Macro Brief: Governments need to have both shepherds and butchers.

Governments need to have both shepherds and butchers.
Voltaire

 

This week is all about whether Germany will or will not fully commit to fire-wall. Clearly this weekend's press have the compromise ready: Chancellor Merkel will allow ESM and EFSF to run simultaneously, but only for one year while the EU led for Olli Rehn is looking for a more permanent size.

 

The math is as follows:

 

440 billion EFSF (200 billion committed to Greece, Ireland and Portugal) + 500 ESM = 940 billion EUR-200 billion EUR=  740 billion EUR.

 

In the German version this only run until July 1^st 2013, while EU Commission and Club Med wants it to be permanent: Whatever happens I think the below chart from Bloomberg Brief indicate the real size needed in to make the fire-wall attack free: (The numbers are only bonds maturing up-and-to 2013). Market is looking for 1.5-2.0 trillion as the magic number – a number big enough to buy time for reforms.

 

Maturing debt from now to end of 2013:

 

As always it is all eyes on Germany – will they or will they not – that's the only question we need to ask. What all other countries do or think is irrelevant – get used to the new Europe – one master, one decision maker – no wonder the fathers of Europe is concerned!

 

Meanwhile in Spain where the title race is still relatively open between Real Madrid and Barcelona J, things are going from bad to worse – this weekends local election in Andalucia, where Spain's centre right People's Party failed to secure an outright majority, leaving Prime Minister Rajoy without a mandate to carry on with tough austerity – was a bad start to week where we on Thursday will see a major general strike aimed at… Yes, you guessed it: Austerity measures.

 

 

The European story remains one of major promises and no actual reforms. A low interest rate and an extreme sense of "security" created by the illusion of easy money and low interest rates forever, but as I wrote  in the piece: Interest rates: the market has it all wrong  this weekend, we could be on route to an exit strategy from central banks which at a bare minimum will be a goodbye to "unconventional measures" and if so, the low in interest rate cycle is in place – and the interest rates will continue on down-ward projection in 10-30 years, but increase in the very short-term (0-2 years) as the focus needs to be on reforms. The only way central banks creates a proper exit from unconventional is to hand over the torch to reforms from governments and politicians. Unlikely,yes, needed? Absolutely, otherwise we are doomed to 30 years of Japanisation.

 

 

Otherwise we have a busy week with plenty of data  - note how US data has been disappointing keeping the "mean-reversion" we firmly believe in: (Market goes from expecting too little improvement to believing in too much growth):

 

 

Macro Brief: Interest Outlook - Voltaire: 'A sovereign state that owes money only to itself could not become poorer'

 

Voltaire, 1738: "A sovereign state that owes money only to itself could not become poorer" (Source: Gilles Bransbourg, NYU & Bloomberg Briefs)

 

To say the last four year since the financial crisis broke out for real in 2008 has been slightly atypical would be the understatement of the century. The central banks across the globe have been deep into their toolbox to find what they call "unconventional measures" – which is really short for cutting interest as low as possible for as long as possible – when rates hit the floor (zero interest rate) in the short-end (0-2 year),  they moved their effort further out on the yield curve buying most of the bonds issued by their own governments Treasuries. Decades ago that would have been called a Ponzi scheme, but in today's world it is sold as the "only alternative".  Voltaire saw it coming.

 

Traditionally the central banks have only controlled the interest rate curve from Overnight to one year through their policy setting rates, but the severe drop in equities in 2008/2009 and the huge fiscal imbalances created from biggest fiscal stimulus in history created a need for securing "orderly business" through ample liquidity at low rates. That was followed up with a PR blitz from central bank and policy makers telling us: It's all ok – we got everything under control! Sure you do! We then migrated from one bubble to another, and ended up in a debt trap, where governments and banks remains thinly capitalized and often without access to further credit.

