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Friday, May 29, 2009

Financials: Charts Say "Decision Time"

The Bank Index (BKX) was rejected by the declining 200 day EMA (green line) and is now sitting on support, entangled by the 20 and 50 day EMAs (blue line and red line).

An oversold bounce is possible, but failure to do so would make this chart "roll over". The broader markets would have a tough go of it without the financials.

Momentum is waning. The MACD has crossed over twice now and never confirmed the last price high...

The Regional Banking Index (KRX), is clearly weaker than the BKX. Price is now below all three moving averages, the 200, 50 and 20 day EMAs (green, red and blue lines). The regional banks are the ones that got deep into commercial real estate loans. They're also the ones that got bailed out the least and are expected to be the "next shoe to drop".

Make or break time for financials and the broader markets can't make a sustained move without them...

Possible Breakout and Up?

I don't like it, but could there be another leg up?

Despite the turmoil in the bond markets and rapidly rising mortgage rates, equities could be poised for another move up. After consolidating and working off some overbought indicators, the declining 200 day EMA (green line) remains as the final hurdle on the NYSE Composite and the S&P 500.

Futures are up pre-market.

A green day today could result in a break out and to the upside of this consolidation for the NYSE Composite Index. Prices seem to keep finding support at the rising 20 day EMA (blue line).

A green day today could result in a break out and to the upside of this consolidation for the S&P 500. Prices seem to keep finding support at the rising 20 day EMA (blue line).

Thursday, May 28, 2009

A Quick Green Shoots Check

FN: There can be no "green shoots" until foreclosure numbers first stabilize and then start falling. The problem is that this can only occur when unemployment rates first stabilize and then start falling. Clearly this is not happening yet. Throw suddenly rising rates into the mix as the global bond markets shudder under the impossible burden of supporting a global quantitative easing campaign and it quickly becomes obvious that there really are no "green shoots" of recovery.

Mortgage Delinquencies Rise to Record on Job Losses (Update1): "Americans fell behind on their mortgages and banks seized homes at a record pace in the fourth quarter as unemployment rose to a 15-year high and real estate values tumbled.

Mortgage delinquencies increased to a seasonally adjusted 7.88 percent of all loans, the highest in records going back to 1972, the Mortgage Bankers Association said today. Loans in foreclosure rose to 3.30 percent, also an all-time high.

The U.S. real estate market lost $2.4 trillion in value last year, according to First American CoreLogic, and unemployment jumped to 6.9 percent in the fourth quarter, the highest since 1993. As the recession enters a second year, unemployment is becoming a major cause of delinquencies, said Jay Brinkmann, the Washington-based trade group’s chief economist.

“When it’s a loan structure issue, you can deal with that, but when it’s an unemployment issue, unless you go out and find them a job there’s not much you can do,” Brinkmann said in an interview. “Eventually that loan will go into foreclosure.”

The combined percentage of loans in foreclosure and at least one past due was 11.18 percent, the highest ever recorded by the Mortgage Bankers. The percentage of loans 60 days past due and 90 days or more past due all broke records set last quarter."

FN: The media loves to spin meaningless statistical noise into something with a silver lining. Jobless claims came in at 623 000. That is a reduction of 13 000 or about 2% from the 636 000 last week. Such a small change is well within the margin of error of this report. Regardless, weekly jobless claims in excess of 500 000 are a very bad thing, especially if they are prolonged.

U.S. Initial Jobless Claims Fall 13,000 to 623,000 (Update1): "Fewer Americans filed claims for unemployment benefits last week, a sign the biggest rounds of firings may be over.

Initial jobless claims fell by 13,000 to 623,000 in the week ended May 23, lower than forecast, from a revised 636,000 the prior week, according to Labor Department figures released today in Washington. The number of people collecting unemployment insurance rose to a record in the prior week for the 17th straight time, reflecting restrained hiring.

Fewer job losses reduce the risk that consumer spending, the biggest part of the economy, will falter, delaying the economic recovery projected for later this year. Still, companies will be reluctant to add workers and increase production until sales show sustained gains."

FN: Durable goods are supposed to be part of the "green shoots" theory. This is what equities have rallied on... in anticipation of.

