Friday, June 17, 2011

Hiding behind Greek smoke

Today is largely about option expiries, so we thought we'd take the opportunity to sit on our hands and, instead, have a look at the "Big Picture".

TMM reckon that the current state of the World can be described as follows:

  1. The US: The slowdown is dramatic (more on this below) but positive actual GDP prints, a Pavlovian dog-like response in the form of dip-buying on weakness (learned over the past two years), and a belief in the Fed coming to the rescue have prevented both the PhD and punting community from embracing a negative view.
  2. Europe: Smoke is coming out of the tail pipe, kangaroo-ing down the the road. Going to break down soon.
  3. China: "DON'T TALK ABOUT ANYTHING NEGATIVE!" as China is the only hope the West has. It seems to TMM as though punters are looking through to the peak in inflation and holding onto the soft-landing view - something they sense from the fact that most commentaries on China they receive seem to talk about how too many people are fearful of a hard landing/inflation etc... where is the *real* consensus?

This morning's rumours around a further EUR 150bn package for Greece have TMM shaking their heads at the Eurostriches, as it is no longer about the amounts, so much as the conditionality. The PASOK cabinet reshuffle appears to be something of a wash, and we look to next week's confidence vote for direction, but it doesn't really seem as though either side are backing down from conditionality. TMM trust in the A-Team's ability to screw it up. But given the moves in the credit market this week, it's hard to get overally bearish on the Euro or spreads here without an imminent credit event, especially in the context of EUR trading around it's 100day moving average.

But what TMM find particularly interesting is that many players still seem to view the recent risk aversion as a function of Greek developments. But hiding behind this facia, is the dramatic slowing in global data and, in particular, that of the US. Many have tried to argue that this is simply the result of supply chain-related shock-waves from the Fukashima earthquake, but it is becoming increasingly difficult to justify this view in the face of the recent Empire & Philly Fed surveys, not to mention the jobs data more broadly. Indeed, all TMM seem to see in terms of commentary on the disappointing data is that surely the data can't continue to surprise to the downside indefinitely. That, of course, is a mathematical certainty. But TMM, reluctantly, must quote their arch-nemesis Merv the Swerve: "It's the levels, stupid". Many assets are only correctly priced if the data rebounds, not if expectations are lowered. TMM do not believe markets (or the PhD community) have even come close to capitulating on their growth views in the way they did last summer.

This is striking, because this year's slowdown is far more material than last year's. Indeed, TMM's models of ISM (see chart below, blue line) based upon the Philly Fed (red line) and the Empire State (green line) surveys are consistent with ISM falling to around 49. Admittedely, these (in particular, the Empire survey) overstated the weakness in ISM in 2010 but, particularly in the case of the Philly Fed, have provided a much closer fit since. TMM have barely heard a peep about a "double dip" or indeed, the "R" word. Should ISM print close to this level, we reckon that such talk (and associated market moves) would have to become more widespread.

And this is where TMM reckon there is extreme complacency. There has been a bit of chatter about the potential for QE3, but it is clear from the political backlash - both domestically and internationally - to QE2 that the bar for further balance sheet expansion is significantly higher than it was last year. Perhaps we would need to see a sharp increase in the unemployment rate or, more worryingly, a negative payroll print. In this context, TMM believe that policy is *already* too tight and that the Fed needs to ease. The below chart shows a longer history of ISM & TMM's Philly-Fed based ISM model vs. difference between Fed Funds and it's 6month rolling average (in order to show when policy was being tightened or eased). The Fed have eased policy when these measures fell to 50 on all but one occasion. And TMM would suggest the exception (where the model touched 50, but ISM held above in this case, during the GM/Ford-driven CDS auto-correlation scare in the spring of 2005) is probably just statistical noise as a result of their model being somewhat basic. It is notable that when we reached similar levels last summer, the Fed moved to an easing stance.

