TMM solves the UK structural deficit

Well, it's that time of year again, when the media and political classes all get in a tizz about bank bonuses, and while Team Macro Man often cannot believe their eyes at how bankers keep shooting themselves in the foot as far as political sensitivities go, TMM reckon that there are a fair few other areas of society that ought to pay their dues. So in this regard, TMM will attempt to try and plug the UK's fiscal hole by proposing a set of windfall taxes along the lines of the Bank Bonus Tax. But this time, with the *real* culprits.

Banker Tax. As mentioned above, we are often incredulous at how retarded bank PR has been over the past few years, with a seeming inability to accept wrongs or indeed even give an inch to policymakers. In particular, the way banks behaved in 2009 despite unprecedented public support, forced politicians to act. But it didn't have to be that way... UK banks, in particular, blew up as a result of the structured finance books and exceptionally poor decisions by senior management at a few of them (Fred Goodwin, we're looking at you).

Given all those bankers and traders who were in the employ of foreign un-rescued banks who have nothing to do with UK lending, and in jobs like operations or IT had very little to do with the losses that materialised, it seems somewhat unfair that they are made to pay the windfall. Whilst banks may soon try to redefine their activities ("Hello Barclay's Butchers, can I help you?"), it's the other non-bank banks we feel real sorry for, e.g. Blood Banks, Bottle Banks and err. where they keep "man-deposits"?.

Anyhow, the Bank levy is supposed to raise around £2bn, so let's distribute that a little more fairly. HMRC data show that Income Tax and NIC contributions from Financial Intermediation for 2009-10 were £23.2bn. As a ballpark guess, the average tax rate (including NICs) on that is probably about 40%, implying ~£58bn of pay. Again, taking a guess that around 5% of the payroll was responsible for the losses, or ~2.9bn, that implies a tax rate of 69% for those guys to raise the Banker Tax's £2bn.

Accountant Tax. Barry Ritholtz popped this post up as we were writing this. Enough said. They've got to be good for another £2bn.

Ratings Agency Tax. As TMM have oft pointed out, this little lot are directly responsible for the start of all this in the first place with their split ratings on turds. They are currently playing havoc with Europe. We suggest adding a tax of 1 penny on every bond issued that carries one of their ratings. This would either raise a sum of 0.01 x 1 trillion = £10bio, or alternatively drive people to do their own risk assesments. Both being positive outcomes.

Lawyer Tax. So lawyers were never involved in okaying all those structures that brought the financial world down? Guilty! Lawyers to be nationalised and pay to be capped at 100 pounds per hour and bonuses to be payed 1% cash and 99% in legal aid vouchers. Given the UK boasts 151,000 lawyers, probably earning an average salary of £50k, that would raise about £7.5bn.

Labour Party Tax. In running an expansionary fiscal policy, Gordon Brown pushed up the UK's Real Exchange Rate in line with the Mundell-Flemming framework. However, in doing this, the private sector economy became uncompetitive and vulnerable, resulting in large swathes of UK Plc. being sold to the French, Germans and Americans along with their future tax revenues in order to finance the UK's current account deficit. By doing this they were part and parcel of the fundamental imbalance in the UK's economy. Brown's meddling with the regulatory framework also prevented a sensible and coordinated appreciation of the risks prior to the crisis and also an appropriate response during it. While it's hard to put a concrete number on this, the Labour Party membership stands at around 92,000. Guessing that they earn the UK's average salary of £26k, a 69% Labour Party Tax would raise around £1.65bn.

Bank of England Tax. TMM's nemesis, Mervyn King, and the other ivory tower economists that have inhabited the BoE since its independence also clearly contributed to the crisis in keeping monetary policy far too easy to begin with, then far too tight as the crisis evolved and then to outright lunacy as banks started to collapse around them. Not to mention the money market reforms of 2003 and 2006 that sent leverage ratios on HBOS & Northern Rock's balance sheets northwards (we'll do a post on this at some point in the New Year...). Unfortunately, the Bank of England's profits already accrue to the Treasury, so there isn't room for a tax here.

Estate Agent Tax. The cheerleaders of the past 10years of ever-rising property prices. In the UK, House Price to Earnings ratios jumped from around 2.6 in 2005 to around 4.9 at the peak and TMM reckon that the difference between the 2007 peak ratio and the 1989 peak ratio is probably a fair assessment of their contribution, or around 40% of the valuation move. The HMRC data show Real Estate, Renting & Business Activities as paying £43.3bn in Income Tax/NICs in 2009-10, so guessing an average tax rate of about 30%, that makes about £144bn of taxes. Guessing that about half of this payroll (conservatively) was involved in residential & commercial property sales, and applying the 69% tax rate above gives an Estate Agent Tax of £49.7bn.

Buy-To-Let Tax. The next group are those that priced first time buyers out of the market and amassed large property portfolios (anyone remember the stories of people on £26k a year, but owning 10 buy to lets?!). TMM cannot find much data on this, but taking a conservative assumption that there are ~200k buy-to-let landlords each owning a single second property, worth the average house price of £165k and yielding an average 4.5% results in a Buy-To-Let tax take of £1.02bn.

Media Tax. Kirsty Allsop, Property Ladder and all those other "buy! buy! buy!" property programs who provided tips to would be buy-to-letters and property developers (the polite name for "speculative flippers"). In this group, we'll add The Press and the BBC, who get a special mention for Robert Peston fueling the run on Northern Rock, which cost the taxpayer £40bn. It's pretty difficult to find data about earnings here, but as a proxy, the BBC's budget is £4.8bn, so at 69%, the BBC Tax would raise £3.3bn.

The Simon Cowell Tax. To be introduced for reducing half of the population of the world to dribbling morons every Saturday evening and reducing workers efficiency on Monday mornings as the previous Saturdays are discussed. With yearly earnings of $54m, that's another £37m.

UK Consumption Tax (VAT). TMM learned a long time ago never to underestimate the stupidity of the UK consumer - he/she will just go on spending no matter what the consequences. As we all know, overconsumption is unsustainable and represents an imbalance, so hiking VAT pushes up the relative cost of imports to exports in tradable goods. The hike to 20% is expected to raise around £18bn, so why not hike it to 30%? Substitution and a collapse in consumption is likely, so it probably wouldn't raise a huge amount more, but if it's only 50% as effective, that would raise about £36bn.

Overseas Private Infrastucture Company Tax. How did they raise all that money to buy our monopolies? This should be hugely popular given recent experiences at Heathrow and on the trains. An alternative is to go the whole hog where the UK instead sells ALL national interests to overseas purchasers, only to renationalise the lot six month later (the Putin trade). Estimated revenue £10bn.

Footballers Tax. You know the bubble isn't over until these guys go back to being paid thrupence a week for the honour of bladder kicking for their local factory town. Half of the rhetoric offered for taxing anyone with the name "bank" in their company title is that "everyone must do their bit". Except, apparently, footballers, whose money when spent lavishly in nightclubs on imported booze and mock "insert era here" houses is deemed to be helping the economy and anyway they provide a great role model to the youth of today. Ahem. Tax them too. Estimated revenue £500m.

Psycho-delusional Politician Tax. Taxing Vince Cable is about as indiscriminate as the taxes he is suggesting, so let's go for that too. Given all the freebies and expenses putting his earnings at around £280k, at 69% that should raise £190k.

TMM Tax. We realise that there is little chance of getting that lot invoked without the chance of someone trying to get their own back. So we are going to pre-empt it and tax ourselves. Revenue estimate - £ 38.57.

Totting that all up raises an annual £123.7bn which is about 8.6% of GDP and pretty much bang on the OBR's estimate of the UK's structural deficit. Job done. Mr Osborne, we expect your call.

Merry Christmas. TMM will be back in the New Year.

Order of Service

Welcoming Address

We would like to welcome you all here today to celebrate a very special year in the world of finance.

Reading from the Gospel According to Mangler Merkel

Trichet sent an angel to a girl named Merkel. "Mangler, you have nothing to fear.", the Angel told her, "Trichet has a surprise for you: you will give birth to a son and call him Eurobond, and he will save the Euro from all its sins". Merkel asked how this could happen, and the Angel explained that the Berletchsconi would come upon her, by Trichet's power, and that the baby would be called Eurobond, Son of Delors. Merkel was ready to obey. Then the angel left her.

