G3 Recap 8-18-11

Main Items:

  • Initial Jobless Claims increased to 408k last week vs 395k prev
  • US CPI rose 3.6% YoY in July vs 3.3% exp and 3.6% prev. Core CPI rose to 1.8% YoY vs 1.7% exp and 1.6% prev.
  • Philly Fed dropped to -30.7 in Aug vs 2 exp and 3.2 prev
  • Existing Home Sales dropped to 4.67mm vs 4.9m exp and 4.77m prev
  • Both GS and MS cut global growth forecasts. Both see 2011 Growth at 4%. Deustche and MS both cut growth forecasts for China.
  • Yesterday, the ECB lent dollars to a Eurozone bank for the first time since February, signaling escalating financing tensions in the regions financial system. A single bank borrowed ~$500mm for a week. At this point, one bank isn’t a big deal, but the market will now be looking to see if more banks tap the ECB for dollars.
  • The PBOC again hiked yields on its debt sales (it raised rates on its 3–month bill and 3-year bond sales), sparking further speculation that an outright rate hike is imminent – DJ
  • “Obama’s recent conversations with CEOs, including General Electric chief Jeff Immelt, head of the president’s jobs advisory council, have been surprising, officials said. While they have pitched the usual pro-business changes to the tax code, almost all say that the unprecedented corporate hoarding of cash is the product of a lack of confidence in the recovery — not a result of any specific government policy” Politico

Overseas:

  • UK Retail sales ex Auto Fuel was flat YoY in July vs 0.3% exp and 0.4% prev

Commentary:

  • Recession. There is no denying the risk now, despite Dudley’s comments to the contrary. The Philly Fed print today was the lowest since March 2009, and just barely. The implications for an upcoming recession is shown in this chart from BarCap, where recessions are shaded in grey:

    We are probably going to get an ISM print in the mid to high 40’s next month. The Fed will probably initiate QE3 at the next meeting on Sept 20th, based on ISM and equity market price action. Historically the Fed has eased every time ISM has touched or broken through 49:

    And to top it all off, based on current trends, we may have to wait until the end of 1Q12 before we see a sustained recovery in the data.

    Asset prices appear to have some of this scenario priced in. 10yr yields at 2% already prices in a very high probability of QE3, given that core CPI just printed 1.8%. If earnings fall 10% YoY, the S&P at 1150 would trade at a trailing PE of 12.8. At the end of 2008 it was at 12.3, although it dipped to 10 in March 2009.
    However, the implied volatility surfaces across multiple markets are surprisingly sanguine. The rolling 3rd Vix contract is trading almost 7 vol pts below the highs from a year ago, even though the recession risk this time around is clearly higher. Similar disparities apply to fixed income and currency vol markets:

    Finally, liquidity risk is becoming a serious threat in the EU, as indicated by an article in the WSJ. Of particular importance is the fact that an EU bank had to access the ECB’s lending facility for 500mm USD last week. The 1yr ‘TED’ spread between EU swaps and BuBills are now above the highs last year. 5y CDS on EU Financials have broken through all time highs.

    Unfortunately, it’s difficult to see what will turn that around. The EFSF is expected to start operations in September, but the size remains too small to deal with the problem. A long term solution is needed.

    Based on the data trend and the EU problems, the balance of risks appears to be for another move lower in risk assets, perhaps after a bounce. Asset prices may need to be more fully price in a recession before they can stabilize.

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2 thoughts on “G3 Recap 8-18-11

  1. ECB seems to be capable of handling the liquidity problems for now. They’re somewhat ahead of the curve and their policies basically amount to the same redistribution governments should do fiscally – since they sterilize their interventions by selling non-distressed assets, they drive down the yields on whatever they intervene in while driving up the yields on whatever they’re selling. Politicians don’t meddle (so far) and crazies from the Bundesbank seem to have been neutralized somewhat.

    1. Sid – the ECB sterilization is typically done in short term money market instruments, usually reducing the amount it is lending or taking deposits.

      In any case, the funding problems are appearing in USD, hence the WSJ article yesterday. The Fed announced that it lent 200mm to the SNB as well last night, so even Swiss bank(s), or the Swiss branch of some foreign bank(s) are short on USD. Most foreign banks still depend on short term market based funding since they lack a deposit base, hence the Fed’s worries.

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