The financial news was sparse today. Abu Dhabi stepped into the breech and provided the cash necessary to prevent a “default” on the Sukkuk instruments; no great surprise as this buys DUBAI some breathing space to do a credible workout and the credit markets get a chance to bring some light onto the Islamic debt market. The Greek government came up short on a credible plan to curb the spiraling deficit so the German/Greek 10 year differential increased by 15 basis points to 225. Interestingly, the rest of Europe quieted down and even the GILT market was bid, helping to give the British POUND some support. Also in Britain it appears that the battle for CADBURY will heat up as the KRAFT offer has been deemed insufficient so we look for other “players” to enter the game. This could give a bid to the POUND as the bids for the confection company get sweetened. Also in the realm of more negative divergence, the Mexican DEBT market was downgraded by SP but the Mexican PESO barely budged. The PESO has shown some strength of late so the fact that the MEXICAN stayed strong makes it necessary to watch. Peso strength may well be a proxy for a positive outlook for North America.
As we noted in undertaking the writing of NOTES–we wanted to generate qualitative discourse in the realm of trading. Last night’s piece brought forth a need to expound on two separate issues. First, a thinker of the highest order inquired about the line…”When the U.S.truly starts on a growth path this issue will be brought to the fore.” We were discussing what could bring downward pressure on the EURO when we wrote that line. Up to now the U.S. has not been a destination for foreign investment as there has been too much uncertainty over U.S. policy, from the FED, Executive and Legislative. As the fog begins to clear foreign investors who are laden with DOLLARS are going to be in search of assets –hard assets besides precious metals. Sovereign Wealth Funds [SWF] will be scouring the U.S. investment landscape for industrial concerns and various types of real estate. Prior to the collapse of Lehman and Bear Stearns foreign funds had invested heavily in the U.S. financial markets. The fact that they have been so badly shaken by poor timing they will be more cautious this time around. They will avail themselves of using a depreciated asset [THE DOLLAR] in the only place its value has been sustained. In addition, they will be buying at depressed prices rather than a top. We believe that the private equity groups [Blackstone, Ochs-Ziff, Apollo] and others have been seeking out SWFs to help finance the purchases of large real estate portfolios. This is what we mean by the growth path–for up to now this equity rally has been basically a domestically based carry trade; the next leg up, if it occurs will be led by foreign investors believing they are missing out on a great opportunity.
Another response came in seeking more info on the misunderstood Maastricht accord. When you hear the talking heads on T.V., pay little attention when they pontificate on the European Union. If you need to polish up your knowledge the best book to read is Bernard Connolly’s The Rotten Heart of Europe. The original Maastricht accord was crafted to appease the demands of the Bundesbank. Strict guidelines of debt and deficits were to be adhered to so that the peripheral countries would not continue their profligate spending habits and expect to be bailed out by the more disciplined nations. There is no bailout clause as the spendthrifts were actually to be fined and forced back in line. Well as usual the guidelines were very rarely adhered too–especially when it suited the stalwarts of the EU, Germany and France. Therefore all the peripherals felt that in stressful times the Maastricht strictures should be tossed aside for all. Once the economy went into a major recession in 2007-2008 all rules were laid aside except that Germany was better positioned than the others and wanted the Maastricht rules adhered to and therein lies the problem. Germany has gotten wages under control over the last 6 years and is in the best competitive position—both in Europe and globally. The German economy is running the third largest trade surplus in the world and especially so within Europe. Will the good Bavarian burghers be willing to transfer their hard earned D-marks, sorry Euros, to pay for the profligate ways of her fellow European citizens? The wanton sinners are supposed to be fined not rewarded and therein lies the rub. Something is truly rotten in the state of Denmark! Oh well, neither a lender or borrower be.
Very little news and action after the wild ride on Friday’s unemployment. The DOLLAR stayed relatively strong after its significant rally on Friday. The YEN regained some ground on all the crosses as we have word of a stimulus package out of Japan. The DPJ finally approved a 80.6 billion dollar stimulus plan and this gave some immediate support to the YEN, but we don’t expect this to last as the Japanese are nervous about a strong currency while deflation is renewing its vigor. Now that a stimulus program has been approved we need to be watchful of some type of intervention to stem the recent YEN strength.