Carol
Hark The FX angels sing,
"Glory to devaluing!",
What on earth? These movements wild,
Get those trades all reconciled.

Vengeful, all the nations rise,
Join to sell down from the highs,
With the CB host proclaim:
"Devaluation is our aim".
Hark! The FX angels sing,
"Glory to devaluing!"

Reading from the Gospel According to Darth Weber

And so it came to pass in those days Europe issued a decree that a census should be taken of the all the banks. And everyone went to their own regulator to register. So five Spanish banks and two Germans also went up to the town of Frankfurt in Germany, the town of Weber, because he belonged to the house and line of the Buba . They went to register with CEBS who also, was a descendent of the ECB and of the tribe of Hawks. At that time Greece was expecting a bailout. While there, the time came for the Crisis to be Born.

Carol

We Mervyn Kings of BoE are,
Printing money, so you can buy cars,
Gilts and Sterling, both are curling,
Inflating our debt away.

Ooohh... STIR of wonder, STIR of might,
STIR when money is not tight,
Inflation leading, not proceeding,
Guide us to the perfect Rate.

Reading from the Gospel According to Jim Rogers

There were miners camping in the outback. Suddenly, an Angel stood among them and Gold's glory blazed around them. They were very scared. The Angel told them, "Don't be afraid. I bring you good news". Today a saviour has been born for you. You are to look for a bid wrapped in rhetoric and lying through its teeth.". The Angel was joined by a huge host singing "Glory to Gold in the Heavenly Heights, Pieces for everyone on Earth". The miners ran to Asia and found China and Korea, and the bid lying with the reserve managers.

The Lord's Prayer

Our Ben,
Who art in heaven,
Hallowed Be-nanke,
Thy auctions come,
Thy Bill's be done,
In Twos as they are in Sevens,
Give us this day our daily FED,
And forgive us our Treasuries,
As we forgive those that default against us,
And lead us not into recession,
And deliver us from deflation,
For thine is the borrowing, the easing, and the printing,
For ever and ever.
Amen.

Closing Address

This Christmas may we have the joy of the FX Angels, the wonder of commodities and the giving hearts of the central bankers; and may the Blessing of Gold, Equities, Fixed Income and FX rest on each one of us. Amen.

More on Ratings Agencies and Consultants - What a bunch of quants!

More on one of our pet themes. After Moody's fun with the US yesterday they have turned their attention to Spain now. If the ratings agencies don’t state anything new but only officially "time stamp" what we know already on the risk curve, why do markets insist on step change moves in response to their announcements? Are there really investors so comatose that they don’t react until a ratings agency announcement tasers them out of their torpor? Yes, apparently there are and people even pay fees to these people to manage their money. How do they justify these fees? Well, dear investor, it's called Benchmarks and, to paraphrase the Sex Pistols (and to nick a chapter heading from from a friends book), "Never mind the benchmarks". Because benchmarks are indeed bollox.

It's all part of the cycle of unintended consequences. The investor tries to protect himself from risk by insisting that his money only be put in "safe" investments, but who decides whether they are safe or not? Enter the ratings agencies who then carve up a normal curve of risk into thick histogram buckets with Hoover Dam-like edges. The difference in real risk between a top BBB+ rated bond and a single A- may be non-existent in reality. But to the benchmark-driven, ratings agency-dependent passive bond fund, investment dicta handed down from a board of fund trustees made up of laymen advised by "consultants", it can make a difference on the order of 1000bp of performance (just look at where the crossover indices got to in 2008). Does that reflect TRUE risk? No, it reflects a self-inflicted market distortion, which just adds risk to the very portfolios that introduce these rules to try and reduce it.

What is more, as the rest of the investor community can see the ratings agency changes coming a mile off, it means that any portfolio changes based on their actions hit a market that has already discounted them, undermining performance even further. But the really magic trick is that it doesn’t matter because performance is measured against a benchmark of similar passive funds that have to follow the same rules! And as a benchmark reflects the average, then on average, they are average. Collect the fees and shrug.

That is the case for passive managers. But there are examples of active investors doing their proper bottom up research on assets, discovering that they are hugely undervalued despite the risk of downgrade, but can't take the risk of buying them, because in the event of a downgrade the contract they have with the client (usually advised by a top consultant) makes them a forced seller into the "mark-to-market" price freefall. To make things worse this is the moment the supposed risk-taking "Market Maker" suddenly backs off, becoming an "agency broker" on commission! Or in the case of a bank, the regulator forces them to increase the amount of "risk-weighted capital" held against the asset following the downgrade, making the original investment case untenable. What is more, the derivatives of ratings agency-dependent products have their margins and haircuts set against the same ratings, creating a horrible negative feedback loop in response once a downgrade occurs.

This is exactly what happened with the ABS/MBS market and in particular the genuinely high-quality end of the US MBS market, where ratings agencies changed their methodology on rating bonds for the potential of default. Despite the fact that an MBS might only suffer a projected default over its life of 1 dollar, the security was rated sub investment grade, destroying the investment thesis of even a good researcher and closing a massive investment opportunity to bond fund managers and the back books of banks alike.

The fundamental problem is there is a total disconnect between the "risk taker" and the "risk controller". In this case the "risk taker", the real name for whom in the modern market is "investment manager" and the risk controller, i.e. the legal rules and compliance depts set up to control the dangerous risk taker (because as we all know taking any kind of risk is far too dangerous for the masses) and "protect" the capital of the end investor. The good investment manager does the research, finds the asset, works out the fair value, compares this to the market price and, if the market price is cheap to fair value, should be able to buy as much as possible within his level of prudence and conviction. But then in steps the risk controller who has no more information than an arbitrary set of rules thereby emasculating the investment manager and guaranteeing that the investor's capital is put at higher risk than it needs be.

This is all the more pertinent because we are only a gnat's crotch away from some regulating do-gooder kicking the plug from the comatose UK public sector pension's life support system. It has been noted that the deficit has doubled in the last 3 years to £100bln and we know what happens next by looking back at what Myners did to the UK Pension funds in 2001/2. Scream outrage at the losses occurring, look at where the funds were invested and regulate that they are no longer allowed to invest there at the absolute bottom of that market. So with the "consultant" on the radio today complaining that 70% of these UK local funds' money is in equities, you can be pretty sure the next move will be to tell them they have to go into bonds. RIP.

Of Squeezes, Ratings Agencies, Lawyers and Haircuts

Well the Mervynflation report came out again and managed to show remarkable stability as inflation ex-everything is encouragingly low. Well done, Mervyn. Great application again of the Gaucho Grill.

Elsewhere December is going just swimmingly as far as the general "stuff you" moves go. We are still intrigued at the almost desperate recycling of Eurowoe headlines in an effort to get Eur/usd down again. But the price is not responding. The path of pain beckons beyond the oft quoted 1.3450 JSTFR point. The latest excuse for this further squeeze on Euro shorts came via the mood swing on USD. Or rather the Moody's swing on US. Once again the ratings agencies come out and screw a country with their views observed through their rear-view blindingly obvious binoculars. Are the ratings agencies as dangerous and uncontrollable as Wiki-leaks? No. Probably not, as what they say has normally been out in the public domain for years (though a lot of folks would like to see them go down for abuse crimes). We have bankers' taxes, how about ratings agency taxes, where we refuse to allow ratings agency employees to receive bonuses if their agency causes financial upset?

Whilst we are on the subject of taxing professions. How come the lawyers get off so lightly? Talk about a tax on efficiency, a tax on lawyers, if it decreased their activities and intervention, would actually be a tax that INCREASED efficiency. And if you thought Winston Churchill was talking about the RAF when he said "Never in the field of human conflict was so much owed by so many to so few", it's more likely he had just received a lawyer's bill.