U.S. Durable-Goods Orders Hover Near 13-Year Low (Update2): " Orders for U.S. durable goods hovered near the lowest level in 13 years in April as demand for business equipment weakened, indicating that investment will be one of the last areas of the economy to recover.

Orders rose 1.9 percent from the previous month after a revised 2.1 percent drop in March that was more than twice as large as previously estimated, the Commerce Department said today in Washington. A rebound in automobile orders and a jump in defense spending spurred the gain in April.

Companies, which have record levels of spare capacity, will probably continue to trim spending on capital equipment such as computers until sales show sustained gains. The worst credit crisis since the Great Depression has prompted economists to scale back forecasts for growth in the second half of the year."

Wednesday, May 27, 2009

It Has Begun: Stocks Drop and Yields Rise Anyways

"The most commonly known example of an event horizon is defined around general relativity's description of a black hole, a celestial object so dense that no matter or radiation can escape its gravitational field. This is sometimes described as the boundary within which the black hole's escape velocity is greater than the speed of light." -Event Horizon

FN: It has begun. Today equities fell significantly and the "safe haven" bid was not large enough to overcome a deluge of selling. Yields rose. Again. This is not likely to be an isolated incident. This will happen with greater frequency and increasingly disruptive consequences.

We are rapidly approaching the point of no return. Once the event horizon has been reached, there will be no turning back.

Calculated Risk points out that mortgage rates have accelerated higher in Mortgage Rates: Moving Higher. Watch the "green shoots" of recovery wilt and die...

U.S. Stocks Retreat as Treasury Yields Climb, Monsanto Slides: "U.S. stocks tumbled as a jump in long-term borrowing costs spurred concern government attempts to reduce interest rates will fail and Monsanto Co.’s disappointing forecast triggered a drop in raw-material producers.

FN: The bond bubble has finally burst... and there is NO fixing this. Debt monetization (Interesting article by Daniel L. Thornton: Monetizing Debt.) does not work. An increase in debt monetization would be like pouring fuel on a raging fire.

The U.S. bond market is getting destroyed and that’s why we’ve rolled over,” said Peter Boockvar, equity strategist at Miller Tabak & Co. in New York. “It’s awful for the housing market; mortgage rates will get higher. It’s awful for anyone who needs to refinance in a highly leveraged economy -- higher interest rates are like kryptonite.

FN: I mentioned the steep yield curve yesterday in Bear Steepening of the Yield Curve. Today even the mouth breathing pump monkeys over at CNBC have started to twitch nervously.

Treasury Yield Curve Steepens to Record as Debt Sales Surge: "The difference in yields between Treasury two- and 10-year notes widened to a record on concern surging sales of U.S. debt will overwhelm the Federal Reserve’s efforts to keep borrowing costs low.

The so-called yield curve steepened to 2.75 percentage points, surpassing the previous record of 2.74 percentage points set on Aug. 13, 2003. Yields on 10-year notes have risen more than 100 basis points since Fed officials said in March they would buy up to $300 billion of U.S. debt over six months to drive consumer rates down and lift the economy from recession.

The markets are starting to grapple with the issue of what happens when the Fed exits and the Treasury needs to continue at the same pace,” said David Greenlaw, the chief financial economist in New York at Morgan Stanley, one of the 16 primary dealers that trade with the Fed and are required to bid at government bond auctions.

U.S. 10-year notes have lost 8.7 percent this year, according to Merrill Lynch & Co. indexes, while 30-year bonds have lost 25.5 percent. Two-year notes have gained 0.3 percent.

Investors are selling long-term Treasuries as the government borrows record amounts of debt to fund bank bailouts, stimulus spending and a record budget deficit. The U.S. will sell $3.25 trillion of Treasuries in the fiscal year ending Sept. 30, according to primary dealer Goldman Sachs Group Inc.

Balance Sheet

After selling $1.9 trillion of debt maturing in one-year or less in the fourth quarter, the Treasury is increasing sales of longer-maturity debt. Officials have boosted 10- and 30-year bond sales to monthly from eight and four times a year, respectively.

