Now, I’m not suggesting that Treasuries didn’t over-do the discount somewhat in the other direction with the 5 year yield dropping 1.2% and the 10 year yield dropping 1.14%, reflecting the belief that abnormally low short rates will persist for many years to come but I am pointing out that the response in the aftermath was the realization that there was no more room left in equity prices to celebrate.

Risks of a downturn have increased enough for the Fed to delay its exit from unprecedented stimulus already in place. Not too long ago the fear was placed in anticipation of the way the market would absorb the unwinding of existing quantitative easing. That fear will arise again with even more weight as part of the method of unwind, the expiry of assets on the SOMA balance sheet, has been removed and extended. The good news is now equities can join fixed income in relying on macro-economic data and actual economic conditions to drive price action rather than acting emotionally, at least until the next fundamental picture forms.

Looking forward in our managed futures fund space we are not looking to abandon the theory that it is prudent to keep an eye on the balance between inflation and deflation expectations. The near-term picture clearly shows inflation to be a more desirable scenario than deflation as we have more experience in managing it. However, current situation included, no sooner does the market get answers than they are wrong, leaving no time at all to rest on our laurels. That lends me to stress the importance of the ability to be nimble. Bonds, equities, and commodities all take a price trend cue based on the inflation/deflation aura. Right now the bias is toward discounting how much and when the Fed will take further QE action. However, with a string of better than expected numbers talk of inflation will resume and the markets will start to factor in an over-done scenario. Luckily for me, the kind of trading we do only needs a bias toward style rather than a trending direction to be opportunistic. Still, my finger has moved closer to the trigger.

FinReg, Double-Dipping, and the American Dream

Kirsten O'Farrell — Thu, 22 Jul 2010 20:10:00 GMT

Yesterday was a big day for history books. President Obama signed the most elaborate set of financial regulations since the Great Depression into power. Yesterday was also Ben Bernanke’s semi-annual Humphrey Hawkins Testimony. Both came at a time when the markets, investors, and the American public are looking for direction. Recovery strength is uncertain, markets remain hesitant, and elections loom around the corner. Some believe Bernanke stuck to the script by not lending a direction. Some believe he should have given more of a glimpse into the Fed’s actual plan, if there is one. There are those too who believe the Fed is more confused than they let on. In spite of this, my general sentiment about the economy is that we are in a good place-the middle. Strength of growth has waned but likelihood of a double-dip in our economy has also diminished. Economic data do not continue to meet expectations, yet they still reflect strength of the system. The markets have slowed their delusional press upward yet hold solidly the growth reflected in consumers and investors.

Listening to Bernanke’s testimony yesterday illustrates three major issues which largely overlap. The first is, should we fear deflation or inflation? The second is, should the Fed use additional stimulus or is it hindering growth by doing so? The third is, will the increased regulation hinder business or simply add to the deficit and negatively affect long-term fiscal sustainability?

I have long claimed that market confidence is the core of all change, actual or false. Talk of a double dip began when the markets and data began to show signs of pull-back or slowing. We feared losing the momentum gained in the first half of the year as a result of stimulus. But, on the contrary, we should fear rapid growth. Severe upswings are as dangerous, if not more, than severe down-turns. Just as we like when the economy begins to slow and rates are high, the Fed has room to move, we should like the idea that there is potential for growth, rather than imminent inflation due to the economy heating up too fast. In my opinion, the Fed has done a good job here of inflicting the perfect attitude onto the markets. We are still growing, just not so fast. I like this article: Guest Contribution: Double Dip? Seven Reasons Why Not* http://blogs.wsj.com/economics/2010/07/19/guest-contribution-double-dip-seven-reasons-why-not/

