Catching Dutch Disease

All quiet on the Western Front where "No news is bad news" and hence, yesterdays drop. With Europe and US jostling for top dog status (dog as in "real dog") everywhere else is a safe haven. And on that basis the AUD is just going from strength to strength and its correlations to US equities is now completely reversed. CPI data yesterday has just added to the joy as it looks like the RBA will hike in August. Even through TMM's jaundiced eyes, any country that offers the chance to be paid more than an Investment Banker to blow things up really is God's country. We are ditching the suits and going "49er".

Full job description here... Yes, AUD1,250,000 salary plus bonus (if you blow even more things up). Join the queue.

Now TMM realise that calling blowups due to Dutch disease is generally a good way to end a career - the trend that causes the upswing in terms of trade can run an awfully long time before it all becomes painfully obvious that the rest of the economy has been hollowed out. But hollowed out it is getting- look at the retail component of the ASX. This is another thing that goes into TMM's "obscure trends that are working out" box, despite how miserable bigger picture index / FX stuff can be thanks to politicians.

This has all prompted TMM to rewrite the Vapours classic "Turning Japanese".

I'm catching dutch disease:

I've got your iron, and coal and AU,
And if your good I may sell them to you,
I sit here drinking, as there's nothing else to do.
You buy my FX as it never goes down,
And forget housing, thats just fine mate
'cos I'm Gods country with never a frown.

I've got your minerals, I've got your minerals,
I'll make a trillion if I dig more to sell,
I want more Asians, to take my minerals.
So I can sell to the West via them as well,
You've got me digging up and digging down,
And digging in and digging 'round.

I'm catching dutch disease,
I think I'm catching dutch disease,
I really think so,
Catching dutch disease,
I think I'm catching dutch disease,
I really think so,
Catching dutch disease,
I think I'm catching dutch disease,
I really think so,
Catching dutch disease,
I think I'm catching dutch disease,
I really think so.

I've got inflation, I've got inflation,
So I'll hike rates and you can go to hell.
I got Glenn Stephens, to cure inflation,
And McCrann to tell the "inside" as well.
I got rates raising up, not turning down,
I'll crank 'em up, won't pss around.

I'm catching dutch disease,
I think I'm catching dutch disease,
I really think so Catching dutch disease,
I think I'm catching dutch disease,
I really think so Catching dutch disease,
I think I'm catching dutch disease,
I really think so Catching dutch disease,
I think I'm catching dutch disease,
I really think so.

Got sun, and money and wine and women,
Its fun, some beer, stuff you, no worries, it's great!
Everyone around me is a total whinger,
Their Debt defaults, but I am in no danger.

I'm catching dutch disease,
I think I'm catching dutch disease,
I really think so,
Catching dutch disease,
I think I'm catching dutch disease,
I really think so,
Catching dutch disease,
I think I'm catching dutch disease,
I really think so Catching dutch disease,
I think I'm catching dutch disease,
I really think so.

[repeat]

At the lights

Today, TMM's Macro traffic light is showing:

US: RED

EUROPE: AMBER

CHINA : GREEN

Allowing the vehicles of AUD, CHF, NZD and CAD to speed on by and Asia to do 0 to 60 in 3 seconds.

As for the US... Have they decided yet? No? wake us up when it's over please.

We only have one thing to say on the issue. GLENN STEVENS FOR PRESIDENT!!

Yours, TMM.

We can't believe it

Politics is an evil subject, isn't it? Far too bipolar in the US and it causes all sorts of trouble. That bipolarity is also pretty clear in the market.

1 US - Default yes/no
2 Europe - End of Euro yes/no
3 China - Hard landing yes/no

So there are 8 outcomes ranging from disaster yes/yes/yes to super bullish no/no/no through a nice probability curve reminiscent of those recessive gene charts you did in school biology (well, used to; if the UK education system is anything to judge by, A level biology now probably just involves identifying where the ears are on a rabbit).

With 1) and 2) running on politics and 3) dependent on data we can't trust, it leaves TMM twiddling their thumbs in a grumpy manner. So we have been chewing the fat between ourselves this morning, but all that seems to fall out from it is the feeling that it really isn't worth saying as most of the banter involved a catalogue of "I can't believe"'s. But in the spirit of full disclosure of this morning's I can't believe positions .. TMM

Can't believe that the periphery sell off is much more than models
Can't believe that CME is haircutting USTs
Can't believe that dates have so many calories in them, and did we eat THAT many?
Can't believe that there is no one on the bridge steering the US debt ceiling Titanic
Can't believe that its so lovely in Devon at this time of year.
Can't believe anything out from the UK ONS
Can't believe anything on the balance sheet of Chinese ADRs
Can't believe that the prices the Chinese pay for famous named wine
Can't believe that England might get ranked top in world cricket
Can't believe that Georgie is no longer on the bid (Soros is handing back external investor money)
Cant' believe that Amy Winehouse is dead (there's a warning to you, young Bieber)
Can't believe that Amy Winehouse lived so long
Can't believe Deloitte is still in business in China
Cant believe that the UK will lose its AAA rating before France
Can't believe that Japan could successfully intervene alone
Can't believe that we haven't managed to lose ANY weight ahead of summer hols
Can't believe the Squid is laying folks off before year end without getting a full years graft out of them
Can't believe that ducks haven't naturally evolved a crispy aromatic coating to guarantee their survival for as long as man exists
Can't believe how their BLSH (buy low sell high) model has evolved into a BHSL model

Mostly rubbish, but then so are the markets.

