Recap 9-16-11

Main Items:

  • U Michigan Confidence improved to 57.8 in Sept vs 57 exp and 55.7 prev.
  • Bloomberg reports that Bank of America will consider putting its Countrywide unit into bankruptcy if litigation losses threaten to cripple the entire company.
  • 3m Libor set higher again today, despite yesterday’s CB announcement.

Overseas:

  • EZ Labor Costs rose 3.6% YoY in 2Q vs 2.6% prev

Commentary:

I wrote on Monday that risk assets are likely to rally ahead of QE. With short term oscillators now overbought, the VIX at range lows and the end of quad witching today, short term traders may want to consider booking some profits.

I also note that most of the very near term worries have now been addressed: Greece will get its money next month and an EU bank run will be avoided for now. As a result, much of the ‘disaster’ premium has receded from asset prices. Against this, the economic data will most likely continue to signal slowing, but borderline recessionary G2 economies. Furthermore, US fiscal and monetary policy is attempting to stimulate the economy. The confluence of these factors suggests that there is sufficient room for a further recovery in the S&P.

Further out, the risk factors remain unchanged. A Greek default, possibly as a result of a continuation of its ability to meet fiscal targets, will most likely occur in March, when 10bn will be disbursed AND a 14.5bn bond issue matures. (It is now trading at 55c bid, or a yield to maturity of 150%) Over this time period, EU banks will likely continue to face worsening funding conditions.

But that is still 6 months away. We should remember that 3 years ago, US banks faced funding stress for over a year before Lehman defaulted, and the S&P had a nice 14% rally in between. We could well see something similar this time around.

But remember, the structural issues WILL get flushed out, one way or another. Credit availability in the EU has been contracting for some time now, in conjunction with austerity measures that WILL push the region into a recession. (See chart below – German Industrial Production YoY is in blue) This will further limit political willingness to sacrifice to preserve the Euro. The worsening data will of course also generate further losses by EU banks. Even if the ECB can continue to provide unlimited liquidity, with further credit deterioration, eventually some banks could run out of ECB-eligible collateral. And even if that doesn’t happen, in a few years the average interest cost for various periphery countries will reach levels that will guarantee default.

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