Another profession that appears to shun efficiency as much as the lawyers is, surprisingly, hairdressing. How many of you are as bemused as TMM by the questions even one's regular hairdresser asks. "What is it to be then?" Errr... Shorter? "Would You like it layered?"... Wassat? "Scissors or clippers?" Err.. "Tapered or straight across the back?".. I dunno I never look at the back! "Wet or dry cut?" Why the hell do I care? Basically we don’t speak "hairdresser language", so much as we'd love to be able to trot out "scissor-over-comb-1/2inch-over-ear-layered-1-inch-top-thinned-tapered-back-dry-cut-shaken-not-stirred", we can't. We are normal people and don’t watch reality hairdresser programs. So here are some TMM top tips to all our hairdresser readership. Please do one of the following.

On completing a haircut, jot down exactly what you have just done in hairdresser language on a small card that we punters can present to the next hairdresser to get the same results. Or set up "HAIRNET", an internet based service that you log the above data in, preferably with photo, so that it can be accessed at salons globally, then make it into an "app". Or don’t act surprised when the client, as this one did, hands over a phone and asks to have a photo taken of the result for use at the next visit.

Finally a tip for us customers. You know that bit at the end where they get out a mirror and show you the back (as quaintly traditional as offering that stupid oversized pepper pot in Italian restaurants) and you mumble the expected "yes lovely thanks" ?
Well, instead scream: "WHAT THE HELL HAVE YOU DONE TO IT!! ". It doesn’t half freak them out.

Now we know we should be saying something intelligent about the markets, especially after the very generous responses a few of you have made to the TMM "last request" Christmas appeal, but we really haven't anything intelligent to add. But, to those of you who have responded - A really Big Thank You. It is a lonely place doing this for the love of it, so seeing your appreciation and support being channeled to something worthy is heart-warming. Thanks again. To those of you that haven't responded, we are sure that you have good reason, but there is a candle lit in the window of the "JustGiving" site for you just in case.

TMM

Christmas - Time for Giving?

The Christmas lunch season is fast descending upon us, which will play havoc with our posts from now on, so we apologize in advance if they become more sketchy.

But this is much more important -

With Christmas nearly upon us we thought it worthy to revisit Macro Man's Last Request (tagged in the sidebar). Back in May when MM moved on, leaving TMM nursing his baby, he launched a little charity request for any appreciative reader over the years to help the children at Great Ormond Street Hospital. Your immediate response raised about £1500. Now, 7 months on, fresh help has slowed to a trickle but we would love to be able to have one last push over the Christmas period to help us get to at least £2,000 by year end or, hopefully, blow that target away.

So, calling all of our readers who haven't helped already, you referral blogs, you mirror sites, you syndicating sites, you press readers and as the radio phone in folks say "Every one else who knows us", please can you spread the TMM Christmas Message and help us to help them at -

Macro Man JustGiving

Yours
Team Macro Man

Competition Time

We are back in the badlands of admin-o-tastic bullshit. It feels like career regression is kicking in big time, with one member of TMM feeling he has actually just crossed below his original entry level into the world of finance. Didn't they invent machines powered by steam 200 years ago that can do the job better than the current ones we are given, powered by electrons?

Out there in the real world it looks as though the falling bonds have been saved by the twanging of the safety rope and we are generally on hold. Pause day. Or COMPETITION DAY!!

Now TMM recently received an offer to invite our readership to participate in an essay competition run by a body of investment managers. The competition involves writing a paper that critically looks at how investors "might better manage portfolios during market downturns yet still capitalize on periods of superior performance". The winner would receive a sum of money and the chance to tell others all about it.

Which leads us to consider all the oxymorons, tautologies and downright "D-UH"'s involved in this. But instead of raising little points like "Well, if it works so well, why am I telling you about it" or "You mean you haven't heard of short positions or options?", we would just like to launch our own TMM Award.

Entrants are asked to submit papers on their designs for a "free money" machine, accompanied by $20,000 of the free money it has made as proof of its success. The winner will receive a sum of $10,000, the chance to talk to a field full of sheep in North Wales, a MUG and will then be told to bugger off.

Runner up certificates will be awarded to anyone sending in over $1,000 of free money to TMM. We look forward to your entries and sailing off into the sunset at your expense.

Most Faithfully Yours,
Dr T, Dr M and Dr 'Bleedin' M, PhD, MBA, CFA (and random qualifications from the Univeristy of Cowboywebsite, Witchy-bloody-taw)
Joint Chairs, Dining Table and Tea Tray
BigImpressive-Sounding Fund Management, Inc, LLC
Bowlacks, USA

Bad day for Goldfinger, but worse for Mr Bond

Well, TMM were happy with yesterday's Gold move, but they are sure they are not alone in cringing at the car crash that has occurred in the Treasury & FX markets overnight as Tens smashed through 3% and then proceeded to trade as low as 3.25% on the London open. Cue a barrage of excitable emails, Bloomberg messages and IBs from all corners of the market, intellectualising about how the Treasury move shows that the market is now worried about the sustainability of the US debt load, or that equities cannot rally with yields moving higher, or that QE2 has failed, or that mortgage convexity selling is about to send yields to 3.5% etc etc... Usually, TMM's "signal" for when things have gotten a bit overdone is when emails on rather complex subjects start to come from single stock equity guys or the FX market... we'll merely refer you to our Armchair Generals piece.

But in seriousness, TMM have a hard time buying a lot of these arguments and we will attempt to explain why. In terms of debt sustainability, in our view, looking at US sovereign CDS is not particularly useful, given that US banks cannot trade it and given that most hedge funds have US banks as their prime brokers, there is little point in them trading such instruments, and as such, it is rather illiquid. However, the Treasury market and Overnight Indexed Swap (OIS) markets are very liquid. Now TMM is totally open to the idea that the US is the next "obvious" candidate for the bond market vigilantes to target, it is pretty hard to do so when Voldemort & his Deatheaters and the Fed are on the bid. And the former doesn't have any other obvious candidates given the Eurozone train wreck and the latter will buy until growth and inflation are back to "normal" levels. But back to the UST/OIS markets. A much better way of observing (and trading) the pressure on the US fiscal position is to look at the 10yr UST-OIS Swap Spread, as the latter is a much better proxy for the "real" risk free rate (usual caveats apply, but it's pretty close) - see chart below. It's pretty clear that the rates sell-off is not related to fiscal concerns.

And as far as TMM can tell, at around 12bps, there is no particular concern evident here, and we are well-off the wides of ~30bps earlier in the year. Clearly the financial crisis has taken its toll, with the measure no longer trading negative due to the premium they have had as a result of the USD being the reserve currency, but we are nowhere near the kind of levels that the equivalent Eurozone spread is trading at. The below chart shows the GDP-weighted EMU yield vs EONIA, and even though this measure includes the King of fiscal prudence, Germany, at 118bps the debt sustainability concerns are very clear:

But what about growth prospects? Obviously, payrolls excepted, the US economic data has generally surprised to the upside over the past month or so and the Vampire Squid (amongst others) have revised up their 2011 growth forecasts significantly. TMM like to look at the 5y5y forward real rate as a market proxy for future growth, and the below chart (white line - 5y5y forward real rate, orange line - consensus economist 2011 GDP forecast, lagged two months) seems to indicate that the bond market has revised up its view of GDP to close to 2.7%. With 5yr real rates still negative, and both economist and market growth expectations higher, TMM struggle with the idea that equities cannot push higher.

We also note that next week sees the FOMC meet, and in the context of the bond sell-off, TMM would be very surprised if their statement were not overtly dovish. And while QE2 was marketed as trying to keep real bond yields low, it was also intended to force investors higher up the risk curve and out of Treasuries into riskier assets. On that basis, given the UST sell-off and equity rally, you could easily argue that QE2 has been as successful as QE1, which met a similar reaction, culminating in a capitulatory sell-off in June 2009. Given the ferocity of the sell-off and the fact that on the 7yr Note (a proxy for the 10yr Note future CTD) has touched the 50% retracement of the April-November move, with a fierce 36bp two day sell-off that smacks of a combination of convexity paying and long capitulation, TMM wonders if the end of this move is near. The million dollar question is whether Fannie 4s breaking below par will trigger a new round of convexity paying or not. Now the Fed's MBS purchases have removed a lot of this risk from the market, so it's unlikely that mortgage accounts will be dramatically caught offside, but in December, anything can happen.... So while TMM are biased to put on their "catch a falling knife" gloves, they're putting on the Kevlar-strength ones, and only buying a small amount for the time being.