So, to sum up, TMM reckon that the Fed will eventually be forced to ease, but the higher bar conflicting with the demonstrable view that policy is already tight mean that the curve needs to continue to flatten. Which is also in conflict with many punters' continual efforts to sell Treasuries. That said, with many assets trading close to technically important levels (the Euro and Spooz, in particular), TMM find it hard to express much conviction here, and wait for either an opportunity to sell a rally in risk assets or sell a break.


Ambo said...

Agree with your fundamentals,last year was a fake out.While your breaking out of your shell in regard to techs this caught my attention going through the old recs this week.
I had the following targets before QE2 expires

Dow = 12200
Euro = 1.4200
Betty = 1.6500
Oil = 92 \ 94

As it happens we've had a throwover in the Dow from that level due to your mention bias that traders have grown to love.


Anonymous said...

with current inflation prints and oil close to 4$ a gallon, more fed money supply "easing" may very well cause more commodity based tightening.

not paying interest on excess reserves would push more cash into real economy whilst possibly preventing another commodity/oil melt up.

Alen Mattich said...

Terrific insight as usual. I've got two questions for TMM:

1) Even if Greece approve the new austerity programs, who's going to enforce it. Are Greek tax collectors going to be any more efficient than they were in the past? As for asset sales, how do the buyers know what they own isn't going to be confiscated through renationalization or taxation further down the line?

2)We're all focused on the possibility of QE3. But could it be that recent market action has had more to do with fiscal policy than moneatry? In other words that the current market swoon reflects the slowdown in the rate of increase of fiscal stimulus than what Bernanke and co are doing?

CV said...

Spooz are doing a nice little pre-open hourrah today on the Mangler's capitulation. EUR/USD is bid, so is the Aussie.

All well then?


cpmppi said...


Thanks. We're a little tied up today, but we'll get back to you with answers to those questions. But we are minded to agree to some extent on the fiscal side of things.


Charles Butler said...

This perpetual sighting of Lehman repeats isn't doing anybody any favours - other than an otherwise content starved noise-o-sphere. The big news is probably that a spell of sub-par growth is all that many countries can hope for from the upside of the economic cycle for the foreseeable future.

As a possibly interesting side note, the periphery contagion thesis is not quite confirmed by Spanish debt yields. The 2-year peaked yesterday at 40+ points below late November's high. The stress, to the limited degree that the term is adequate, is found at 10 years and out. This may salvage the commentary squadron's need for hard data to prove a point (the Bond Vigilantes had to stretch to 15 to get their requisite record high yield), but it's difficult to argue that positions are seriously being taken vis a vis an imminent eurozone collapse.

This could be interpreted as either complacency or clairvoyance, but I suspect that nobody's going to get the expected bang for their buck from whatever Greek outcome materializes.

How to turn a dime from a meander around the recession line is another matter for punters, business people and governments.

Anonymous said...

It appears that the fiscal effects have been overlooked whilst many were just looking at the monetary conditions.
Pray tell what is the difference economically to the man in the street between ;
1.A substantial rate hike
2.A substantial cut in public sector spending
3.A substantial increase in the prices paid for non discretionary spending.

All 3 will curtail or impact the way in which he spends and some of course will severely dent his confidence and willingess to spend as well.

All 3 of these have been implemented or felt in various countries in the last 9 months inparticular and some of course more heavily than others.
Cumulatively though you would have to be myopic not to expect some economic contraction to result from these policies and when assets are already priced for the opposite expectation then it's going to be trouble when this divergence becomes clearer.

Leftback said...

No QE3. Not for the time being, surely? At least not until most of the undesirable effects of QE2 have had time to wear off. The problem with this form of untargeted monetary stimulus is that it is so easily and enthusiastically misdirected into speculation in commodities.

Alen is correct in his comments about the critical importance of fiscal stimulus. Presumably, Bernanke anticipated the rise of the Austerilizers and fashioned QE2 as a way of pumping some life into the economic corpse.

