Money for Nothing and Your Debt For Free
Here are some excerpts from the latest edition of Stock World Weekly: Money for Nothing and Your Debt for Free
We tried to make sense out of the ECB's Long Term Refinance Operation. HAPPY HOLIDAYS TO ALL!
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Last week, we noted the lack of a traditional “Santa Claus” rally going into the Christmas holiday week. This week, Santa finally arrived on Wall Street (or was that the European Central Bank in disguise?). A bit later than usual, and with a somewhat lighter load of presents.
During the week, there was good news for the U.S. economy, with Initial Jobless Claims falling to their lowest level since 2008, while the Reuters / University of Michigan Consumer Sentiment index came in at 69.9, handily beating estimates. However, the good news was countered with bad news. The GDP was revised downward by the Bureau of Economic Analysis (BEA) to an annualized rate of 1.8%...
More bad news, the price of a barrel of oil ended the week 6% higher due to tensions in the Middle East sparking fears of supply disruptions. In Iraq, the smoldering power struggle between two dominant Muslim populations, the Shiite Iraqi government and the Sunni minority, heated up. On Thursday, multiple bombings erupted in Baghdad. Hundreds of people were wounded and dozens were killed. The inherent instability of the Iraqi government, struggling with sectarian conflicts and a semiautonomous Kurdish population to the North, has aroused fears of escalating rounds of bloodshed and retaliation. (Car bombs kill 65 in Baghdad, worsening crisis)
Adding to tensions in the region, Tehran announced plans to stage ten days of naval exercises in the Persian Gulf. These exercises have the potential to affect shipping through the Strait of Hormuz, a critical choke point providing passage for roughly one-third of the world’s oil tanker traffic. Reuters reported, “The war game, named Velayat-90, will be carried out over an area extending from east of the Strait of Hormuz to the Gulf of Eden.” According to Iranian Navy Commander Habibulah Sayari, “The maneuvers will be carried out with the intention of displaying the determination, defensive and deterrent power of the Iranian armed forces as well as relaying a message of peace and friendship....” (Iran navy war game to begin on Saturday) He added, “It will also display the country's power to control the region as well as testing new missiles, torpedoes and weapons." (Iran Begins Straits of Hormuz Wargames)
Discussing the oil market in Friday’s article, Phil wrote,
“So why do the NYMEX traders pretend to want to buy February (front-month) oil for $100 a barrel when December 2014 barrels are trading at $91.37? Because the front-month pricing determines what US consumers pay at the pump. Even if the traders take a $10 loss on 250M barrels ($2.5Bn), that is a drop in the bucket compared to the relentless price gouging at the pumps committed by the Evil Corporations that employ those traders...
“So Merry F’Ing Christmas to all the Corporate crooks and their pet politicians, who are selling this Nation and its once-proud people down the river to line their own pockets. Forcing people to overpay for necessities like food, fuel, housing and health care has created the largest wealth gap in recorded history for a developed nation.”
Another important development this week was the European Central Bank’s deployment of the “Long Term Refinance Operation” (LTRO). The ECB provided €489Bn in funding to 523 banks via the LTRO, attempting to shore up investor confidence in the Euro’s future while pushing down yields on Italian and Spanish government debt. At least in the short-term, this bolstered the Euro at the expense of the Dollar. The weakness in the Dollar was correlated to a rise in the stock market, but the usual mirror image movement between the Dollar and the Dow was less apparent.
Regarding the ECB's Christmas present to EU banks (the LTRO), Mark Hanna wrote,
“The hope is that the ultra-cheap and ultra-long funding will have a range of beneficial effects, including bolstering trust in banks, easing the threat of a credit crunch and tempting banks to buy Italian and Spanish bonds, thereby calming markets and easing the currency bloc’s sovereign debt crisis....
“Of course we do not know what this money will be used for, but as outlined last night the expectation is a good portion will be for a form of ‘backdoor QE/TARP-lite’ as an end around the treaty for the ban on ECB’s direct purchase of sovereign debt. But as a speculator, what the banks eventually use the money for is less important today, than the PERCEPTION of what the banks will use the money for.” (Massive Demand for LTRO, as 523 Banks Request a Total of 489B Euros ($641B))
Perception is everything and as Reuters observed, “Optimism that the lunge for funding would ease Europe's two-year old debt crisis quickly faded, sending the euro and stocks lower after an initial jump.”