Investors are also shying away from longer-term debt as government officials inject cash into the financial system. Fed policy makers have expanded the central bank’s balance sheet to $2.2 trillion and pledged as much as $1.8 trillion in debt purchases, including $300 billion in Treasuries.

Inflation expectations have increased. Ten-year breakeven rates, the difference between yields on 10-year inflation- indexed bonds and nominal Treasuries of the same maturity, touched 1.9218 percent today, the widest the spread has been since Sept. 23."

FN: Things are orderly right now. They can't be for much longer. When the world starts dumping long term sovereign paper (not just US treasuries) governments the world over won't be able to finance themselves.

Mortgage-Bond Yields Jump, Jeopardizing Fed’s Housing Effort: "Yields on Fannie Mae and Freddie Mac mortgage bonds rose for a fourth day, after yesterday for the first time exceeding where they stood before the Federal Reserve announced it would expand purchases to drive down loan rates.

Yields on Washington-based Fannie Mae’s current-coupon 30- year fixed-rate mortgage bonds climbed to 4.51 percent as of 2:17 p.m. in New York, the highest since Dec. 5 and up from 3.94 percent on May 20, data compiled by Bloomberg show.

The Fed, seeking to use lower home-loan rates to stem the housing slump and bolster consumers, said March 18 it would increase its planned purchases of so-called agency mortgage bonds by $750 billion, to as much as $1.25 trillion, and start buying government notes. Rising mortgage-bond yields, driven higher in part by climbing Treasury rates, means the Fed now “faces a challenge to its ability to sustain low mortgage rates,” according to Jeffrey Rosenberg at Bank of America Corp."

Korea, Crazier Than Usual

“The Korean People’s Army will not be bound to the Armistice Agreement any longer." -Official Korean Central News Agency

FN: Kim Jong Il is one crazy bastard. We all know this. BUT, he has never in the past gone so far as to strike down the 1953 Korean War Armistice Agreement. Technically, North and South Korea are still in a state of war. This armistice was the only thing keeping things "civil".

Over the weekend North Korea conducted both a nuclear test and a ballistic missile test. They've done this in the past, so it was quickly considered to be the usual saber rattling. However, throwing away the Armistice Agreement changes everything.

The sudden bellicosity of North Korea is very telling. I suspect that internally things are unraveling quickly in the "Hermit Kingdom". The global economy has imploded. While the North Korean economy is completely useless and isolated it must nonetheless be adversely affected as well. It is likely that things have significantly deteriorated and the regime is attempting to distract its own citizens.

Alternatively, Kim Jong Il has gone from just plain vanilla crazy to bat-shit crazy. U.S. intelligence officials believe he suffered a stroke last August...

North Korea Threatens Armed Strike, End to Armistice (Update1): " North Korea threatened a military response to South Korean participation in a U.S.-led program to seize weapons of mass destruction, and said it will no longer abide by the 1953 armistice that ended the Korean War.

The Korean People’s Army will not be bound to the Armistice Agreement any longer,” the official Korean Central News Agency said in a statement today. Any attempt to inspect North Korean vessels will be countered with “prompt and strong military strikes.” South Korea’s military said it will “deal sternly with any provocation” from the North.

South Korean President Lee Myung Bak ordered his government to take “calm” measures on the threats, his office said in a statement today. Japan’s Chief Cabinet Secretary, Takeo Kawamura, echoed those remarks and called on North Korea to “refrain from taking actions that would elevate tensions in Asia.”

The threats are the strongest since North Korea tested a nuclear weapon on May 25, drawing international condemnation and the prospect of increased sanctions against the communist nation. South Korea dispatched a warship to its maritime border and is prepared to deploy aircraft, Yonhap News reported, citing military officials it didn’t identify.

“This rapid-fire provocation indicates a more aggressive shift in the Kim Jong Il regime,” said Ryoo Kihl Jae, a professor at the University of North Korean Studies in Seoul. “Kim is obviously using a strategy of maximum force.”

Tuesday, May 26, 2009

Bear Steepening of the Yield Curve

FN: A quick follow up to yesterday's post With Each Interest Rate Tick Higher Another "Green Shoot" Dies.

Rates continued to rocket higher yesterday and an interesting post from Across the Curve, an excellent fixed income blog I follow regularly.

