Recap 11-15-11

Main Items:

  • US Retail Sales ex Auto & Gas rose a strong 0.7% in Oct vs 0.2% exp and 0.6% prev.
  • US Core PPI rose 2.8% YoY in Oct as exp and 2.5% prev.
  • US Empire Mfg improved to 0.61 in Nov vs -2 exp and -8.48 prev
  • Efforts to leverage the EFSF have hit roadblocks according to an article on DJ. Finance ministers have publicly talked about having a new enlarged facility up and running by Dec although sources say that timeline isn’t practical. Meanwhile, it also seems unlikely that an accelerated schedule for ESM implementation would be adopted – DJ

Overseas:

  • German Zew Survey declined to -55.2 in Nov vs -52.5 exp and -48.3 prev
  • UK CPI declined to 5.0% YoY in Oct vs 5.1% exp and 5.2% prev. The Core measure increased to 3.4% vs 3.2% exp and 3.3% prev
  • China continues to ease policy rates lower, issuing 1y bills at 3.4875%, 9bps beneath its benchmark deposit rate for the first time since January and compared with 3.5733% at a Nov. 8 sale.

Commentary:

Last week, I noted that the big question for markets is how long the ECB keeps buying BTPs. Apparently, the answer was 2 days. With periphery, Italy and France debt markets all facing a buyer’s strike, the ECB’s SMP program has to increase by 10x to keep yields steady and head off this self feeding cycle. Clearly, this is not happening. The extrapolation of this trend is fairly straightforward, and is made worse by the fact that no rescue plan is now under consideration. The supply/demand balance for EU sovereign debt boils down to:
1) EU banks represent a substantial chunk of EU sovereign debt buyers
2) EU banks are required to delever, which necessitates less buying or sales
3) EU sovereigns continue to run deficits, which necessitates additional bond sales
4) Further declines in sovereign debt prices necessitates further EU bank deleveraging
If true, EU sovereign yields will continue to rise regardless of enacted austerity measures. Regardless, the resolution necessitates an increase in the money supply. And as the crisis gets worse, the reliance of any solution on monetary policy grows, because government yields have multiple equilibrium levels. Italian yields at 7% for an extended period is an equilibrium level that leads to default, while 3% yields is an equilibrium level that allows for continuity. The higher yields climb, the more buying (or commitment to buy) is required to bring yields down.

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7 thoughts on “Recap 11-15-11

  1. Picked this up from ZH blog/DB report and may explain why the Euro is where it is (1.35) against most expectations:

    One broad conclusion is that the EUR is probably the worst instrument to express negative EUR area views, with both periphery bonds and equities purer gauges of stress.
    The portfolio data would fit with the DB Select data that suggests that leveraged funds have their EUR fund on, but are getting no joy, because of both the broadly flat underlying EUR area basic balance position, in combination with net portfolio inflows, partly related to the repatriation story.
    In general it would be expected that repatriation flows, to support year-end window dressing should offer the EUR a degree of support in the coming month. Even from a medium-term standpoint, this would play to selling realized volatility, since the EUR crisis will provide plenty of constraint to EURUSD’s upside, while the above story suggests there is some less visible protection on the admittedly much more vulnerable downside.

    Seems a reasonable explanation to me.

    1. Yes, this looks very reasonable. Also, the stable Brent prices are a positive as OPEC continues to recycle USD to EUR. But selling vol on EURUSD in size here requires a lot of cohones given the tail risks…

  2. Also, the process of European bank deleveraging (via balance sheet reduction) is EUR supportive over the medium term.

    1. Indeed. Unfortunately we have to get through the short term first!
      A key mandate for Central banks is to allow deleveraging to occur in an orderly manner. In this sense, the ECB is completely shirking its mandate.

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