Tomorrow morning [8 a.m. CST] we will hear from the Bank of Canada. We expect no change in their current interest rate as the CANADIAN DOLLAR remains relatively firm and this has been a concern of the Bank. If the currency weakens after the no change we would look for the LOONIE to regain its strength as its fundamentals remain the most attractive. Wednesday will bring the PBR from Britain. Chancellor Darling will deliver his outlook for the British economy and we are waiting to see if the budget will reign in the massive amount of stimulus that has run the current deficit to over 12% of GDP. The question is curtail spending or raise taxes. If the budgetary stance is for cuts in spending we don’t anticipate much movement in the STERLING but we believe that higher taxes would have a negative effect. Britain has to be careful to not tax the financial jobs out of LONDON as some hedge funds and private equity groups have already announced their intentions to move to more favorable business environs. This coupled with the anti anglo-american sentiment emanating from Brussels the British need to keep their financial markets globally competitive or risk losing the golden goose. The euro/sterling cross will be very directional for this sentiment —as always check the technicals to ascertain the real story. If Euro/sterling holds support we will see continued weakness in the British currency.
Dateline Brussels: Today European powerhouse, the prime minister of Luxembourg, emphatically stated that the EURO was overvalued. We say that it is JUNCKER that is way overvalued.
——-Live from Chicago its Tuesday night——-
In typical fashion the European bigwigs were out today decrying the appreciating EURO and the more they talked the higher the currency went. We say that if you think your currency is too strong then cut the lending rates to 25 basis points and let the weakest currency come clean. As we noted last night — the rumor of the Chinese taking 25 billion in Greek bonds would remove some of the present stress in the European system. At 1:00 this afternoon out intern, Scott, ran the 10 year yield differentials within the European Union and this is what he found:
When you do the maths you can see why the Chinese are interested from a financial standpoint in buying that Greek debt. An investor picks up an extra 173 basis points and gets an asset priced in Euros. If you thought the DUBAI situation was a problem when the U.A.E. was thought to allow a default, imagine the instability in markets if the Germans or French failed to support the debt of any European sovereign entity. So we see the Chinese have rearranged their holdings while picking up some sovereign yield. We are beginning to see the benefits of Euro debt versus U.S. treasuries. Do the technicals and find your comfort zone.
We also heard from Russia again today talking up the Canadian dollar. This is the second time in two weeks so we know who must be long. Not only is Notes From Underground lifted from the great Dostoyevsky, but as an aside we can tell you we have been Russian watchers for a long while. We have learned that the Russians love to create chaos inthe markets when they have the opportunity. For the previous three years the financial gurus of Moscow have been busy rebalancing Russian reserves from dependence on the dollar and have the lowest amount proportionately in Dollars. This gives them the ability to rattle the markets every so often by making incendiary comments like today’s about the Canadian. Please be cautious when it comes to the BEAR. Remember back in August when they said they were selling some GOLD which caused a quick break but proved to be false. Again we stress to beware the BEAR as they relish the opportunity to tweak the markets—especially when the Chinese are carrying the brunt of the load.
While we are sending out alerts, put the concept of the Islamic debt issues on your radar screens. It will be of great market interest to see how the DUBAI workout gets done. The SUKUK market which is debt written to Islamic law totals between 500 -700 billion dollars. This is not traditional debt by Western standards so how a possible non-payment gets resolved becomes a keen issue to creditors. We have not heard the last of this –just when you think you are out they drag you right back in!
We open tonight’s notes with the sage words of Rudyard Kipling from the poem IF.