Bond Market Close May 26 2009: "Why is the market crashing and why is the curve so steep?

We are drowning under the weight of near term supply for sure but I guess I think something else is afoot here.

Look at the breakeven spread on the 10 year TIPS bond. That spread is currently 185 basis points. I do not believe that we have been that wide since the advent of the financial crisis in 2007. I think that investors are uttering a gigantic and collective nyet regarding the implementation of monetary policy and fiscal policy in the US.That is why the curve is steepening so dramatically.

Foreign central banks continue to intervene, buying dollars and selling their local currencies. The names most mentioned in that endeavor are Russia and Brazil. Sources tell me that the fruits of the intervention are parked in 2 year notes and 3 year notes. There is a dearth of central bank interest in the longer maturities.

Some cite the very strong 2 year note auction today as a sign of the market’s health. I think not. The issue is propped up by the prospect of a very low funds rate for an extened period of time. The carry and ride down the curve profits are seductive.

Central banks bought over 54 percent of the issue. I would submit that while that is great for the 2 year note it is a less than festive sign for the 5 year note and the 7 year note which will auction over the balance of this week, The money in the 2 year note is money that will not be invested in the 5 year note and the 7 year note. The treasury should organize a posse to search for marginal dollars for the 5 year and 7 year. If one wishes to observe bond market panic I think it would develop quickly if the 5 year note or the 7 year note auctioned with long tails as we observed in the Bond auction earlier in May.

A long tail in a bond auction with its attendant risk is one thing. If that were to occur in a shorter maturity in would be a sign that investors are in full retreat from longer dated US assets.

Maybe the final climactic event is upon us. Maybe the final bubble to burst is the US Treasury market and maybe we are on the verge of a financial Krakatoa which will realign financial markets.

Whatever the case it feels like the calm before the storm and we are about to embark on another interesting expedition."

FN: I couldn't agree more. These are ominous developments that aren't getting the attention and scrutiny they deserve.

In Gold: Massive Catalyst Required I argued that something big and bad had to happen for Gold to crack $1000 and go higher. The implosion of the sovereign bond market would be just such a catalyst.

With Each Interest Rate Tick Higher, Another "Green Shoot" Dies

"There isn't enough capital in the world to buy the new sovereign issuance required to finance the giant fiscal deficits that countries are so intent on running. There is simply not enough money out there," -Kyle Bass

FN: Giddy talk of "green shoots" has completely drowned out a more sober and rational assessment of the global situation. Random statistical noise in various minor economic indicators have over the past two months resulted in wild exclamations of "the worst is definitely over".

It most certainly is not.

With every major economy in the world attempting to solve this economic crisis with both loose monetary and fiscal policy, it was only a matter of time before the global credit markets would reach their limits.

These limits have almost been reached.

The long end of every curve of every major economy has been steadily climbing. The rate of change has now accelerated and interest rates on these important benchmarks have now reached "pre-crisis" levels. In a ZIRP world this is definitely a bad sign. Formerly respectable governments from the US to the UK have gone the "banana republic" route and started monetizing their debts in a desperate attempt to prevent long rates from rising, to no avail. A veritable tsunami of debit issuance now sits just over the horizon, waiting to dumped on a crippled and saturated global debt market.

The UK will eventually lose it's coveted triple 'AAA' rating and the US cannot be far behind. Rising rates will drag everything from mortgage rates to credit card rates higher. Everything from residential and commercial real estate to businesses will feel the pain of higher borrowing costs. The central banks of the world have no more real options left. They've lowered the rates they control to zero and have flooded the financial system with liquidity. Their balance sheets are now swollen with toxic assets and outright debt monetization won't bring rates down.

With each interest rate tick higher another "green shoot" dies...

US bonds sale faces market resistance:

"The US Treasury is facing an ordeal by fire this week as it tries to sell $100bn (£62bn) of bonds to a deeply sceptical market amid growing fears of a sovereign bond crisis in the Anglo-Saxon world.

The interest yield on 10-year US Treasuries – the benchmark price of long-term credit for the global system – jumped 33 basis points last week to 3.45pc week on contagion effects after Standard & Poor's issued a warning on Britain's "AAA" credit rating.