Now, I can hear you saying, “But what about unemployment?” As Bernanke stated today, we are seeing a “gradual decline” in unemployment. As the economy grows at a moderate pace the unemployment rate will equally abate. It would take an inflationary scenario to stimulate so much growth as too immediately reduce the American jobless rate. If the GDP data show 2.6%, as estimated, at the end of the month, that will put this year’s growth at the fastest recovery rate in thirty years. The risks of inflationary or deflationary outcomes seem to be contradictory. There is the element of cheap money causing hesitation in banks to lend which makes the Fed an agent of deflation. However, we can all agree, a deflation situation such as Japans is highly unlikely given the unconventional tools the Fed has used and has left to use if the situation warrants. The weaker economic data that came out over the past month prompted speculation of increased monetary stimulus. To this Bernanke answered, “We will continue to carefully assess ongoing financial and economic developments, and we remain prepared to take further policy actions as needed to foster a return to full utilization of our nation’s productive potential in a context of price stability.” He also said, however, that the Fed remains prepared to eventually raise interest rates and shrink their record balance sheet. By doing so the Fed has projected into the markets the confidence that it still has the ability to act. Confidence is all it takes.

The Dodd-Frank Bill, named after two Democrats, Senator Chris Dodd of Connecticut and Representative Barney Frank of Massachusetts, has three main facets. First, it gives the government new authority to unwind failing financial firms that may threaten the entire system. Secondly, it imposes new rules on derivatives markets. Lastly, it creates a consumer-protection agency at the Federal Reserve to monitor everything from home loans to credit cards. The argument has been whether the bill will hinder or protect and promote long-term economic growth. Only time will tell the answer to that as multiple newly formed federal agencies must now begin writing the regulations that will give the framework for enforcing the law.

Bernanke used the words “unusual uncertainty” to describe the state of the markets and the economy yesterday but also said the Dodd-Frank Bill made “significant progress” toward reducing the likelihood of a crisis such as the one have just lived through. What I’ve come away with after watching the Humphrey Hawkins Testimony and the passage of FinReg is that we are right where we are supposed to be. We don’t need to be racing upward in order to prevent falling back.

Yields on the Fly

Kirsten O'Farrell — Thu, 04 Jun 2009 20:08:00 GMT

Interest rate futures markets are increasingly baking in higher rates. A guru pointed out on Tuesday that Eurodollar contracts four years out have 3M Libor back around 4.75%. Then we have our classic 2/10yr yield curve at unprecedented record highs, today around 275, with the 10 yr adding 11 basis points since this morning’s jobless claims. As Bernanke said in his Testimony before the House Budget Committee yesterday, the rise in yields partly reflects deficit concerns, i.e. inflation, as well as signs that the pace of economic contraction may be slowing. There are also less obvious reasons, as in China dumping the dollar as its main reserve and treasury selling to hedge mortgage buying as the housing market show signs of bottoming. Is the rapid rise in yields premature or is it a hint that we are in for a ride?

The argument for rate action being premature is the point that foreign selling of longer dated maturity treasuries and mortgage-related selling are temporary phenomena and the market will digest these and stabilize. This may be, but just as some wanted to dismiss the inversion of our yield curve 2 years or so ago as “different this time” and not a signal of recession, I think it would be just as unreasonable to dismiss the steepening.

The other side of the coin has inflation being the cause of the recent spike in yields. There is the question if officials have gone too far to curb threats to financial instability. We heard the Kansas City Fed President Hoenig say the rapid rise in yields signals early market concern over inflation and the Fed must be alert to the market’s message. Although I lean more to this side, I don’t feel the need to adopt an extreme view. The expectation that the Fed will someday have to release all these treasuries on the balance sheet into the market may fuel the yield rise in part but it’s a little ignorant of anyone to think that this could happen in one fell swoop. Just as the buying is a measure of quantitative easing to help drive down mortgage and traditional lending rates it can be used as fire for quantitative hiking.

As Bernanke put it yesterday, “even after recovery gets under way, the rate of growth of real economic activity is likely to remain below its longer-run potential for a while, implying that the current slack in resource utilization will increase further.” That’s not to say that Bernanke himself is not worried about imminent inflation but does address the uncertainty with which policy will be applied going forward to maintain fiscal stability.

On a shorter-term note, we have May jobs data tomorrow. The majority seems to see it falling around -500K, but more significantly, the unemployment rate around 9.2%. If this is the case, it will be an employment scenario not seen since 1983. Bernanke warned in yesterday’s testimony that we can expect to see higher unemployment in the coming months. If these number s are better than expected, expect those in the camp that believe our steepening yield curve to be a sign of certain economic recovery to be saying “I told you so.” If not, use it as a chance to get in on the flight.