Peter Tchir, of TF Market Advisors surmised that LTRO might not lead to more purchases of sovereign debt.
“The market has completely latched on to the idea that LTRO is a backdoor QE [quantitative easing]. Does this make any sense and can it even work? So banks can borrow money for up to 3 years from the ECB. They can buy sovereign bonds with that money. These bonds would be posted as collateral at the ECB. The bull case would have banks buying lots of European Sovereign Debt with this program. The purchases would be focused on Italian and Spanish bonds with maturities less than three years... So banks buy the bonds and earn the carry and all is good? Not so fast...
“Banks are struggling to borrow money right now to finance their existing positions. How much of LTRO will be used to finance new bond purchases, rather than to replace existing forms of funding? Any bank that is already running a big sovereign debt position will look to LTRO to replace existing forms of financing. They can eliminate the repo roll risk on bonds they are financing in the repo market, or they could stop attempting to borrow in the interbank market. Those are positives for the banks as they can earn more carry (cheaper financing) and reduce roll risk (3 year term). But that doesn’t create new demand for bonds. So the LTRO can help the banks with their existing funding problems without a doubt, but it is unclear that encourages new bond purchases.” (Deus Ex LTRO)
The Wall Street Journal described the mechanics of the LTRO. “Governments in Europe are tying themselves in knots to prop up their banks, desperate to blunt the cost and embarrassment of a fresh wave of taxpayer funded bailouts. In Italy, for example, the government is encouraging banks to buy public properties that the banks can then use to borrow money. As part of a broader deficit-reduction program in Portugal, the government essentially is borrowing money from bank pension funds and could use some of the funds to help state-owned companies repay bank loans.” (Just Don’t Call It a ‘Bailout’)
Calling the LTRO “the latest bank heist,” Russ Winter at the Wall Street Examiner wrote,
“The LTRO totaled $641 billion as European banks passed on collateral in exchange for a 3 year, 1% loan. In return the ECB just was handed a gigantic can of worms. The ECB balance sheet is now up to $3.5 trillion USD...
“Illustrating the nature of this circular transaction, Bloomberg reports that Unicredit and Intesa, two insolvent Italian banks are using “state guaranteed bonds” as $52 billion collateral to throw at the ECB. So rather than even using actual Italian sovereigns, the ECB accepts something more nebulous down the food chain. If anybody knows exactly what this collateral is, I’d love to know. It can’t be good, you can’t make this stuff up.”
Pimco’s Bill Gross described the LTRO operation by tweeting, “ECB’s LTRO auction on Wednesday may only prove it is possible to take from one hand and give to the other. Shell game possibility.” Later, he wondered whether the LTRO was a shell game, a cash for trash plan, a three card “monti” or all the above? (Pic by Russ Winter, Peak Heist.)
The ECB is making it possible for eurozone member states to sell assets such as government buildings to banks, whereupon the banks turn the properties into asset-backed securities which are then pledged as collateral for borrowing from the ECB. It is not clear to us how this additional liquidity being pumped into European banks is going to affect confidence, the global economy, the Euro, the Dollar, or the stock market.
Retail investors have been pulling money from domestic equity funds again this year. Zero Hedge reported, “If anyone thought last year was bad with the flash crash and all, the $98 billion that was pulled in all of 2010 is a pale imitation of what 2011 is setting up to be. And this year we didn't even need a 1000 point DJIA drop.
“As for where the money is going, why straight to Gresham's finest: taxable fixed income, with another $4.7 billion in cash entering the fixed income arena and departing equities, probably forever. Our advice to the Chairsatan - if he truly wishes to get savers to push their money out bonds and back into stocks, he may very well want to consider some very traumatic event in fixed income: a flash crash for bonds if you will. Because at this rate mutual funds will i) have no cash left very soon (as a reminder here is what cash balances at mutual funds look like), and ii) will be forced to start selling assets to satisfy redemptions.” (Retail Investors Pull $132 Billion From Domestic Equity Funds In 2011, 33 Of 34 Sequential Weeks Of Outflows)
We have no new trade ideas this week. Phil is back in a wait-and-see, cashy and cautious mode.
Wishing all of you the very Happiest of Holidays!
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