Swimming with the Sharks

Bounce-time Baby. We are happy with yesterday's thoughts as today the scramble to de-leverage the stress trades grabbed hold with the world looking just like an old fashioned "risk on"/"bash the Dollar"-fest. Usually at this time of year, TMM are cursing Voldemort and his Death Eater chums for coming in with a massive Euro "buy" programme. The past few weeks they have been somewhat absent from the market, but TMM knows that Voldemort loves to screw speculators, so to come in right now when the market is trying to be bearish Euros would be "very FX".

Commodities are all screaming higher too and though oil took a bashing in the back end yesterday and the soothsayer signals suggest a sell, there appears to be a rampant background chat of $100 around the corner which no doubt will suck in another round of spivs short term traders. So rather than "Red Adair" it we' d rather let it burn itself out.

But there really hasn’t been much Macro change - it feels more like the positional Micro (though we are sure that the world will be allocating retrospective Macro news headlines to explain it all). Now with everything going just so swimmingly with our bounce view and us being the stupid bored adrenaline junkies that we are, we thought it fun to do the equivalent of going for a swim at Sharm el Sheik and raise the matter of our nemesis. Duck! Incoming Spam Tins!

So TMM have dusted off their trusty Gold-Real Rate charts and found to their surprise that since the QE2 set sail sank, Gold has diverged significantly from real rates. Indeed, while during the May Eurozone turbulence, both Gold and Real Rates moved in unison, excepting a brief QE2-fade trade, Gold has pushed to new highs, while real rates have crept back up to where they sat in late-September. To date, TMM's view has been that Gold is only a bubble if US Treasuries are, because the moves in Gold have been fully consistent with those in the Treasury market. But this is something different, with the Gold vs Real Rates relationship suggesting a 14.5% valuation gap (the largest we have noticed since 2008 - see chart below: white line - Gold, orange line - 10yr World real rates) and increased chatter about Gold being "the true" reserve currency. While we generally try to stay clear of these quasi-religious debates, it's looking increasingly like Gold is getting a bit "frothy" again. Of course, this divergence could just be year-end balance sheet-related as dealers (and leveraged money in general) have been caught long USTs at the wrong levels. TMM are just as wary of putting on large RV trades just before year-end, but it might make sense to begin scaling into long Treasuries vs short Gold betting that this relationship snaps back. The one worry we have, however, is that now that Europe has had its fiscal crisis, the next fiscal domino to fall (Uncle Sam) could play havoc with this trade. But that is probably next year's story.

The Sharm el-Shiekh toe-dipping trade is the GOLD/UST one, but the full immersion, Steve O, Jackass trade is Short XAU/EUR (see chart below). We are going for the latter. Yeee haaaaw!

Eurobear Squeezes and Footy Swaps

Well the beginning of last week saw Europe tanking, US data doing ok and China continuing on its tightening theme. But now we have bad US labour data, China increasing money supply and the short Euro play being bazooka'd by the ECB.

The mood has been resolutely bearish in Europe since the US QE announcement, but we feel that, without some enormous Tape Bomb (huge news event), the imminent risks are fading as are the chances of another successful attack on Europe before the end of the year. So despite a good attempt this morning to get the Euro down (involving the cut and pasting of any and every Euro negative headline) we think another Euro bear-squeeze may be on the cards. As for trying to sell Euro on a large US fund man's view on Ireland? Not only do we think said organisation's views get FAR too much airtime, we also remember his Gilts calls. This cartoon in today's London Daily Telegraph sums up the Europeriphery perfectly.

As for equities, the JBTFD ("just by the dip") policy is working well. It doesn’t feel as though many people caught that 4% US rally last week and a year-end melt UP certainly feels like the pain trade, once again, tape bombs forgiving. And with that we guess we would see the usual carry asset suspects go back into "creep up" mode.

And that, folks, is probably that. Mince pies and Xmas parties to dominate global markets from now on, but before we sign off, TMM have been wondering how the ECB is going to be funding their bazooka. Whilst others consider the idea of the E-Bond, we actually think there is another cunning plan being instigated in the background, the first glimpses of such were surely seen last week with the outcome of the World Cup venue decisions. Europe is obviously entering into "Footy swaps", in which FIFA votes are nominally exchanged for funding using some sort of long-dated off-balance sheet product. If we consider the amounts needed, we calculate that duration must be out to 600 years. Football's never coming home.

Groundhog 28 Months

It's US payroll day today, but TMM can honestly not remember an NFP release that holds less interest for markets. Given that just about all asset correlations are at 1, markets are (correctly) trying to focus on the ultimate driver, which is the condition of the Eurozone Sovereign credit market.

The only was that TMM can see NFP being relevent is if the number is materially lower than 100k, which could perhaps dampen the recent enthusiasm on US growth. On the other hand, it might put a stop the slow pnl drip out of UST longs' trading books. But certainly anything close the the 150k consensus forecast will represent a continuation of the recent trend.

In fact, rather than write a post, we'll just refer you here to a post Macro Man put up 28 months ago:

It's US payroll day today, but Macro Man can honestly not remember an NFP release that holds less interest for markets. Given that just about all asset correlations are at 1, markets are (correctly) trying to focus on the ultimate driver, which is the condition of the credit market.

The only way that Macro Man can see NFP being relevant is if the number is negative or near-negative, which could perhaps encourage the Fed to relax its language next Tuesday. Failing that, Macro Man would expect the FOMC statement to retain its relatively tough stance, which could prove to be an ideal catalyst for the start of the next downleg in risky asset prices. Certainly anything close to the consensus 125-130 forecast will represent a continuation of the recent trend.

As for views on all the other stuff going on, it will have to wait. Behind the scenes TMM are still not out of their "bright lights big city" meets "trains, plains and automobiles" real life experiences...

Lifestyles of the rich and … us.

As we wait for the Eurobollox to unravel in a new load of Eurevelations, the UK is under a coating of Eurosnow. This is a special type of snow that is denied by officials right up to the moment of its unplanned arrival and then turns the infrastructure of developed countries into that of Third World states. So today instead we will step back from Europe themes, take a break and offer a little glimpse into the heady lifestyles we lead (hoho).

Well, it's all glamour in the life of a macro man. Yesterday started with a leisurely awakening on the country estate, followed by being driven to the office for a pleasant day profitably saying "yours/mine", a long lunch and an early departure for a night spent mixing with the rich and famous at a private art show hosted by a famous actress (and close friend, of course) at her palatial house. Of course, wit and repartee positively dripped from the tongue and all present were wowed and dazzled by the stream of intellect and insight offered on any subject they wished to raise; the evening ending with a very famous billionaire whisking said macro man off for a night of very classy debauchery... No names, of course.

Well that would have been a great day, but here is the REAL day in the life of...