Up In Arms

Kirsten O'Farrell — Mon, 13 Apr 2009 19:27:00 GMT

The media just likes saying the word “pirate,” but I suppose that’s exactly what they are. The name for these marine criminals makes me think of Gooneys or some other fantasy movie that I pretended to be a character of as a child. All kidding aside, not that I wish any harm on crew trying to do their job, it’s refreshing to hear about something other than the global economy, politics, or the great scammers of our time. Now that everyone’s safe, the pirates are dead, and Thai protesters appear to be settling down, we have no choice but to get back to the aforementioned topics.

This may not be the first time we are here but right now the markets are sensitive. There’s less of a resolve in either direction to be confirmed by data or headlines. Although we are already in the process of laying the groundwork for a foundation, the upcoming earnings reports and data points will be key in establishing either a footing or a bit of disappointment that the market has gotten ahead of itself. This week’s Goldman tomorrow, JP Morgan Thursday, and Citi Friday are especially pertinent. I’d like to insert that the market’s recent overzealousness is what has set it up for possible disappointment. Alan Abelson puts it perfectly, “…the exchange struck us as symptomatic of the insatiable yearning of Wall Street, in general, and sell-side analysts, in particular, to uncover some sliver of bullishness beneath the dismal surface of the unvarnished truth.” (See Barron’s: Barrons Online - More Meltdown) But I do think hangovers are part of this rebuilding process.

I’ve heard talk that lots of factors could make this week bond positive. The first is earnings, second is Fed buying, and third is data, and fourth is that technically speaking, it’s time for a pull-back in stocks, which normally fuels treasury buying. The only solid factor here is that the Fed is committed to keeping borrowing rates low so buying is definite. The other factors have as much potential to be bond negative as positive and it will be interesting to see how the markets digest each. If we have another stock positive week it will only force the hand of the Fed to lay out more cash and so fight the inverse between stocks and treasuries. Today being Easter Monday, action is not at all indicative of what the rest of the week will bring but we are seeing stocks make a comeback on the day on optimism about bank earnings. To be continued.

In a 60 Minutes interview back in March when Bernanke was asked what he thought would be the first signs of recovery he said this: (BERNANKE)”one sign would be that a large bank is successful in raising private equity. Right now, all the private money is sitting on the sidelines saying, ‘We don’t know what these banks are worth. We don’t know that they’re stable.’ And they’re not willing to put their money into the banks.” Goldman was just able to raise $5.5B in private equity dedicated to buying private equity investments on the secondary market as part of a plan to pay back $10 Billion in government funds. Since they have already been able to raise $6B, I don’t think this should be taken lightly.

So, this week here in the U.S. we have a big data week. We have PPI, Retail Sales, and Business Inventories on Tuesday, CPI, Empire Manufacturing, and Industrial Production on Wednesday, and Housing Starts and Philly Fed on Thursday. The numbers could be totally benign or, in search of treasure, the market could take anything better than expected and run, further setting itself up for disappointment as the foundation is laid. I’m still not ready to be bullish equities and I’m still not ready to be bearish treasuries. This should be a fun week for traders though.

Something You Don't Know

Kirsten O'Farrell — Mon, 06 Apr 2009 19:51:00 GMT

The theme with markets and traders this week is a focus on whether or not the market has a clue. I’ve seen several interesting articles on the topic this morning already, including one cleverly titled in Barron’s: (Barrons Online - Promises, Not Problems, Occupy Markets). The stock market’s disregard for a devastatingly weak jobs report deserves some speculation, as does the fervor with which it has recently rallied. Being from the fixed income side, I hesitate to think the stock market may actually know something the rest of us don’t. Still, it would be nice if it did.

As pointed out this morning in the Journal, (WSJ.com - It's Starting To Look a Lot Like November) the hallmarks of a bear market rally are still evident. Although we have stronger drivers than what spurred the bear rally in November, we have reached a similar turning point. This will be a tell-tale week as first quarter earnings releases begin.

