Sunday, 3 July 2011

Macro update - Scaring off the Stymphalian birds (or the bonds vigilantes) and "Stuck in the middle with you"

After cleaning the Augean Stables, Heracles was given the task of defeating the Stymphalian Birds, man eating birds with beaks of bronze and sharp metallic feathers.

This week's analogy follow up on the post relating to our hero's task of cleaning the Augean stables, relating to the amount of toxic greek debt plaguing the Augean stables (European banks...).

Although our Heracles hero, shot many of Stymphalian birds with his arrows and the rest flew far away, supposedly never to return, the Argonauts later encountered them. In the European Greek saga, our Stymphalian birds (or the bonds vigilantes), will indeed return at some point, like they did for the Argonauts. The problem with Greece, is an acute problem of solvency rather than a funding issue. M Market's big relief at both the Greek agreement on another round of austerity measures (155-138, a Pyrrhic victory?),
as well as a welcomed decent print for the ISM in the US (ISM came at 55.3 which was better than expected the 52), gave us some welcome respite in all this recent price action and excitement. Question being now, will this ISM print prove transitory and when will our greek friends come back to haunt us?

Time for some macro and markets updates!

Greek 5 year Sovereign CDS, some respite in its stratospheric rise:
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Similar story for European Sovereign CDS:
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Given the correlation between Sovereign CDS and Banks Senior 5 year CDS, no suprise even there on the tightening move:
Daily Focus Graph

In Portugal, tightening for Portuguese banks 5 year senior CDS:
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and in France:
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On the 29th of June according to CDS data provider CMA, Ireland CDS 5 year was standing at 783 bps, giving a cumulated probability of default of 47.5% over 5 year, and Portugal was standing at 775 bps with a similar level of CPD (Cumulated Probability of Default) of 48%. Greece was at 2132 bps, with a CPD of 81.5% over 5 year. Clearly the solvency issue for Greece is not resolved. Please note Greece 5 year CDS is still trading upfront, meaning, that rather than making a quarterly payment for the yearly spread, it is "cash only" upfront please for the premium. At this level of spread we are talking about a premium of around 35%, meaning for a 10 million notional trade, you would have to fork out 3.5 million USD to get covered, cheap...

Meanwhile on the 30th of June, the Italian government introduced additional fiscal austerity measures that aim to reduce the general government deficit by €47 billion (3% of 2011 GDP) by 2014. S&P said there was onne in three chance it will cut ratings of Italy in the next 24 months. Italy's debt to GDP ratio was at 119% at end-2010.

On the 30th of June we also got Unemployment Claims in the US at 419k versus 429k previously. Unemployment is still a major drag. Same story so far.
Chicago PMI came at 54.1 versus a previous print of 56.6. This set the tone for the ISM which was announced on the 1st of July. ISM manufacturing index rose to 55.3 in June from 53.5 in May
From that point Mr Markets mood changed from "Risk off" to "Risk on". Equities should continue to rise in the short term.

Nearly two thirds of the total beat of the ISM came from a jump in inventory levels, this is not great: from 48.7 to 54.1. Why ? Because an increase in inventories is a negative for future activity. Let's keep an eye on the ISM.
We are getting confusing data, The University of Michigan Consumer Sentiment index fell to 71.8 in June from 74.3 in May, well below the 74.0 that was expected.

Emerging Markets Top Gun: Welcome to danger zone...

The Economist Overheating index:

The Economist - Temperature Gauge"THIS chart, based on an analysis by The Economist, ranks 27 economies according to their risk of boiling over. We take each economy’s temperature using six different indicators: the inflation rate, the unemployment rate relative to its ten-year average, GDP growth relative to trend, excess credit (the growth in bank lending minus the growth in nominal GDP), real interest rates, and the forecast change in the current-account balance in 2011."

Emerging Markets Consumer Prices, percentage increase on year ago, thank you QE2?
Source - The Economist

Emerging Markets Real interest rates:

GDP Growth Forecasts for 2011:

Also in the news: China's official Purchasing Managers Index fell to a 28-month low to 50.9 in June with imports index tumbling to 48.7, lowest since August 2010.