 

The world government and commercial banks now takes so much of "credit cake" – that the private sector is only left with  crumbles. The private sector which is traditionally the risk taking and profitable side of the economy has been cut off from its oxygen : Credit. The macro side of the economy have taken over the micro. Trust me you want the micro economy, you as a person and individual companies, to have the maximum flexibility and access to capital and risk, instead they are cut off, overtaxed and overregulated.

 

In 2012 so far we have a gradual normalization of interest rates. The move this month has been dramatic and lead to talks of changing fundamentals and a potential for mainly the US for having turned a corner. We were constructive on the US back in Q4-2011 as we saw the expected future growth by consensus economist being too low (Remember the talk of double dip?) – now fast forward to Q1-2012 and the market is, in our view, too busy to project recent "stabilization" into long-term growth. It's too early, if anything our forward looking indicators remains constructive but showing signs of a slow down , hence we believe the US will still be the star of 2012 but only because everyone else will do much worse.

 

This leaves the recent interest hike as almost a counundrum: Have the interest cycled bottomed – are this the new normal or is it back to mean-reversion? The world needs low interest rates to carry the gigantic debt in front of it, so the outcome to this question will a large impact on future growth and investment climate.

 

Chart: US 30 year Yield since 1993 – Source: Stockchart.com

 

 

We presently see three potential scenarios:  (the percentage probability is consensus expectations)

 

-          Much lower interest rates going forward(60%) – based on infinite monetary expansion. The reflation trade. This is the one option favored by politicians as it is of balance sheet and off accountability for them (Stealth crisis help from central banks). These facts makes this the most likely scenario and if you look at charts also very appealing. Ever lower interest rates in downward channel as seen above.

-          Lower in a channel but all-time low in place(30%) – rates have seen the low overall. The "unconventional measures" needs to exited. The biggest policy mistake historically has always been staying too low for too long. The politicians are clearly getting "hand shy" for continuing the "unconventional measures". Another game stopper could the law of stock versus flow. The policy makers have printed in excess of 3 trillion US dollar globally to keep the financial market and government afloat. This means to have additional impact the net new issuance of money needs to be much bigger in nominal terms(10% of 1.000 is 100. – 10% of 7.000 is 700 – so to get 10% impact in this examples you need to print 600 more for same impact). This is our preferred outlook path now

-          Crisis 2.0(10%). Our old theme which is really the loss of faith in government and its ability to repay its debt. To some extent we have had Crisis 2.0 in Club Med, but it is yet to pass on to major economies like Germany, France, US, Japan and the US. This is the least probable scenario, but IF… we break the higher channel in the above chart if would signal a start to a whole new paradigm where FIAT money no longer is sustainable.

 

If we are right and the market is wrong, then the move away from "unconventional measures" is a major game changer. The banks- and government are dependent on the false sense of security low interest rates creates. Even a historic normal expected move in interest rates from the bottom- to the high-end of the present long-term trading range 3.0% to 4.75% would have dramatic impact on debt crisis.

 

Across Europe and the US house owners remains under pressure – any move – small or large would put 100.000s further under water in equity value. That is the negative impact of a debt trap, the inability to create any economic environment where you can exit from the pain of the debt service – look at Japan. The stock- and house market topped in 1980 – now 32 years later the stock market is 75% below its peak. Too negative? Probably, but a long life in trading has taught me a few long-term facts: 1. Everything mean-reverts – What comes up must come down. (Think stock market, house prices, excess, state intervention) and more importantly 2.  We never lean any from history

 

Safe travels,

 

Steen

 

 

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Macro Brief: Do worry be happy

 

 

It is time for a brief macro update – I had spent the week reading a serious amount of research of which I would recommend a few:

 

Albert Edwards: Always worth a read and one of the few more bearish than me…..Talks about the seasonality of the improvement in the US data – which also gets him on to the view that this year Groundhog Day – same swings, maybe for different reasons, but he is very determined US rates is going to new lows:

 

http://ftalphaville.ft.com/blog/2012/03/21/932261/albert-for-all-seasons/  & http://www.zerohedge.com/news/treja-vu-albert-edwards-expects-new-lows-bond-yields-equity-rally-turning-dust-just-it-did-2011

 

James Montier of GMO – explains very elegantly how everything mean-reverts (where have we heard that before) and that the massive improvement in MARGINS is due to government consumption – yes government consumption. Take 15 min to read it. Important macro lesson for all to have:

 

https://www.gmo.com/America/CMSAttachmentDownload.aspx?target=JUBRxi51IIBtbYEu0yy2D233Qql0krF9YIWDpyU9bC1DsIW9OxrQN38JW598obIegPVL5Vm43jTd74zJ0R1rY2lRRYvkFggPe%2bdZF4oUF%2bEun279ii1ThA%3d%3d

 

Finally, Goldman Sachs is out with massive recommendation for buying stocks called: Long-Good-buy. I am tempted to say…. No, I will not…. J

My in-house Audi-dealer (I call all equity analyst' Audi dealers – as if you walk into a Audi store – what car will they sell you? Yes, of course an Audi) was all excited about the report, and it is always good to test your own bias vs. a well-researched opposition:

 

http://www.scribd.com/doc/86194691/Long-Good-Buy

 

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Away from the academia, which all of above is, the real market is in state of confusion. All clear – Alles klar Kommisar!  Europe has turned a corner(Sarkozy told us so…), but… hang-on what's going on in Spain?

 

 

What? How can they? Spain has seen higher 10 YR rates and higher 5 YR CDS most of this month – can you spell – R-E-T-R-O-A-C-T-I-V-E-L-Y changing Bond terms?

 

This is the price for bailing out ECB(and pretending they made a profit!) and for Spain for ignoring the fiscal compact and real reforms.

 

The Spanish Labor law is not a real reform – it's political posturing: 40% of working force in Spain is in temporary jobs . The 60% have fully protected jobs. Rights which dates back to Franco's time and reducing the lay-off period from 45 days to 33 days is not going to change that. The Spanish labor system is one of two separate systems. One with too many rights, and with no rights, and the worst ting being there is no new jobs being created in either side of the system, as austerity, lack of reforms is continuing to inflict a vicious circle of higher unemployment, more social costs, and lower growth.

 

I hope, and it's hope like in a church, that Spain will pull through but I do not see the political mandate in place. The general strike on March 29^th is not a good sign for reform and change is it?

 

The big discussion though remains that of how far in the "normalization" of interest rates. I wrote piece last week which talked about outlook that this was a reduction of the tail-risk for the world overall, this leads to less propensity to buy bonds, which unwinds some of the overboughtness of fixed income:

 

 

– That's all fine and plausible. Where from now? There are two or three paths from here:

 

-          Much lower interest rates going forward(60%) – based on infinite monetary expansion. The reflation trade. This is the one option favored by politicians as it is of balance sheet and off accountability for them (Stealth crisis help from central banks). These facts makes this the most likely scenario and if you look at charts also very appealing. Ever lower interest rates in downward channel. Albert Edwards, Soc. Gen in above link makes a very elegant case for this: More of the same. World needs growth and low interest rates to deal with the debt crisis. It may get the later but probably not the first …hence….the winner is….

-          Lower in a channel but all-time low in place(30%) – rates have seen the low overall. The "unconventional measures" needs to exited. The biggest policy mistake historically has always been staying too low for too long. The politicians are clearly getting "hand shy" for continuing the "unconventional measures". Another game stopper could the law of stock versus flow. The policy makers have printed in excess of 3 trillion US dollar globally to keep the financial market and government afloat. This means to have additional impact the net new issuance of money needs to be much bigger in nominal terms(10% of 1.000 is 100. – 10% of 7.000 is 700 – so to get 10% impact in this examples you need to print 600 more for same impact). This is my present thinking

-          Crisis 2.0(10%). Our old theme which is really the loss of faith in government and its ability to repay its debt. To some extent we have had Crisis 2.0 in Club Med, but it is yet to pass on to major economies like Germany, France, US, Japan and the US. This is the least probable scenario, but IF… we break the higher channel in the above chart if would signal a start to a whole new paradigm where FIAT money no longer is sustainable.