On the bright side, if this is just another happy bear, there is mounting evidence that the market has begun forming a solid foundation. It’s one thing to rally with no redeeming data to inspire it and another to rally briefly with some sturdy support. The week before last we got signs of improvement from home sales, Richmond Fed, durable goods orders, and University of Michigan consumer sentiment. Last week we saw improvement in auto sales, pending home sales, and manufacturing.

This week we have our eyes on market reaction to Treasury issuance (just announced: $35B in 3 yrs and $18B in reopened 10 yrs Wednesday, after $6B TIPS auction tomorrow), Fed buying ($2.35B in 10-17yrs today), and earnings releases. For data, we have consumer credit tomorrow, wholesale inventories on Wednesday, new and continued jobless claims on Thursday, and the budget deficit on Friday.

My forecast is for some more bottom-forming/foundation building in equities. And that could mean we bottom again. I’m not ready to be bearish fixed income on the same token, in spite of more issuance. The Fed is determined to ease credit and the foundation building process should fuel a flight to safety. However, the historical inverse relationship as we know it is slightly off kilter (I love talking about the tug-of-war between equities and treasuries, especially when it’s thrown off). Today is a perfect example. Treasuries are selling off with equities. Also, why did treasuries sell off across the curve after such a dismal jobs report? Because job losses are a lagging indicator? It being baked in or worry about inflation caused by quantitative easing is kind of stale. Although I don’t think the market is done, I do think it’s possible that market psychology is beginning to change. We already know ‘not bad’ news is enough. For all rights and purposes the inverse relationship is still there because equities are not going to be allowed out of the cage until rate market intervention is not absolutelynecessary to facilitate market functioning. Intervention alone should be considered ‘bad news.’ You know, Fed buying (etc.) supports fixed income, which holds rates down, which encourages borrowing, which scoots confidence in equity markets. At least, that’s what they hope is the consequence.

I think the fact that the equity market can rally with a partial inspiration from easing mortgage rates is a red herring. While rates are eased synthetically there is still the air that markets cannot function on their own. Whether they ever will again is another story but I don’t long for the days where I have to search for something to write about.

Momentum

Kirsten O'Farrell — Mon, 30 Mar 2009 19:34:00 GMT

In spite of the disappointment after today’s Fed buying that took bids out of the bond market, stocks don’t get positive flow because of auto industry concerns. Last week’s treasury buying by the Fed in effort to lower consumer borrowing rates surprised to the upside at around $7.5B in shorter dated maturities so this week only buying $2.5B was deflating for prices. Coincidentally, as a good mood in stocks tends to take yields higher, this week’s dismal mood in the equity market kind of reassures yields will be held down so not as much buying is necessary. We keep in mind that month end/quarter end has accounts taking profits on the recent rally but although the Fed has a planned amount of buying in the works, it appears the quantitative easing through treasury buying can be circumstantial.

Theory in point is that this implementation is going to allow some ultimate official control and it’s a good thing. The normal push-pull will be shaken up and so asset flow won’t be so indicative of ‘safety.’ Issuance drags on price but bad news flight to quality supports it. There’s enough bad news buying of treasuries going on with auto makers in the spotlight and jobs numbers expectations this Friday that the Fed doesn’t need to buy as much to hold yields down. Inversely, an equity sell-off like the one we’re seeing today would normally cause the bond market to go bid. Although this is supportive, the bond market has its own news, i.e. the disappointment after less Fed buying than expected, so less of a swing. I’m sure I’m not the first to realize that or point it out but I’m stating it because I think it shows commitment to reduced volatility on the part of the government which could pull the plug on option premiums in rate space and maybe even pull some liquidity back into the market in outright futures.

So, Wagoner. Now, I know everyone has been saying for a while that the government should not bailout the auto industry because it’s too socialist of a solution and then what other industries could go knocking on the government’s door? And officials listened. There is less of an attack about giving them money because allowing them to go bankrupt is an option on the table. Again, as with the case of AIG, the government is now a business partner because they chose to step in. It just seems so much simpler of a situation in this case though because of bankruptcy restructuring. Frankly, I don’t see why the market is so concerned about it. The reason it’s easier for the government to let them go bankrupt rather than just throw money at it is because its failure will be easier to absorb.