LB expects we will see a continued hosing of the energy speculators for a while, to the point where lower gasoline prices allow the US consumer to "drive" a modest recovery. This might happen a bit sooner than many observers expect. $4 at the pump seems to be an important number from our perch as a (British) observer based in the US.

So maybe no recession just yet, although without fiscal or additional monetary stimulus, one is surely awaiting the US in the winter?

Claus, all is forgiven about the Marmite.

Anonymous said...

The next ISM is July 1. That means we may have another couple of weeks of misery while we sell the rumour. After that it will be the July 4 holiday and the start of Q3, that might be a whole new ball game (as we say over here).

Anonymous said...

Our firm's "experts" seem to think there will be a fiscal stimulus included when congress raises the debt ceiling. No president has ever been re elected w employment >7.4%. Comments?

Leftback said...

Interesting relationship between US retail sales and gasoline:

Retail Sales and Gasoline

Bernanke succeeded in stimulating the price of crude and gasoline, perhaps his aim - b/c they feed into prices of almost all goods, thereby preventing or delaying the effects of other deflationary forces !

getyourselfconnected said...

Great post.

Anonymous said...

(BN) GM Will Idle Michigan, Indiana Plants to Pare Truck Supply

pirate of seven seas said...

some ideas being talked around here on the current ghosts based on the observations from latest BIS Statistics, that you can look by yourself at the following website

1. Default Insurance Makes the Difference: 30% of exposure to PIIGS debt is covered by CDS, meaning that bondholders will absorb 70% of the losses in case of default, while CDS issuers will take a hit on 30% of the losses.

2. Exposure in Europe, but also in the U.S.: In terms of exposure to PIIGS debt, it seems European banks loaded up on the bonds whereas U.S. institutions sold CDS.

3. Default May Hurt U.S. and Europe: While European institutions would take more direct losses through the bonds they own if one of the PIIGS defaulted, U.S. banks apparently have just as much to lose via the CDS they wrote on those bonds.


1. Both sides of the Atlantic seem to have been the main beneficiaries of QE2 Fed policy initiative: QE2 reserves did benefit European banks as it allowed them to plug some of the capital holes created by their exposure to PIIGS debt. This temporary situation gave some happy people a good opportunity to leave the Euro at nice exchange rates.

3. If the BIS data are correct, saving the PIIGS bondholders (mostly European banks) also served to dress well to some financial institutions who wrote CDS on those bonds (mostly U.S. banks and insurance companies).

4. When Greece defaults (September? Only IMF knows) US banks are going to have to dip into capital to pay those commitments and the capital that should be available for loans to businesses, but will have to be paid to European banks instead. Oops, looks like they did it again.


geert said...

Anon 9.06
The CDS coverage only goes in case of default and default doesn't seem an option, but of course with the Greeks, you never know.
I guess that governments who still have a big stake in their banks, can push them to accept a Vienna style restructuring.
A Vienna style rollover won't force banks to recognize losses and some forgiveness is possible as long as it is in line with provisions that have been reserved already by the banks.

WellRed said...

Looks like we have the 2011 redux of last summer's sell-off, bailout announcement, sell-off, bailout announcement, sell-off, bailout announcement, ad nauseum on our hands here. Meanwhile, the Greek debt chip shuffling from private to public balance sheets continues (sorry German taxpayers).

I agree with Gert that governments with stakes in their banks can strong-arm those banks into accepting a "voluntary" restructuring. In fact, it appears they are doing so as German and French banking groups have stated that they would participate in a maturity extension. However, the entire stock of privately held debt will not be extended, as those who do not owe their respective governments have no incentive at all to extend maturities.

Leaving alone the Greek population's take on the situation...

Leftback said...

IF the Greek bailout were finally successful, would that constitute a FETA complis?

(Boom, Boom)

CV said...

Ha ha ... Watch out with them espresso shots LB, or was that marmite ;) ?

Anonymous said...

@LB, I love that kind of shamelessness ;-)

- Whammer

Ambo said...

You heard here first at TMM,USA ripped it off Japan and give it a name.

The QE reflexivity trade.