 

 

Strategy

 

We are shortly introducing a more detailed strategy where we will have pro-active positioning with track-record in order to be more accountable. The positions presently in our model is:

 

Short AUD.USD. China story. Slowing growth. RBA looking to cut rates. Curve is steeping.

Short Coffee. Better and better harvest.

Short Natural Gas. US just became biggest exporter in the world.

Short EUR.USD – strategic trade we think end of April is crunch time with ESM votes, French election, Spanish strikes, and probably forecast cuts across Club Med.

Long S&P vs. short STOXX50. Our model is long S&P – we are short STOXX50 against it.

Short IEF – as proxy for US rates.

Short Gold – our model have gone short, but risk is option expiry next week which generally leads Gold much higher.

Short CRUDE (May) – our model sold Crude today @ 105.68

Long EUR.SEK- we still like EURSEK long-term but respect the model.

 

Overall strategically we have: 50% cash, 30% in corporate credit, and now 20% in macro bets above.

 

Safe travels,

 

Steen

 

 

 

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Macro Brief: How real is real?

 

"All truths are easy to understand once they are discovered; the point is to discover them."  Galileo Galilei

 

 

The 60 bps move in US rates have so far had little impact on the risk-on vs. risk-off market. Yes, AUD vs. USD is small down and yes fixed income is having a negative year (outside: Club Med)….but how real is this move and why is it happening?

 

We see a major change here which will be confirmed tonight if 10yr close again above 2.1000 – there is something  changing in the "perception" vs. "reality" trade. The easy part of not fighting Fed is done – now comes the hard work.

 

My great and educated colleagues Peter Garnry, Mads Koefed and John Hardy have provided me with some ammunition which could be of interest to you:

 

 

Mankiw model looks at where Fed should be for them to be in line with a dual mandate. Looking at the chart Greenspan's major policy mistake in 2003/2005 stands out (Red line lower to flat while inflation and labor market took off) – now we are entering EQUILIBRIUM – but as the great George Soros  says: No market is ever in balance for more than a nano-second, and the present management at US Monetary Printing Inc. – sorry Fed is unlikely to react, like Greenspan, before they are behind the curve.

 

What is also interesting is that the forward curves is moving up – so not only is 10 year yields higher – the whole curve is higher including periods inside UNCHANGED Fed.

 

Add to this my piece from yesterday about volatility being paid in 1 year and 2 year – the "truth" – whatever it is – is hard to ignore – something have changed.. It may only be that the probability of PRINTING INFINITE have become PRINTING for decades but something is clearly happening – the believe in "unconventional measures is waning" – and fast it seems.

 

All the research I get this morning talks about the move higher in yields being overdone (funny how it's never the case the other way around?) but…I think Galilei was probably smarter than today's pundits. (He did not need to update his Facebook profile so he had more time to actually think about things?)

 

 

 

Likewise Bunds and Spanish yield is apparently breaking recent trend – is this the price for retrospectively changing legal language – the impact of Tier-1 capital deleveraging or?

 

 

I think it's all of above. The banks are still underfinanced – take away LTRO and Europe banks are toast – the leverage has risen not decreased in Club Med banks as they have bought more of the toxic government bonds which almost made them go under in the first place; But if you are sacked whatever happens as CEO of a Club Med bank why not put everything on Red? Game-theory at its simplest – and most convincing.

 

My conclusion is this:

 

The early riding the wave of easy money is over- Fed will still try to engineer further easing, but the truth is harder to ignore – and sometime soon even the dogmatic FOMC will need to consider an attempt for an exit strategy – is that not the whole point of this "new" open communication policy they have introduced with great fanfare?

 

Nice weekend

 

Steen

 

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