Fed speak tomorrow could be of more interest than usual with Philly Fed Prez, Plosser, likely to talk about inflation concerns resulting from highly stimulating monetary policy actions. It’s a worrisome topic that’s easy to ignore in the do or die times we’ve been seeing so his speech could have some impact on rate markets (at least here). The ECB rate announcement is Thursday so rate market action over there will have that as a driver.

This bottoming process/foundation building phase we are apparently in with equities is going to be sensitive to data now as well as headlines. There’s been enough stabilization that positive (or not so negative) data can be taken seriously and I like the macro situation returning as a force. For a while, the market just expected bad data and when it was worse than expectations there wasn’t really much of a reaction. It was also numb to better than expected data as it was easily dismissed in the face of headlines. U.S. employment figures Friday could mean the difference between another bottom and support if the housing market price data, confidence and PMI show signs of possible bottoming tomorrow. Look forward to hearing thoughts about GM.

http://thehill.com/leading-the-news/senator-no-consultation-on-asking-wagoner-to-leave-2009-03-30.html

PPIF for Dummies

Kirsten O'Farrell — Tue, 24 Mar 2009 15:23:00 GMT

Historically the bottoming process can have some wild swings while the market builds itself a new foundation. Although stock indexes are 22% off their lows it’s still contrarian to think this is more than a bear market rally. However, it does appear to be part of the bottoming process, which is almost as comforting.

Yesterday’s existing home sales number showed a surprising spike to the positive, up 5.1% while consumers are taking advantage of the deep discounts resulting from foreclosures. The median home price is down 15.5% from last year. Although the latter isn’t a happy fact, it’s what needs to happen for buyers to sniff around.

The stock market likes the details of the PPIF but a pull-back today doesn’t surprise me. Although it will take a while to demonstrate whether or not it will work it is the first time a direct attack on toxic assets has been implemented. All other attempts have been pulled back before they had a chance. The same risks are still there in valuing toxic (aka legacy) assets on banks’ balance sheets because only the owners actually know what they’re worth. Not only can they decrease in value because their elements default but they can increase when recovery comes or an actual market is created and then by banks selling they expose themselves to opportunity risk. Another detail that may make people weary is that PPIF encourages using leverage. A private investor can split the cost in half with the government and then finance it to purchase up to six times more. The tax payer then makes half of whatever the private investor gains. The plan will work if investors find a reason to buy and if banks find a reason to sell.

Strategic planning on the part of officials sent yields to the floor last week when the Fed announced its plan to purchase treasuries. Prices need to be supported, not only to keep yields low in effort to lower borrowing rates but because treasury issuance is funding the bailout. When the stock market has a good day (or days) treasuries tend to suffer as a result of asset flow. The details of Geithner’s plan released yesterday made the market optimistic that our government has the ability to fix our problem. Normally when stocks rally like that we see a spike in yields but that didn’t happen.

So now the next few days will tell the truth about equities and the next few weeks about our recession timeline. This afternoon’s 2 yr auction will be closely watched because it’s the first since details of the Fed treasury buy-back and PPIF (or P, whatever). You’ll notice treasury price charts look like they have just readjusted into a higher range, but are still sloping downwards. Questions, comments please.

http://online.barrons.com/article/SB123777960194411389-email.html

Fiery Green with Envy

Kirsten O'Farrell — Tue, 17 Mar 2009 20:57:00 GMT

I might get some hate mail for this but any idiot knows you can’t retain talent without paying for it. Here’s where I insult government employees. Now that AIG has been given upwards of $160 the tax payer’s stake is 80%. AIG employees are in essence government employees. Would talented individuals choose to work there without the prospect of compensation that rewards their talent?