5am - Awaken to read that the Eurosnow has resulted in no trains from the countryside running into the City. Start to ring colleagues in similar situations to coordinate actions (you can't be seen to be pub-lunching it at home when your treacherous colleagues have managed to struggle in). Drive to local station to find, indeed, "no trains". Drive to mainline station to find the same. 7.30am - give up, go home and start to ring office/log on to Bloomberg, which then intermittently dies on the home PC, making work impossible, as all the local broadband electrons must have been canceled due to the snow. Get a bit gung-ho and decide to break out the ancient Landrover, reserved for just such occasions and drive in to work. Spend an hour prepping the car with de-icer, water, oil, tow ropes, shovel, overnight bag, arctic clothes, drink and food supplies to the point that it's fit for a trans-Siberian expedition. Meanwhile wifey suggesting that, if it needs all that, then the trip probably isn't worth it. But it's become one of those man-missions and MUST be achieved. Set off finally at 11.30am. 200 yards down the road, wonder why the wheels don’t do what they are told. Not the ice and snow, there is something seriously wrong. Limp home and face wifely "told you so's". Not to be beaten ring the local friendly mechanic for an over the phone diagnosis. Nope, bring it round. Frustration now becoming palpable as the mission is losing direction, the vehicle is limped to said mechanic who does one of those air-intake-through-clenched-teeth and shrugs "Oooo, I wouldn't t be driving that. Leave it with me for a week". Ring wifey who kindly turns up to do the lift home. Decant all the survival kit, and then find that the Landy's rear door catch is now frozen and will not engage. Door now flopping around open in a public car park... Arrgghh... Lash said door closed internally with the stashed tow-rope (see? TOLD you it would come in useful), return keys to mechanic and go home. Can't find house/other-car/everything keys. Work out they must be in Landrover... Drive back to mechanic, break into rope lashed car and don't find keys. Ring wifey, who says she's found them in her handbag... HER HANDBAG?? Well I didn’t friggin' put them there. Oh, they were being untidy, were they? So you must have just tidied them up? Get home, apologise for unfair rant and now, adamant not to be beaten, turn down pub-lunch invitations from other strandees and load stripped down version of survival gear into small VW, whilst placated wifey fusses over the bad "man-packing" of the overnight kit and insists on repacking the lot in a "nice" way. FINALLY leave. Now, can someone please sue those people that sell 5 liter containers of blue piss that you put in your windscreen washers? I can assure you it is just blue dye with absolutely NO anti-freeze properties, as the squirties froze up soon into the trip resulting in staring through a screen worthy of a "Help get me out of here" Swamp Trial. But the good news is that after a journey worthy of an episode of "Ice-Road Truckers", mission was accomplished arriving at work at, trumpet fanfare..., 4pm. Just in time to leave at 5pm.

Book into local hotel that is "just a short taxi ride from the office" to save any repeat of above type of trip again. Leave office to find the local tube line is down and hence no taxis . Walk for 20mins through the snow to the Hotel. Check in and walk off to find the light railway station following instructions from the receptionist, armed with a "local map", which turns out to be just a schematic of the UK rail network. Risk life and limb running across a rush-hour highway and scaling a 5ft wall (are you sure this is the right way?) before arriving at the station. At this point the story gets so convoluted in its bizarrity that only regular London Transport sufferers would understand, so the next period shall be blanked over other than to say that a 40 min trip to get to the above mentioned art show ended up taking 2 hours.

So, the witty repartee and intellectual discourse? To hell with that, I need a drink. Lots of drink. Too much drink...whooops.

5am - Awake in hotel. Where's wash bag? It was definitely packed in the "man-packing". Oh, remember? - It got turned into neat "girl-packing" that involved leaving the washbag on the kitchen table. Oh noooo... And what happened last night? Did I really say that at the show? "You must have run out of blue doing that one. It's very...err...Blue" is hardly the cutting edge of critique and "Do you price them per square foot like wallpaper" may not have been the most enamouring question to ask hostess (who was indeed a famous actress). Oh nooooooo... Did I really make the taxi driver back to the hotel pull into a drive thru McDonalds at 1am to then have an argument with the janitor over how a 24hr restaurant could be closed? O, I did? .. Oh noooooo...

Eurobutton

Well, it looked as though it was all getting a bit silly yesterday morning, with dealers even hitting bids in France 5yrs and reports of certain central banks and SWFs in Scandinavia desperate to get out of their Club Med exposures. As we mentioned yesterday, we are strongly of the view that a pre-emptive policy response addressing the systemic concerns that have grown is imminent, with our "preferred" response being a pan-European bank recapitalisation fund aimed at putting the banks in the position that they can buy more European government bonds and thus reverse the direction of the feedback loop between the banking system and the sovereigns. And while TMM accept that the Euro, peripheral bonds and EuroStoxx did not bottom immediately after the May 10th, as trapped longs used the bounce to get out (veterans of EM crises will be very familiar with this type of thing...), when things started to get silly in early June, with selling of France, the Euro and EuroStoxx put in a bottom almost to the day (June 8th) - see chart below (white line - EURUSD, orange - France-Germany 10yr spread, yellow -EuroStoxx). While yesterday's selling of France was not quite a large as it was in June, dealers do not hold the same volume of paper as they did then, so arguably there is now less leverage-driven selling. On that basis, TMM are wondering if *that* is *it* for the time being...

Now it appears from Baron Von Trichet's testimony to the European Parliament yesterday afternoon that he has come around to the idea that the ECB needs to step up a bit, as do the politicians. One of the problems for Europe has been the ongoing tension between the Bundeathstar wing of the ECB, which would very much like to hike rates, and the precarious position of Club Med, and the Baron's comments yesterday suggest that the former are losing the argument - it *is*, after all, about the future of the Euro... Indeed, the reports in the press overnight about a renewed round of stress test and a step-up in ECB bond buying has hinted at what is to come. But chatter in the market this morning about the ECB pushing the nuclear Eurobutton on two trillion Euros of bond buying seems a bit Dr. Evil-like to us, and TMM cannot imagine Darth Weber would stand by and allow such an horrific policy to be announced (mock shock horror) and we imagine he's powering up the Bundeathstar ready to take aim at those dusting off the ECB's printing press. But in seriousness, it does seem as though at least some sort of expanded bond-purchase programme is likely to be announced (and we are sure that Baron Von Trichet will remember the dramatic contagion seen after they did nothing at their May 5th meeting)...

...And it looks as though the political bribes are being dished out to ease Germany's objections to stepping up their Eurozone aid, with German Finance Minister Schaeuble being awarded the French Economic Prize for his role in fighting the EMU crisis. TMM will remind readers that this is the very same Schaeuble that ruled out aid to Greece in the first place, then called the Fed's policy "clueless" and finally was responsible for insisting on the Sovereign Debt Restructuring Mechanism (SDRM) post-2013, which in our view (and, it appears, many European politicians) is responsible for the most recent turmoil in the periphery. Sounds like the ideal candidate for such an award.

But given all the above, TMM is of the opinion that ECB bond-buying - if unsterilized - is a clear Euro negative, but it is a material positive for European equities and, with the S&P500/EuroStoxx relative performance back to the levels seen at the depth of the crisis (and Eurozone data surprises having turned up over the past two weeks) it might be worth countering this. On the other hand, if policy announcements are more along the lines of unsterilized bond buying coupled with a bank recapitalisation fund, then TMM expects both the Euro and EuroStoxx to rally.

Nightmare before Christmas

You know that dream where you find yourself back at school about to go into your finals and you have done NO revision and what’s more for some reason you aren’t wearing your trousers? No? Well we bet some Eurocrats are wishing that was their reality compared to their current “Nightmare before Christmas”.

But say we were to wake up and find ourselves in their nightmare. What would We do?

TMM notes that our path from here is not exactly clear but there are options for which we have invented code names used by the leaker in Merkel’s office***:

1. Increase the size of the EFSF (“Big Bertha”).
2. Create a pan-European bank recapitalization fund and new stress-test round (“Groundhog Day”).
3. Explicitly rule out the SDRM (“Horatio Nelson”). Burying head in sand optional.
4. Instruct the ECB to go nuclear and buy bonds unsterilized (“Dr Strangelove”). Utter loss of credibility counseling to be provided by the Fed.
5. Require Sov CDS to be 100% margined (“The Little Bighorn”). Watch Euro dive some more as all those “down with Europe” flows go into the one remaining market they can.
6. Immediately stick Portugal and Spain into the EFSF (“2 tons of you-know-what in a 1 ton bag”). Have you ever had your shopping bags rip breaking all your eggs on the way home from the grocery store? We have.

We would view (2) as the most positive development. In terms of finance, we would imagine that the Euromandarins are looking at the pre-funded EUR60bn EFSM as a potential source of bank recapitalization funds, supplemented by another draw to take us to, say ~EUR100bn which we would say is enough for the system. If the Euro-banks are capitalized properly (and credibly) this time, then there will be nothing to stop them scooping up all this peripheral debt and thus the sovereign-bank feedback mechanism will work in reverse.

At least, that's what we would do it was our nightmare. However, the Eurocrats have shown themselves to be utterly clueless and comments such as:

*FRANCE'S BAROIN: NO RISK OF A DOWNGRADE FOR FRANCE

show that they are obviously suffering from sleep paralysis. Which as anyone who has suffered it will know is very frightening indeed.