If you can keep your head when all about you
are losing theirs and blaming it on you;
If you can trust yourself when all men doubt you
but make allowance for their doubting too;
These words we believe sum up the action that took place over the two days of Thanksgiving. We were contemplating writing a piece Thursday evening, but we just couldn’t get enough info to substantiate what was taking place. As traders we are aware of the impact of rumor and innuendo and we always view these twin sisters of havoc as a blessing and a curse. Rumors give rise to volatility and thus create opportunity but if we are in a position we know the pain of being stopped out on unsubstantiated info. Now that we have had a few days to measure the Dubai news we can begin to understand its impact on the global financial markets. We were interviewed on CNBC and Bloomberg television on Friday and opined that the DUBAI situation was a continuation of the global credit crisis and very much similar to the commercial real estate problems that overhang the U.S. credit markets. Being that DUBAI is one of the seven Emirates and the one with the least amount of energy production, the authorities had to find another source of economic growth. The ROYALS that administer DUBAI thought to turn their principality into the financial and tourist center of the GULF region. All was well so long as money flowed free and easy and the building boom went on, but as frequently happens over-building occurred and prices began to drop. Vacancies began to grow and the rents declined and debts couldn’t be met. Many of the creditors believed that ABU DHABI, the wealthiest of the Emirates would make good on the debt even though there are no covenants to that effect. Bond prices dropped from par to forty cents on the dollar as the threat of default continued to grow; that was where the markets were with Friday’s early close. To make matters worse there was also an Islamic holiday which meant there was to be no official announcement until today. It now appears that the central banks of the U.A.E. are going to provide a funding facility to insure against default of DUBAI debt. The sovereign wealth fund of ABU DHABI has a purported net worth of 650 billon dollars so there is certainty enough liquidity to support the entire Gulf region as the debtors and bondholders meet to do some type of work out on the debt.
As we caution to keep your head you must look at the immediate impact. First, we find it hard to believe that Abu Dhabi and some others didn’t step in to buy the DUBAI bonds on the very cheap knowing some action would take place to support the little brother DUBAI. Secondly, it is not in the interest of oil producers to see new stress in the global economy as the drop in oil would be far more costly than any type of bailout. Thirdly, we are going to have to see the impact on the nascent Islamic bond market that was created for Muslim investors and borrowers to be able to be part of the modern financial world and still adhere to the stricture of Sharia. Fourthly, this event will put the inflation hawks at the FED on hold as they wait to see the fallout on the lending patterns of the global banks. U.S. banks have a small exposure as most of the credit appears to have been extended by European consortiums and Islamic institutions–but again we don’t know for sure because of the lack of transparency. We will be watching, as will the world central banks, to see the impact on lending patterns after this hit is taken. The banks are cautious as they fear that more commercial real estate hits are coming. We now have a good sense of why global debt and U.S. treasuries have performed so well: the lending institutions are so fearful of more such DUBAIs and thus lock their money in sovereign debt.
Another story out this weekend came from China as the Politburo met Friday and decided it will “maintain the continuity and stability of economic policies, and continue to implement the proactive fiscal policy and loose monetary policy.” Thus we have some insight into what the Chinese are bringing to the global arena. Pressure will be brought to bear on the Chinese for YUAN appreciation but the pressure will be minimized by Chinese promises to lift domestic consumption by continued efforts to maintain growth at a bubble like level. Even the Europeans were rebuffed this weekend by the Chinese. Trichet and Juncker came away empty handed in their efforts to get the Chinese to provide any give on YUAN revaluation. Next time they should send that financial giant Lady Ashton! So with the Asian giant set to maintain domestic growth and the Dubai debt situation set to work out we can begin to think about Monday’s Australian Bank meeting and of course Friday’s unemployment report.
As Fred Flinstone might have said—-Yaba daba DUBAI—–as the cost of emerging from the stone age has been costly indeed.
Holiday markets are in full swing and the lack of liquidity makes the financial arena treacherous to say the least. If you must trade be patient and wait for your levels as many opportunities arise in these types of markets. Most of the responses that we get on a daily basis are in reference to the DEBT markets. Most traders want to play the short side as they fail to see the logic of investors wanting to buy the LONG END of the curve. We always stress that as a trader one should not confuse Ought with IS. When a market won’t break on neutral to bad news it is telling you not to sell it no matter what you think ought to take place. Some group of investors see value in ten year notes at 3.4% or lower so just let the market find its next level of resistance. Everything in the world points to higher BOND yields except the daily action. No matter how bad the fundamentals, prices continue higher and that is to be respected. Remember, “markets can remain irrational much longer then you and I can remain solvent.”