On Squawk Box yesterday Jack Welch discussed the need for leaders of the new partner in these giant ailing firms, the government, to act like business people. The following excerpt comes from The Welch Way (http://www.welchway.com/)
and sums up his comments on CNBC:

There is a lot of heat over the AIG bonuses. Without commenting on specific bonuses, I want to comment on the process... People have to understand that the government is now the majority owner of AIG. They have paid 165 billion dollars and now own 80% of the company. They are, in effect, responsible for the governance of the institution. The CEO and government representatives (like a corporate board and the CEO) have to work together on issues like investment strategy and compensation matters. They can't be public critics (second guessers) of their (and our) company. Tearing the institution apart with carping will not improve our chances of getting our money back.
-Jack Welch, March 17, 2009

Now apparently AIG was contractually bound to pay these bonuses, some of which for employees who no longer work for the company. The money was supposedly left out of the agreement between AIG and the government. That’s something I would throw stones at. Also, I need to mention that the bonuses amounted to much less than 1% of the money received from the government.
If we are worried about percentages of bailout money, I suppose it’s time to ask why there is any current focus on initiatives that are unrelated (in any way) to the economic crisis at hand, initiatives that also cost tax payer dollars.

If you know me at all you know I idolize Larry Kudlow. As interesting and provocative his opinion may be, it’s one that no one has yet pointed out. He says the investor is partly responsible for his or her losses because he or she is responsible for due diligence. I mention that because I believe a more outrageous issue to be the suggestion that the government should aid in recouping losses realized by Madoff investors.

Politics are making a mountain out of this mole hill. I agree with Welch that the accusatory approach is counter-productive and this isn’t the only issue that’s creating division among constituents. It is exacerbated by the administration’s America-splitting pronouncement that spreading wealth is a great idea, and is confirmed by the attention showered upon energy, healthcare, etc. initiatives in a time of economic crisis.

In spite of the public’s outrage the market still managed another positive day. Consensus is that we are in a bear market rally that could last a few more days just to add to the disappointment when it’s over. Just thought I would vent a little. Thanks for listening.

Fool Me Once

Kirsten O'Farrell — Wed, 11 Mar 2009 18:42:00 GMT

Either the market is utterly confused because Obama said that now is a good time for long term investors to buy stocks or there’s little downside risk left in the stock market. I don’t disagree with the President but the latter explanation is quite unlikely.

Under normal circumstances if the market doesn’t fall a good clip on jobs data as dismal as what we got Friday on top of sizeable downward revisions to the two months prior I might read into it that the market is done falling. That’s easy to doubt lately though. Like everyone else, I’m thinking there has to be a different explanation. Many reasoned that since the number was roughly in line with expectations the damage was already factored in so short covering took the market back into positive territory, which is quite logical. However, knowing what we know about seasonal adjustments and unfavorable revisions during a recession, I want to doubt that one too.

Alan Abelson talked in his piece this week about how bottom callers have thinned out. Obviously they’re sick of being wrong. After all, three out of four industries are shedding jobs, with total job losses over the past four months reaching 2.6 million and 4.4 million since the recession began. It seems that market players, officials, and investors alike have finally come to terms with how dire our situation is and how little there is to be hopeful about. You get that feeling when you watch the news, read the paper, or simply talk to the person next to you. On Sunday the World Bank predicted that the global economy would shrink for the first time since WWII as well as that global trade would decline for the first time since 1982 at a rate not seen since the 30’s. It’s also no secret that it’s our (the U.S. that is) fault.

The market will spend the week first digesting jobs data and then debt supply, both corporate and government. The market is going to have a hard time getting any traction while there’s no clarity on plans to remove toxic assets from banks balance sheets and so far today has chopped around in anticipation. I know a lot of people who feel better about the market having no direction than the one it has had for the past few months.

Since I am not afraid to say I am afraid to be wrong, I’m not going to call a bottom here. But I will say this, usually when everyone gets on the same page the page turns.