But back to reality.

Another day, another 1.x% down on the Spanish 10yr and the Euro, though TMM notes that equities are doing OK all things considered. Maybe it’s that the supranational sector equities are actually becoming a sanctuary away from sovereigns, FX and bonds. Even the Ibex index is rapidly turning into the “Telefonica and Banco Santander” index, both of which have big businesses outside of Europe.

Telefonica got $6.4bn of its $15bn of Q3 revenues and $5.4bn of its $7.3bn of operating profit from Latin America. At 8% dividend yield and 8.5x PE it appears that the largest index constituent has reached, as pointed out by our friend, Charles, in the comments yesterday, the point of "compelling un-leveraged cash yield" from whence few things can trade down without any of the complexities of having a heavily debt financed balance sheet like Banco Santander. Though that is looking pretty ridiculous too. Take earnings from Latin America at 12.5x (Banco Itau's level) and the rest of the bank comes at 4.6x PE. That does look pretty cheap and with those two comprising 41% of the Ibex TMM wonders whether mindlessly selling Ibex futures might have had its day.

We are thinking of donning the Kevlar knife catching gloves as we cannot believe there isn’t a "surprise" change around the corner as the Eurostriches wake up and pull their heads out of the sand.

A Line In The Sand

Well we have the bailout plan, cue the usual items from your chosen bailout drama:

• Protests (check)

• Breakdown of government consensus (check)

• Inevitable question of who’s next.

TMM are coming to the conclusion that the drama in Europe is getting fairly predictable and the big question – Spain – is only just starting to be asked by the market. In a cruel twist of fate, Iceland – (Remember that one? Mid-Atlantic Lehman-on-volcano?) – now trades about 30-40bps tighter for 5 year sovereign CDS than Spain. Let it never be said that the gods don’t have a sense of humor, it’s just that they are as cruel and capricious as they were in the Iliad.
But TMM at this point are looking for slightly more nuanced trades than the obvious “it’s all gonna end innit?” ones and this has caused us to turn to none other than CDS indices. The chart below is of the Itraxx financials senior and sub indices which have diverged more than a bit recently.



The reasons are pretty clear: the EU and any bailout packages now expect junior creditors to take the pain along with equityholders whereas decisions have been made by the great and the good that senior lenders should be made whole so that banks don’t get into a collective crisis due to a ramp in funding costs. The objective here is clearly to force the weak to dilute and cram down junior creditors while keeping senior whole and not pushing a wholesale exodus of the bank paper market.
So, is this what the market is pricing right now? Not much, and frankly, not even close. TMM are feeling lazy and thought we’d take a snap of both a 5 year deal on European senior financials vs sub financials and equalize the default probabilities (assuming cross default provisions, naturally) and see what we got.



As can be seen its abundantly clear that you have to set recoveries on senior really low to get these spreads to line up assuming the kind of sub haircuts we are looking at here (0-25%). Now, maybe European financial leaders are joking and maybe this will get so bad that senior will get impaired but right now TMM can’t help but feel the senior/sub trade has more than a bit of a way to go.

While we're onto nuanced trades, it seems to TMM that it's worth having a punt on 10yr Ireland. A quick back-of-the-envelope job suggests that at 71.89c on the Euro, if you assume that Ireland restructures with a 30% haircut when the EFSF runs out in 2013, then you get a loss-adjusted yield of 5.3% - or 255bps above Bunds. Now TMM reckon that once Ireland has a "Number Two" of 30% it will be on a sustainable debt path and that 255bps above Germany *post-restructuring* in such a scenario comfortably prices the risk premium. In fact, that looks like fantastic loss-adjusted real yield with the added bonus of the wildcard option that they manage to pull this beast off. As with all the subprime trades, the key to finding support in prices of toxic waste under-priced illiquid assets, is for there to be a decent enough unleveraged yield. Well in the New Normal world, this looks to be a key candidate.

And finally, a happy announcement to make . With the increase of local denials of any peripheral problems, it would appear that the the Eurostrich has spawned lots of baby peripheral Eurostriches. Aren't they sweet! arrrrhhh



Going "cheep" to a good home .. ( groan)

The Beginning of the END

The situation in Europe has hardly improved over the past 24 hours. A raft of stronger European PMIs and German IFO figures that all outperformed expectations did little to lift mood and go to emphasise that the problems are sovereign-based rather than in the private sector. This morning has seen further blow outs in Eurozone peripherals and associated liquidity trades used by the market to hedge the periphery meltdown tail risk. Specifically, things like EURIBOR/EONIA basis and EUR/USD Cross-Currency basis have been moving sharply, bring back bad memories of May (not 2008, as some are trying to suggest).

Of course this has all added fuel to the "End of the Euro" Army who are being wheeled back out into Media space. More elderly occupants of FX dealing rooms are reminiscing over the old cries such as "Get me Mark/Spain calls", pondering if they might just return one day, raising a glimmer of hope for the drivers of "FX Taxis" where many old EMS FX-Cross traders ended up in the late 1990s. Of course, the 12yr old French quants in the room haven't a clue what they are talking about but smile politely.

TMM have had a think about this and the processes involved in moving from a single Euro to separately tradable sovereign currencies, should it happen. Whilst Euro-Apocalypstas seem to suggest that the move would be a step change, we would like to suggest that the process will mirror the evolution of other emerging markets. In these cases, the markets develop their own products to facilitate speculation hedging before they become officially freely tradable. Namely, the Non-Deliverable Forward (NDF) market. And so it should be with Europe.

So TMM would like to present the launch of a new product to facilitate such "hedging" called The END (European Non-Deliverable) market.

So how would they work and what would be the underlying hedge?

It turns out that the re-denomination clause in Sovereign CDS for G7 countries allows these guys to re-denominate their debt without triggering the CDS. This is particularly interesting in the case of Italy (coincidentally, a G7 member) and provides us with a way to get long Mark/Lira without paying away copious amounts of carry. So, think about doing the following set of trades:

1. Short 5yr Italian Bond funded on reverse repo (currently, 5yr yield is 3.488%).
2. Sell protection on 5yr Italy CDS (currently 206bps).
3. Buy 5yr German Bond funded on repo (currently, 5yr yield is 1.626%).
4. Buy protection on 5y Germany CDS (currently, 43bps).

If you add (1) and (2) together, you effectively have a short position in a risk-free Italian bond (usual CDS/basis caveats apply) that has the interesting characteristic that if everyone's favourite Italian, Uncle Ber-lech-sconi, decides to readopt the Lira, you are short an ITL-denominated bond and the CDS doesn't trigger. On the other hand, if they keep the Euro and restructure then you are hedged (again, usual CDS/basis caveats apply). The opposite is true of (3) and (4) - if Germany readopted the Deutschmark then you are left holding a DEM-denominated bond with credit risk hedged (although I'm sure no-one would bother buying protection on Germany). [As an aside, although most iPIGS CDS trade with the re-denomination clause, TMM is sure that variant contracts will eventually appear].

OK, so how do we price a DEM/ITL END ? Back in Finance 101 TMM remember learning how to price FX Forwards (Covered Interest Rate Parity and all that bollox). Without going into too much detail, and again with all the usual caveats, the 5yr Italy risk free rate is going to be something like 1.43% (=3.488%-206bps) and that of Germany is going to be about 1.2% (1.626%-43bps). Now DEM/ITL was pegged at 989.99, so plugging all the numbers into the FX Forward formula chucks out an outright 5yr forward rate for DEM/ITL of about 992.46. And that seems ridiculously low to TMM.

The first chart below shows the history of the 5yr END and the second shows the FX Forward Points.

Of course there is no guarantee that, upon leaving, either country would readopt their old currency at the levels they entered the Euro (they could have the NuovoLira, or NeuMark or whatever). But the above is illustrative that the market could very easily start trading contracts based upon Euro-exit as the hedge does not depend at all upon the new currencies or rates that they re-denominate at (these are, after all, purely arbitrary). TMM reckon that it would be pretty easy to trade their ENDs purely as the implied interest rate spread with a contract clause to add in the appropriate new Mark/Lira exchange rate upon exit, given its arbitrary nature.