The yield has risen over 90 basis points since March when the US Federal Reserve first announced its controversial plan to buy Treasury bonds directly, a move designed to force down the borrowing costs and help stabilise the housing market.

The yield-spike may be nearing the point where it threatens to short-circuit economic recovery. While lower spreads on mortgage rates have kept a lid on home loan costs so far, mortgage rates have nevertheless crept back up to 5pc.

The Obama administration needs to raise $2 trillion this year to cover the fiscal stimulus plan and the bank bail-outs. It has to fund $900bn by September.

"The dynamic is just getting overwhelming," said RBC Capital Markets.

The US Treasury is selling $40bn of two-year notes on Tuesday, $35bn of five-year bonds on Wednesday, and $25bn of seven-year debt on Thursday. While the US has not yet suffered the indignity of a failed auction – unlike Britain and Germany – traders are watching closely to see what share is being purchased by US government itself in pure "monetisation" of the deficit.

Don Kohn, the Fed's vice-chair, said over the weekend that Fed actions would add $1 trillion of stimulus to the US economy over time and had already prevented "fire sales" of assets.

"The preliminary evidence suggest that our programme has worked," he said.

The US is not alone in facing a deficit crisis. Governments worldwide have to raise some $6 trillion in debt this year, with huge demands in Japan and Europe. Kyle Bass from the US fund Hayman Advisors said the markets were choking on debt.

"There isn't enough capital in the world to buy the new sovereign issuance required to finance the giant fiscal deficits that countries are so intent on running. There is simply not enough money out there," he said. "If the US loses control of long rates, they will not be able to arrest asset price declines. If they print too much money, they will debase the dollar and cause stagflation.

"The bottom line is that there is no global 'get out of jail free' card for anyone", he said.

The US is acutely vulnerable because it relies heavily on foreign goodwill. China and Japan alone hold 23pc of America's $6,369bn federal debt. Suspicions that Washington is trying to engineer a stealth default by letting the dollar slide could cause patience to snap, even if Asian exporters would themselves suffer if they harmed their chief market.

The dollar has fallen 11pc against a basket of currencies since early March. Mutterings of a "dollar crisis" may now constrain the Fed as it tries to shore up the bond market. It has so far bought $116bn of Treasuries as part of its "credit easing" blitz, out of a $300bn pool.

When the Fed first said it was going to buy Treasuries in March the 10-year yield to dropped instantly from 3pc to near 2.5pc, but shock effect has since worn off. Any effort to step up purchases might backfire in the current jittery mood.

In the late 1940s the Fed was able to cap the 10-year yield at around 2pc, but that was a different world. The US commanded half global GDP and had a colossal trade surplus. The Fed could carry out its experiment without worrying about foreign dissent.

Fed chair Ben Bernanke has long argued that central banks can bring down long-term borrowing rates by purchasing bonds "at essentially no cost". His frequent writings rarely ask whether foreigner investors – from a different cultural universe – will tolerate such conduct.

Mr Bernanke is betting that under a floating currency regime there is no risk of repeating the disaster of October 1931, when the Fed had to raise rates twice to stem foreign gold withdrawals, with catastrophic consequences. This assumption may be tested.

It is not clear where the capital will come from to cover global bond issues. Asian central banks and Mid-East oil exporters have cut back on their purchases of US and European bonds as reserve accumulation slows. Russia has slashed its holding by a third to support growth at home. Even Japan's state pension fund has become a net seller of bonds for the first time this year the country's population ages.

Japan's public debt will reach 200pc of GDP next year. Warnings by the Japan's DPJ opposition party that, if elected this autumn, it would not purchase any more US debt unless issued in yen, is a sign that the political mood in Asia is turning hostile to US policy.

There is no evidence yet that foreigners are in the process of dumping US Treasuries. Brad Setser from the US Council on Foreign Relations said global central banks added $60bn to their US holdings in the first three weeks of May.

This is bitter-sweet for Washington. It suggests that private buyers are pulling out, leaving foreign powers as buyer-of-last resort.

We just have to hope that G20 creditors agree to put a clothes peg on their nose and keep buying Western debt until the crisis passes, for the sake of the world."