About Obama making market calls:

http://www.foxnews.com/politics/first100days/2009/03/03/obama-good-time-buy-stocks/

About the World Bank’s predictions:

http://www.iht.com/articles/2009/03/08/business/econ.php

Good for the Chicken, Bad for the Egg

Kirsten O'Farrell — Mon, 02 Mar 2009 20:51:00 GMT

Oddly enough, I came across an article with the same I title as I gave my piece last week. It’s called Commonwealth and is from the February 6th issue of NY Magazine. This article had a similar connotation to mine except with a much more specific and controversial thread. Now, I’m not saying I agree or disagree, but I like that someone took the time to point out the other side of the coin. Its subtitle reads, “Sure, we want to see Wall Street humbled. But beggaring these guys is bad for New York.” I’m hoping, and not alone on this, that we see another book out of Michael Lewis about the demise of some gluttonous financial operations. Liar’s Poker is the first book I read when I decided to enter this realm. This writer, though you can tell he doesn’t have the depth of knowledge on the subject that those in our little financial world do, believes, “Wall Street has a warped incentive ecosystem, but it’s evolved that way because, over the years, it’s worked.” And he thinks Michael Lewis is wrong about the industry being doomed. I will confess I also disagree with Lewis. Please read this. It’s short.

http://nymag.com/news/intelligencer/54080/

Although a staggeringly unfathomable number, we have selectively disregarded the budget deficit this week. After all, it’s last week’s news. This week the AIG bailout restructuring holds the candle. The first attempt was hastily put together back when bailing out was barely considered as an option. Now that officials have more of a handle on a strategy it’s only right that they should use the same one on AIG. The Treasury is exchanging $40B of the preferred shares they currently hold for preferred shares with terms that more closely resemble common equity as well as another $30B line of credit. The Treasury will now have a 77.9% interest in the company. (See front page of today’s WSJ)

Equity markets are choking the AIG plan down being reminded of how hopeless the financial world seems but the treasury market is actually able to take a safety bid from equity’s slide while it has a break from issuance this week. Next week we get 3’s, 10’s, and 30’s. The curve has recently been pushed to the steepest levels since Nov and now we call the 2-10-yr yield spread flat when it runs under 200. Next week’s issuance is likely to push it even wider.

The question is no longer whether or not the government will spend the money it’s what they will spend it on. The Financial Stability Plan will be in textbooks from here on with the same regard as the New Deal. There are just as many, if not more, acronyms invented in its progress. The most prominent at the moment are TALF and PPIF. The decision of the government to buy toxic assets off the sheets of financial institutions is the solution that would stem the need for nationalization. The risk is in how truthfully they can be valued. As soon as details about the PPIF are released, I’ll be sure and post them. I don’t mean to be such a Debbie Downer but every time we wait for THE answer, we are disappointed. Just a heads-up.

Stress Test? What answers are we looking for that we don't already know?

Kirsten O'Farrell — Tue, 24 Feb 2009 17:32:00 GMT

I'd like to find out your opinions on nationalization and, more specefically, this stress test idea. It sounds to me like another creative way of stalling the public from demanding answers. But will there be any?

Common Wealth

Kirsten O'Farrell — Tue, 24 Feb 2009 17:00:00 GMT

Speculation about bank nationalization is the market’s fuel, in either direction. Treasuries may fall on the news of a takeover because for one, they are the funding, and two, they may be less valuable due to what the capital is spent on. The market waits for signs about how much help the government will lend banks and while financials so understandably drag the market down, treasuries don’t get their normal flight to quality bid when more issuance will be needed to fund what lies beneath those falling stocks. Treasuries can’t get flight to quality support when the cost of supply keeps getting higher.

The inspiration for today’s market moves began when it was announced before the start of Asian trading that Citi had approached the government for help. The “help” would consist of a conversion of some government-owned preferred shares into common shares. This would help Citi raise some temporary capital but is preferential to another step in the direction of nationalization.

The treasury market is heavily weighed upon by this week’s issuance and headlines that there will be $15B given to states this week to help with healthcare. $61B of 3 and 6 month bills will be auctioned today and a total of $94B of 2, 5, and 7 year notes will go on the block this week. The market is anticipating more issuance as rescue plans get thicker. The flow of negative news has been supportive for the long end of the curve but this may end up being an opportunity to initiate a steepener after the flow of shorter-term supply is absorbed as short end prices under pressure may alleviate and/or the long end will realize it has to pay too.

To get back to the idea of help through conversion of preferred stocks, this week government officials have said they will put banks through stress tests this week and support the banks that fail through issuance of convertible preferred shares. What is a stress test? Do we not already know the answer? I’m curious to see if there will be a definitive outcome to this. Stay tuned to the blog this week.