Gold,equities, and currencies all rally–while the bond follows; and not just U.S. bonds but DEBT worldwide. Yes indeed, 2+2=5. Today we saw the release of the FOMC minutes and there was no great surprise. The monetary hawks were thrown a bone by the FED saying there was some concern that low interest rates could possibly cause an asset bubble and they would be vigilant. This is a meaningless statement as from Bernanke on down there has been constant reprise that monetary policy is too broad an approach to halt an asset bubble. So we pass this off as no great concern. Tonight the commerce reported that they were cutting the average duties on CHINESE STEEL PIPE [$3 billion worth] from 21.3% to 13.2%–throwing the CHINESE running dogs a bone–we will watch to see if there is any response from HU JINTAO and company. Also today we received word that WEST LANDESBANK had in fact been bailed out by the German government. They will infuse 3-5 billion euros and set up a good bank, bad bank format to offload the stressed debt. Short term effect has been to give some short term rally to the EURO but this is still a work in progress.
As we give thanks for all the good health and prosperity we have been blessed with, we will offer our thanks to all our readers and the high quality of discourse these NOTES have started to generate. Thank you everyone! One last thing we want to put on everyone’s radar screen. Two years ago we heard the constant drumbeat of how Sovereign Wealth Funds were going to be the scourge of America. The holders of U.S. dollars were going to come a calling as their depreciating asset [the DOLLAR] was going to return to its source for that is the only place it truly has any real value. Well the early movers into the U.S. markets were either blocked under the guise of strategic interests or else were badly burned on the assets they were able to acquire. If the DOLLAR continues lower and commercial real estate and other assets continue to decline in value these sovereign wealth funds will return in search of hard assets with a high return in mind. The question is not if but when–this well may the biggest story of 2010.
“Everybody is talking at me / but I don’thear a word they’re are saying / only the echoes of my mind.” – Harry Nilsson
From the serial bubble blowers, to the talking heads of the electronic media, it is carry trade and dollar funded risks on and off. Being that we have covered this concept for a long time we give it great respect for its ability to drive markets to levels that appear to be irrational. We will always look to assets that seem to break away from the symbiotic nature of the trade; one for all and all for one. Today was one of those days when some of the elements of the carry ceased to cooperate. The dollar was generally strong versus most currencies and while that set an unwinding to the carry trade as defined in the popular press, by the end of the session the metals, equities, and commodities went on their separate way from the influence of the stronger dollar. Euro currency weakness is making us wonder if the trade is just suffering from exhaustion. The EURO is not a favorite currency of ours as the underlying problems of the European Union are to say the least — ENORMOUS. However, when the global reserve currency is under attack for poor policies it matters not what problems another currency suffers from, it is only that it is not the DOLLAR. Yesterday we pointed out that some analysts were confusing this present carry trade with the trade that made so much money and wreaked so much havoc in the 1998 period. We state categorically: this is a different strain of carry trade and it is far more virulent than the interest differential predecessor. The simple trade of borrowing YEN at 50 basis points and investing it in short term deposits at 750 basis points while hoping for some depreciation of the borrowed currency was relatively easy as long as not too much leverage was employed [see LONG-TERM CAPITAL]. Again, we stress this one is different for it searches not solely for interest rate differentials amongst the primary currencies but for more exotic assets in its quest for higher returns. Stocks, corporate bonds, sovereign bonds, commodities, precious metals–nothing is beyond its reach. In a world where money reaches to every nook and cranny this trading technique can levitate the loneliest of assets. Its power is such that Brazil, Taiwan and others have recently enacted restrictions to curb the power of this newly found possessor of the philosopher’s stone.
For you traders who have been enamored of using the dollar or the yen to do your funding, beware of the use of other currencies to be used to do the alchemists work. Remember, global interest rates are low across the board and if the tide turns and the EURO were deemed to be the new funding source then the cross rate matrix would undergo a dramatic change. What difference does it reall make to borrow in EUROS at 100 points if you thought Europe will be the one with the worst economic policies. The siren call of a weaker currency to pay it back in is the greatest aphrodisiac of all. When we stare at the board and see the EUR/GBP, EUR/YEN, EUR/CHF, EUR/CAD, EUR/AUD all start to make the Euro looked fundamentally challenged we wonder if Trichet and company are going to get the weaker currency they so desire. Terrible news out of AIRBUS and other euro corporations complaining about the strong EURO hurting their bottom line may well be the clarion call to set the change in motion. We know the funder will not be the Aussie for rates are relatively too high and the Canadian has the best fundamentals making it tougher to fund the carry trade. Thinking aloud is necessary when you see the dynamics of the board begin to change and when you see the negative divergence occur on a more frequent basis it is time to look for the causality to the change–maybe that is why the long end of the treasury market is surprising so many bears.