Wednesday, January 27, 2010

Big Day In DC

It's a big day in D.C. today, indeed it should prove to be a big couple of days. Tonight we've got the FOMC announcement and Obama's first State of the Union address, followed tomorrow by a Senate vote on cloture in the Bernanke debate and, possibly, on the confirmation itself.

Given the timing of the first and third of those, it would appear unlikely that the Fed will rock the boat too hard at this evening's announcement. "Extended period" seems likely to remain, and it is likely somewhat premature to expect changes to the discount rate (though a recent hot 'n' heavy rumour suggested a rise is possible come March.) While there have been some suggestions that the Fed would change its policy mechanism to target interest paid on reserves rather than the Fed funds rate (given that they have lost effective control of FF given the participation of the GSE's in that market), such a significant policy shift two days before the possible exodus of the current chairman would appear to be very unlikely indeed.

As for Obama, he'll naturally touch on both health care and foreign policy, but from a market perspective the most interesting aspects of the speech will be his rhetoric towards the banks and his comments on fiscal policy generally. While the president may not be sporting a hair shirt when he makes his speech, "austerity" may be the new religion- both in terms of banks' capacity to earn, and the government's capacity to spend.

How effective such a policy stance ultimately turns out to be remains to be seen, of course, given that passage through Congress remains uncertain. On the face of it, however, less earnings for banks and less spending by the government should generate a widening of swap spreads. 10 year swap spreads are only a few bps from their lows and remain well below levels prevailing before the crisis. While this has been a function of both increased Treasury issuance and the assumption that TBTF banks are ultimately a public sector liability, a general policy move towards weaning banks from public support should re-introduce a credit premium into their liabilities.

Indeed, since Obama's announcement last week, a basket of CDS spreads of 4 US banks (BAC, C, GS, and MS) has widened modestly, as one might expect, though it remains well higher than levels prevailing at the outset of the crisis. The relationship between banks CDS and swap spreads has been a convoluted one during the crisis; since July 2007, the correlation between the two has been -0.41 (implying that wider bank CDS means tighter swap spreads.) However, since the advent of QE and the "normalization" of markets in March '09, that correlation has flipped to a more sensible +0.22. Macro Man would expect that relationship to continue, particularly if and as some institutions contemplate withdrawing from bank holding status (and thus the warm embrace of government guarantees.)

Elsewhere, Europe is no less interesting today as the orgy of demand for that Greek 5-year issue has yet to materialize in the secondary market. Amusingly (at least for those who didn't participate), the bond has sold off back towards its original offering guideline of swaps + 375 (verus an issue price of swaps + 350.) For all the sturm und drang about the leechiness of big global banks, the underwriters did a superb job of drumming up interest in this sucker and saving the Greek government a few euros.

Meanwhile, BBVA's net Q4 profits fell a cheeky 94% y/y courtesy of a slew of writedowns. Following on from similar disclosures from Soc Gen, it would appear that European financials are finding it increasingly difficult to keep juggling all the balls in the air without letting a few drop to earth.

The trend, should it continue, could pose something of a threat to European dividends. Macro Man noted a couple of weeks ago that he had vacated the last of his positions. While the strip is off quite a bit sicen then, it's still comfortably higher than the levels prevailing 3 months ago. Given that the market is still quite long of these suckers, particularly relative to the available liquidty in any sort of stressful environment, risks must surely point towards further weakness if and as the European bankinbg distress theme gets legs. This should ultimately provide an excellent opportunity to get back into the trade, hopefully at a more tasty discount to the expected divvy stream. This morning's focus on the re-emergence of a bearish Roubini does little to suggest that the time to re-enter is nigh.
That Axel Weber has emerged from hibernation and spread his hawkish wings this morning does nothing to make risky assets seem more enticing. Nor indeed does the by now obligatory Chinese rumour du jour, which this morning suggested that some banks have been ordered to withdraw loans that they'd agreed to extend in the first two weeks of the year. Per the usual, there was no confirmation, but the story didn't stop Asian equities from putting in yet another disappointing day.

It might be a big day in DC, but as noted yesterday it's a pretty eventful time elsewhere, as well. Whether the stars are aligning for a proper risk asset dump remains to be seen, but thus far Macro Man has seen little to contradict the thesis that the next decent move will be down.


Anonymous said...

The sorry state of union will stay put as long as no one in DC finally puts the CDS & their lively sovereign type bros` out of their miserable existence.

Even if we get that call eventually, as far as their fake baseline goes, FED pronouncements remain but a silly joke in an indexed shell game, run off of certain / rate-swapped / BS…

Un-innovating that one is much harder than inventing ATM.

Bob_in_MA said...