So, who's going to be first to trade their ENDs in Euro ?

Gangsta Style- North Korea

One member of TMM has been to North Korea and noted that amongst the very, very few goods you could buy there was music. Though even worse than K-Pop TMM have to give the world's craziest despot an A for effort for ripping of none other than Nas. Bravo. 

Armchair Generals

A large component of the populace of Financial Markets is made up of commentators, advisors, strategists and so called "experts" and they are all there to "help" you make the right decision in your investment process. Whilst their existence can be poo-pooed as unnecessary and a drain on the efficiencies of the market, the very fact that they can survive in one of the most efficient and cut throat of arenas means that someone thinks their services are worth paying for. And for an analyst or strategist his reputation and hence livelihood, is just as much influenced by the success of his calls as is the actual fund manger by his investment performance. Therefore he will try at his utmost to retain that air of authority and "turn to" knowledge.

So today, with the markets attention being blindsided from the Euroblx and China Squeeze by some North Korean fireworks, we predict that every salesperson or broker you speak to will have suddenly transformed overnight into a 5 star Armchair General, trying to sound like WestPoint trained Asian strategic defence experts. But don't be puffed in, remember that these are the same people that only yesterday were Armchair Irish Budget experts and the day before they were Armchair Geologists re: rare earth metals and only a few weeks ago they were Armchair Meteorologists re: Hurricanes in the Gulf and previous to that they were Armchair Seismologists, Vulcanologists, Jet Engine Engineers, and even Epidemiologists when disease is involved. For this is the way it is.

A US Ex-Investment Bank Sales Desk near you awaits your calls:

To be honest it is the fun of the job, the financial markets do broaden your worldly knowledge dramatically and you do get led into studying the workings of things you wouldnt have imagined yourself getting dragged into, but lets just keep a reality check on the pomposity of some of the analysis we are offered up and offer up. Do we know what will happen in Korea? No. To be frank we don't, and our expertise on the subject is so low that it is insulting to offer it up for consumption. All we know is that there are e few outcomes ranging from "all out war" to "will be forgotten about in a few days". And our limited experience would suggest that if we had to make a choice we would plump for the latter.

But of course that doesnt mean that the market cant spend an awful lot of time spewing reams of worthless analysis. And this headline from the ultimate market-lagging arse coverer is winning so far.

**DJ S&P: WILL REVIEW SOUTH KOREA RATING IF IT BELIEVES TENSIONS COULD ESCALATE

No shit, Sherlock! Whatever next? Perhaps:

**MOODY'S MAY REVIEW SOUTH KOREA RATING IF SEOUL WERE TO BE VAPORISED IN A HAIL OF NORTH KOREAN NUKES?

We will therefore try not to be distracted by the analysis but will note what has happeneed to prices. Of course the knee jerk reaction was worthy of Private Fraser in Dad's Army, "We are doomed" but though China stocks were all headed lower during the day interestingly when the news broke Shanghai rallied. HK however continued south, though we would like to believe the points we raised yesterday are just as much a factor.

Finally, on a different subject, one reader wisely suggested that we add a glossary of some of the terms we often refer to in this space. So we are happy to oblige - the glossary can now be found in the sidebar and will be updated when necessary or you can find it immediately here: Glossary of TMMisms. If we have forgotten any please feel free to jog our memories.

QE Bomb Ground Zero

This weekend saw another Eurorevelation - Ireland is/has/will approach the EU/IMF for some money to bail it out. Now whilst this may not be be a surprise to anyone with half a brainstem, it is being presented as a Eurorevelation - when a piece of blindingly obvious euroblx is finally admitted to by the Eurostriches, accompanied, of course, with shock , dismay, resignation and cries of unity and future controls. Of course conjuring 80 gigaeuros out of fresh air is easy these days and even the debt strapped UK is managing to magic up an extra 7 or 8 gigapounds to help (would they mind taking payment in aircraft carriers)? But the real interest is how fast the markets can pack up their field artillery and retrain it from Ireland onto Iberia. With, we imagine, more that a few buying Ireland and selling countries southwest of France today.

The only other news of note was the market's reaction to an S+P downgrade in outlook for New Zealand, which looks a little over-aggressive.

But it is last week’s news in Hong Kong that we want to focus on. Over the past week China and HK engaged in a lot of “micro measures” to counteract the effects of all those QE dollars rushing into emerging markets. For HK property markets these include:
- Punitive tax rates for properties bought and sold in less than 2 years.
- A max loan to value ratio of 50% for properties worth over $12mm HKD (down from 60%, which was down from 70% six months ago).
- Moves to release more land.

TMM are of the view that this is all well and good and likely to work as well as those sandbag barriers and the like erected before hurricane Katrina. The reason is that HK property is an object lesson in the problems of having a pegged or quasi-pegged currency.

When TMM were sitting around in finance classes in their respective universities they were taught that property markets really should come down to purchasing power on the demand side (wages, mortgage rates, credit availability), as well as supply side factors (zoning and land use regulations, etc). As zoning tends not to change that much from year to year and credit policies shouldn’t change much from year to year what you really look for are mortgage rates and wages. All that talk of “rent equivalent housing costs” in inflation data is largely driven by this idea: if you didn’t own a house but rented it how much would your costs move around? On the blackboard that should be some proxy for how much it costs to build a house and how much people can pay for it. Pretty simple right?

In recent history we’ve since learned that the availability of credit is not necessarily stable and that interest rates really don’t follow much of an inflation targeting regime in many places. Nowhere is this more true than in places that pursue either an implicit or explicit dollar peg. To wit look at HK property below with the Hang Seng in Red and Hong Kong Real Rates in Orange. It’s pretty clear that what drives HK property is exactly the same thing as the Hang Seng: real rates.


Now, TMM aren’t calling HK property investors spivvy fools who are investing in something vastly less liquid than HSI futures but... wait... yes, we are! To wit you could just about trade HK property names on Fed funds – it’s abundantly clear that property yields are driven by borrowing costs in HK dollars more than by anything else.


Rents are a little better and do seem to track wages pretty well – if you’re bullish Asian wages longer term then owning these assets at the right point in the real rates cycle isn’t halfway bad, though that time is probably not now.


It is no small wonder to TMM how and why HK locals continue to plow their cash into property and property companies having had a 60% peak to trough decline in property prices only 12 years ago. At least regulators are limiting leverage this time; though that doesn’t stop people destroying their life savings, it may prevent another full blown Asian crisis.

Given where HK property and the relevant equities have run to its worth taking stock of just what you are buying when you buy HK property:
1) Long TUA (2 year notes)/rates. If USD rates increase then this trade looks messy.
2) You’re long the HKD peg staying in place (one would presume an unpegged HK would have higher rates in line with those of China, though that isn’t saying much from a real rates point of view)
3) Financial services in Asia.
4) China capital controls: let’s not kid here, HK is only relevant so long as China’s capital markets remain restricted to foreigners. With China now developing futures, credit default swaps and the like the hissing sound as HK loses its place in Asian capital markets will be all louder if and when China opens up some more.
5) China wage competitiveness: maybe this says something of the company TMM keeps, but if you’re not a broker, trader, banker, capital markets lawyer or auditor in HK, chances are you are involved in manufacturing in Guangdong. The raison d’etre of Guangdong is making it cheaper, and with all the news of Chinese wage rises that’s hard to see that being here to stay.

To that end, TMM would like call HK as ground zero of all that is wrong with global monetary arrangements right now and maybe the most compelling short around. It is TMM’s opinion that the slide in the likes of Sun Hung Kai, Cheung Kong and the like is technically overdone in the short term but here to stay longer term.

After all, what does a sly $3mm USD or $10000 per month buy you here versus here? Purchasing power parity has often been a widowmaker in macro but TMM thinks that the time has come to call it.

CapEx, Capisch?!

Another Friday, another Reuters screw up. Team Macro Man found the misreporting of China's Reserve Ratio Hike as an actual rate hike by the newswires somewhat farcical. We are sure there was no sub-plot in announcing it at the same time as The Beard was trying to explain to the Germans why he is trashing the Dollar! Perhaps it's time to go Long AUD vs. short Thomson-Reuters. But for now, it certainly feels as though "that is it" for the day, with no US data this afternoon and expiries likely to see us pinned around current levels.