UK PMI below expectations, coming at 51.3 on consensus of 52 and below May's 52.3, the fifth consecutive decline since the series' record high of 61.9 in January. UK is entrenched in stagflationary territory. I posted extensively on this blog on the UK situation. It is bleak. The Bank of England is facing higher inflation, weak growth, weak industrial output, high unemployment.

Risk aversion, the big picture, who is weak, who is strong:

A continuation on the story on US banks and why you need to avoid their common stock, David Goldman sums it up nicely in his blog:

Inadequate Loan Loss Reserves: You Read It Here First

“Bad Mortgages Weigh on Banks” is the headline of Nick Timiraos’ WSJ report that nearly 20% of US banks’ mortgage holdings are delinquent.
"The market knew this perfectly well, and reflected this knowledge in the pricing of commercial and residential mortgage-backed securities, as I explained in a blog post June 28. My calculations suggested that US banks will have to increase loan loss reserves."

WSJ Report: Troubled Mortgages Still Plague Banks - By Nick Timiraos"The report said 19.7% of mortgages in banks' portfolios were delinquent at the end of March. By contrast, nearly 6.8% of mortgages backed by Fannie and Freddie were nonperforming, as were 11.4% of all mortgages."

Stealers Wheel's 1972 - Stuck in the middle with you
"Clowns to the left of me, jokers to the right, here I am..."

"While many subprime and other risky mortgages were packaged into securities and sold off to investors, banks chose to keep certain loans or were stuck with them after securitization markets froze in 2007. Loans held on bank balance sheets “in and of themselves are reflective of lesser quality loans” than those backed by Fannie, Freddie, or federal agencies, said Bruce Krueger, a senior OCC mortgage examiner."

and Nick's article as well:
"Banks and thrifts hold around $2.6 trillion in mortgage debt, including around $765 billion in second mortgages and home-equity lines of credit. Regulators said that because banks write down loans long before a foreclosure sale occurs, the longer delinquency and foreclosure timelines couldn’t be used to avoid losses.

But some analysts said the figures should raise concerns over banks’ loan-loss reserves, especially if home prices take another tumble. The loan delinquency rates “suggest that the banks are severely under-provisioned relative to potential losses,” said Daniel Alpert, managing director of Westwood Capital. “Even without the [second mortgage] issue, it’s qualitatively not good.”

So, for some the result will be:

BofA to Book Massive Charges Tied to Mortgages - WSJ - David Benoit
"NEW YORK—Bank of America Corp. will take a massive blow of more than $20 billion in the second quarter for various mortgage-related costs, including $14 billion the bank will put aside to repurchase soured mortgage loans from investors.

The costs show the continuing impact on the nation's biggest bank from the housing crisis and its purchase of home lender Countrywide Financial.

The bank will pay $8.5 billion to settle claims brought by a group of high-profile investors, including BlackRock Inc., MetLife Inc. and Pacific Investment Management Co., or Pimco, that purchased mortgage-backed securities that subsequently went sour."

From Bloomberg - New York Fed Halts AIG Bond Auctions on Market Conditions
"The Federal Reserve Bank of New York is halting its sales of mortgage bonds acquired in the rescue of American International Group Inc. "Given prevailing market conditions” for residential mortgage-backed securities, “we do not anticipate any sales of bonds in the near term or until such time as the New York Fed deems it will achieve value for the public," Jack Gutt, a New York Fed spokesman said in an e-mail.

Funny foreclosure story of the week:

Donald trump versus Bank of America

Donald Trump squeezes Bank of America - Kim Peterson

The Fall of the House of Kluge Leads to the Rise of the Yard of Trump - WSJ
Mortgage on the estate was 22.8 million USD.
Bank of America bought it back for 15.3 million USD during foreclosure auction.
Donald Trump's bid during auction, 3.6 million USD.
Thing is, the Donald had already snapped up in February before the auction: the lawn, the driveway of the foreclosed Kluge Mansion, and the Bank is, well not amused.

Truly "stuck in the middle" with Trump...

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