I think you're placing too much importance on the State of the Union address. It's become a kind of highly manipulated theatrical event. Presidents usually make all sorts of grandiose calls for achievements and reforms that they have little to no intention of pursuing (in 2004, the year he miraculously won reelection, Bush proposed sending people to Mars.)

What will determine what sort of bank reforms and stimulus packages are passed this year will be how the Republicans play their cards, and how the Democrats up for reelection respond to it.

And keep in mind, the worse shape the economy is in in November, the better the Republicans will do in the election. Playing the fiscal responsibility card fits in nicely.

Steve said...

Agree with everything MM, Obama has to tack right in terms of the budget, that is the strong message of the last two elections.

I wonder though, as a bear: Once this week comes and goes, and we settle in wherever we settle, will earnings not give us a nice rally up to maybe that 1121 level? I'm not a bottom up kind of guy, but the only company I have seen that really missed is AA. Everyone else has beaten, which is a hell of a performance given the expectations. Yes the market was ahead of itself and I "get" the selloff, but to me we have the ingredients for a nasty counter-rally, albeit from lower levels.

Bob_in_MA said...

I would also like to say how much I enjoy this blog. I've learned a lot and you have a very succinct way of evaluating market events.

I put it on my very short list of anti-blogs: low on ego, high on thought. Calculated Risk and Michael Pettis are two others.

Anonymous said...

Is it just me, or does Geithner look and sound like a putz?

leftback said...

Can't see the FED doing anything to rock the boat here. No change in language, let China do the tightening and any strength in USD will regulate the markets on its own.

State of the Union is likely to feature rhetoric about spending programs for jobs. That likely means a bad week for bonds coming up ahead. The Feb 5 jobs number is looming large up ahead.

Tiny Tim didn't enjoy his day on the Hill. The emails and the reminder about his taxes certainly got up his nose.

leftback said...

A tiny step towards tightening in the statement, and they are holding firm on ending MBS purchases. Pretty much as expected. Market likes it, business tax breaks ahead in the State of the Union speech, maybe bonds are going to sell off a little this week?

Steve said...

LB I was thinking they would go up, think Obama will have to be tough, support job creation but without saying the dreaded "stimulus" word.

leftback said...

Steve, two arguments against bonds here:

1) with more supply upcoming Feb 10-11, and rates currently fairly low, there is room for some selling of the long end, especially after a bit of job stimulating talk from our fearless leader.

2) technical picture is short-term bearish for long bonds here.

Having said that, I am hedging short-term against my book here - as you know, I am anticipating a W-shaped outcome and hence expect low yields for some considerable time.

der Tillman said...

Bob_in_MA – agree on your point about state of the union.
Consider the scale of the news that has come out since last week:

• China tightening
• sovereign concerns have come to fruition with the Japanese long-term sovereign debt cut to negative from stable
• Initial Jobless claims were higher than expected (who cares that the labor dept. says it was an ‘administrative’ issue)
• Dollar breaks out to 3 month highs

What else? Point is that this is some pretty abysmal news and they are all points about which the market has been concerned for a while. How long have the market and this blog been discussing tightening or sovereign issues?

And yet SPX is down less than 6%. From my perch, this isn’t too bad. And from here the news should revert back to what has driven this rally: low for long, economic #’s better than expected and earnings above consensus, along with those earnings being better ‘quality.’
US equities are still due for one final F*%# You rally.

Steve said...

Yes LB, I do believe we're turning Japanese.

Short-term you could be right, tho I view the charts as bullish. Which is what happens often enough when you have a long...

zjin said...

der Tillman ,

I mostly agree with you. I also believe that there is going to be another strong short squeeze rally in the next few weeks. When Fed stops buy MBS, there will be the first real test.

The Astigmatic Oracle said...

A cousin in the largest background checking firm in Canada says they saw a surprising increase starting in November and a lower increase in US but still surprising. Their numbers usually precede hiring increases by 5-6 months so it is possible employment will begin to increase in May.

May is also the peak month for option ARM resets, with delinquency taking 3 months and foreclosure ensuing in 3 months, that will put massive pressure on the holder's (bankster's) balance sheets 6 months later in November, 2010.

I am looking for a buy the dip type of correction from here to March, improving employment to trigger a series of run ups through summer and fall (just in time for elections!) and a great shorting opportunity starting in October, 2010.

Charles Nenner is also calling for a world of pain to hit in late fall of this year due to a forced exit from low interest rates.

Rossco said...

MM, I have to agree that whilst it may sound noble to increase employment "at all costs" it is tempting to read too much nuance into his statements, as one would a communique from the fed, when there may be no more than a soundbite there. Short of beefing up the military or completely trashing the dollar I can't think of anything that is in the administrations power. As far as trashing the dollar goes I think they've given that a good crack and its still higher than it was in 08.