So TMM thought they'd take a look at something they've been following for the past year as an indicator of when (or if) the corporate investment story is likely to ramp up and morph into a private sector hiring cycle.

Over the years, we have found that the 6m ahead CapEx expectations component of the Philly Fed survey to be a pretty good predictor of non-residential investment. The trouble with survey data is that it is pretty noisy, as sentiment whips around with the equity market. But on a 6m moving average basis, it is a little clearer. The below chart shows the 6m moving average of the said CapEx component (blue line, lagged 6m), non-residential investment growth (YoY, red line, lagged 3m) and year-on-year Non-Farm Payroll growth (green line). From what TMM can tell, corporates appear to have undergone a similar sort of CapEx plan as the early-1990s, when it fell sharply, then recovered, and then looked as though it would double dip (in late-1993), before re-accelerating in 1994 as the outlook became more certain. And it looks like they have done pretty much the same thing this time around, just over a shorter time scale. Their CapEx expectations have recovered back to their post-recessionary highs with it looking like the double-dip danger over.

One of TMM's strongly-held theories is that most trading desks are staffed with guys that, prior to 2008/9, had only experienced one recession - that of the early 2000s, and that this is their playbook for how recoveries develop. But that recession was followed by a very atypical recovery, driven by credit growth, interest cuts and housing-financed consumption.

The early-1990s recovery was very different - it was slow to start with as the output gap was pretty large, but eventually, corporates began to invest and private employment growth followed with a lag (as can be seen in the chart above), and gradually the unemployment rate came down (see chart below: white line - YoY employment growth, orange line - unemployment rate, lagged 6m). Back in the 1990s, Japanese Households and Corporates both had to repair their balance sheets, but in the US today, Corporate balance sheets have never been in such great shape. For this reason, while we buy into the idea that things are going to be slow, we certainly don't think we are turning Japanese. With US employment growth having finally turned positive and the recent upward revisions to private hiring over the past six months, TMM are starting to find themselves itching to get long of equities.

Indeed, it surprises many to find that earnings have nearly recovered their fall since peaking in August 2007 (see chart below), only 9.5% below, and are expected to breach their peak mid-next year. It seems to us that absent a double dip these expectations are very likely to be realised given the position Corporates are in. As far as TMM can see, this has never been a better time for corporates to invest:

• With a split House, there is more clarity on regulation.
• QE2 is keeping real rates very low.
• They have been terming their debt out at record low yields, and not bothering to swap it to floating, resulting in lower funding costs for the years to come.
• Free Cash Flow yields are sitting above the cost of debt.
• The recent economic data has suggested a double dip is not on the cards.

Given all the above, it is pretty hard for management to justify to shareholders either not investing that cash in new enterprises or returning it to shareholders. As we've seen over the past few months, the return of multi-billion Dollar M&A and share-buybacks has ramped up significantly. We expect organic growth through investment to follow...

...and with the S&P500 trading at just 12.4x 2011's earnings, and looking nearly as cheap as it has done since Spring-2009 (see chart below, trailing earnings yield minus 10yr real yields - although, admittedly, this is as much a result of real bond yields being so low as anything) it seems to us that both the valuation and newsflow has turned for the better.

Finally, given the post-QE2 positioning washout and falls in bullish sentiment it appears that positioning is not an obstacle. If yesterday's renewed optimism can hold, then there appears little to stop a melt-up into year-end.

And relax

Aaaand relax. Ok guys that was a good workout, well done. Now do some stretches, cool down and take a break.


US

DXY failure at top of downtrend from June.
The Fed model still very cheap.
CPI yesterday shows fundamentals haven't changed - it's just been positioning.

Europe

The news-fires in the boilers of euro-gloom need more fuel, and it isn't coming today.
Spanish auctions have gone very well, although it seems that local banks are the main buyers. The Irish trade we suppose. It makes sense if you are a local bank as the only way the sovereign goes down is because you have gone under first.

Commodities

Bullish oil data yesterday with a massive draw.
Gold - made of rubber today.

Equities

Fidelity's junk bond king allocating out of High Yield into equities.
GM IPO out of the way so less equity supply.

Asia

China is toning down the possibility of higher rates as it looks like they are applying supply side measures rather than monetary tightening.
Korea capital controls are less than expected and, as the Won is the macro darling, its rally has handed out some decent profit to the street.

Markets

Open interest falls (5yr note future down 9% since QE2 day) suggest CTAs have by and large cut their positions now.
Volatilties are off in most option markets.
The market feels a lot more clean - last few days were serious pain for the kermit and momentum money.

Austerity Weddings

Remember that all of this is due to the announcement that the future King, Prince William, will be marrying Kate Middleton. If you read the UK press you would believe that UK GDP will exceed that of China due to a "feel good factor" the nation is about to enjoy that will make the consumption of recreational drugs redundant. We are buying tressle table and bunting manufacturers as the UK turns into one great street party, although we recommend the royal couple take advantage of the current half price champagne offer at Morrison and gets the wedding dress order sent before the real inflationary pain kicks in in January.


So... It’s a pause, maybe with Thanksgiving coming up next week this "pause" may stretch to a "respite" amongst the usual risk suspects. However there might be a new game developing ready to bite Mr Market on the bum.

A confluence of news has led to some ugly moves in Munis, but so far there has been limited contagion. However, TMM are watching the Muni->Notes->EM bonds-> mess linkage carefully

The Book of Eurorevelation

Chapter Six, Verses 1-17:

6:1 And I saw when the Investor opened one of the seven debt structures, and I heard one of the four living creatures saying as with a voice of thunder, Come.
6:2 And I saw, and behold, a white horse, and she that sat thereon had a bow in her hair; and there was given unto her a great Current Account surplus and she came forth conquering, and to conquer, for she was Mangler Merkel.
6:3 And when he opened the second debt structure I heard the second living creature saying, Come.
6:4 And another horse came forth, with red hair: and to him that sat thereon it was given to take peace from the Eurozone, and that they should slay one another: and there was given unto him a great budget deficit. His name was Ireland.
6:5 And when he opened the third debt structure, I heard the third living creature saying, Come. And I saw, and behold, a black horse; and he that sat thereon had the balance of Greece in his hand. His name was Austria.
6:6 And I heard as it were a voice in the midst of the four living creatures saying, A measure of a Dollar for a Euro, and three measures of peripheral debt for a Euro; and the Oil and the Gold hurt thou not.
6:7 And when he opened the fourth debt structure, I heard the voice of the fourth living creature saying, Come.
6:8 And I saw, and behold, a pale horse: and he that sat upon him, his name was Trichet; and Weber followed with him. And there was given unto them authority over the fourth part of Europe, to kill with rates, and with FX, and with haircuts, and by the wild policies of the zone.
6:9 And when he opened the fifth debt structure, I saw underneath the altar of the European Parliament the souls of them that had been slain for the undemocratic word of The Euro, and for the testimony which they held:
6:10 And they cried with a great voice, saying, How long, O Eurosceptic, the Holy and true, dost thou not judge and avenge our blood on them that dwell in Brussels?
6:11 And there was given them to each one a vote; and it was said unto them, that they should rest yet for a little time, until their fellow civil servants also and their unelected brethren, who should be killed even as they were, should have fulfilled their course.
6:12 And I saw when he opened the sixth debt structure and there was a great crisis; and the markets became black as Wednesdays, and the whole balance sheet became as blood;
6:13 And the stars of bond portfolios fell unto the earth, as a fig tree casteth her unripe figs when she is shaken of a great wind.
6:14 And the heaven of non-mark-to-market was removed as a scroll when it is rolled up; and every central banker and reserve manager were moved out of their places.
6:15 And the Kings of the banks, and the Princes of finance, and the chief executives, and the rich, and the strong, and every bondholder hid themselves in the caves and in the regulator and the media
6:16 And they say to the media and to the regulator, Fall on us, and hide us from the face of him that sitteth on the throne, and from the wrath of the Investor:
6:17 For the great day of their wrath is come; and who is able to stand?

Blessed be the Name of The Euro.