Looking over the edge

It looked for a nano-second as though we were ending the week with the US heading towards some sort of a workout on the debt ceiling and the European statement of intent enough to correct the market's near term peripheral vision.

What we hadn't counted on was just how completely and utterly stupid the Republicans could be and the market has swiftly moved from "they couldn't" status to "Jeez, they couldn't, could they????". TMM still cannot believe that they will let the US go over the edge, but they have stood at the rails at the top of some very high buildings in their time and the view down from this one is even more vertigo-inducing. Staring down this is what TMM see.

The year 2040 -

- Daddy, why do we hate the politicians so?

- Good question, son. You see, back in 2011 we had something called the debt ceiling that was not raised by a group of people. They did it for fun and also to engage in some futile meaningless political signalling exercise. This resulted in global confidence in the old USA collapsing and a sudden need for introversion, as we couldn't rely on the rest of the world funding our lifestyles any longer. Of course, this in turn led to massive internal stresses, which boiled over with the commodity rebellions tearing the old land in half. It was only when the Iraqi peacekeepers arrived that order was restored. Shortly thereafter, the head of the CIA took the country over in a coup which proved that those crazy hippie professors like Noam Chomsky were right after all about the black helicopters bringing the end of America. As it turned out, they were more the end of the end and the beginning of something new.

- Wow, Dad, I bet the politicians that caused all that were in big trouble?

- Well of course, son. When it all fell apart it didn't take long for them to realise the game was up and, rather than garnering more votes, their actions had alienated them from the rest of society. Most of them escaped and hid in the woods. A few, like Nancy Pelosi, found sanctuary in the basements and attics of collaborators, but were swiftly rounded up and sent to special labor camps, where they were encouraged to actually contribute to society. You've probably read the Barney Frank Diaries in school?

What followed was the Petraeus regime, which ruled for a decade and resulted in an economic program that would make Pinochet proud and a purge that would, errr, also make Pinochet proud. The US really needed its Pinochet moment, and as you all learn in school and commemorate on Pinochet Petraeus Day, it's not so much the purge, but the need for a government with a strong mandate and technocratic utilitarian leanings that is important. Weirdly, much like Germany in the run up to WW2, a common enemy made for strange bedfellows and "free-lunch" democrats and "tax cuts without spending cuts" republicans rallied around their belief in a free lunch.

However, the Petraeus economic program managed to turn the USA around. It did nothing to impinge on intellectual freedoms, but did mercilessly go after the main causes of the low level of US competitiveness and the budget condition. To deal with healthcare costs Petraeus surprised everyone, including the Brooklyn hipsters, by putting in place bike paths in many metro areas and raising revenues by enacting congestion charging. Aging Tea Party members were forced to get out of their SUVs and do some exercise, while the government nationalized healthcare and proceeded to brutally cram down Pfizer and others.

Petraeus, of course, also knew a thing or two about wars and realized that Defense and Energy policies were one and the same thing. The CAFE fuel economy standards went up as quickly as the US could get out of the Middle East (which, of course, led to the Great Middle Eastern War and the poisoning of the whole region; which is why it is now so lightly populated). It was around that time that Nevada got its name "The Black State" due to it being literally covered with solar panels.

Meanwhile agriculture was handled well by the man in charge, Jeremy Grantham, who restored the US to an incredible agricultural productivity and sustainability just as the rest of the world's agricultural Ponzi scheme unravelled. That is why the population of the US is the same as India today.

- So, Daddy, sounds like it wasn't a bad outcome after all? Shouldn't we thank the politicians of 2011 for behaving like that collection of puppets Grandpa gave you?

- Oh, them? Yes, I see what you mean.

Euro Statement Translated

Yesterday the long awaited Euro rescue plan was announced. As ever, it is couched in euro-speak so TMM offer up their translation of the document -

Today, we agreed on the following measures:

Greece

1. We welcome the measures undertaken by the Greek government to stabilize public finances and reform the economy as well as the new package of measures including privatisation recently adopted by the Greek Parliament. These are unprecedented, but necessary, efforts to bring the Greek economy back on a sustainable growth path. We are conscious of the efforts that the adjustment measures entail for the Greek citizens, and are convinced that these sacrifices are indispensable for economic recovery and will contribute to the future stability and welfare of the country.

Papa will keep walking and keep smiling because we have a gun in his back. One slip and he's souvlaki.

2. We agree to support a new programme for Greece and, together with the IMF and the voluntary contribution of the private sector, to fully cover the financing gap. The total official financing will amount to an estimated 109 billion euro. This programme will be designed, notably through lower interest rates and extended maturities, to decisively improve the debt sustainability and refinancing profile of Greece. We call on the IMF to continue to contribute to the financing of the new Greek programme. We intend to use the EFSF as the financing vehicle for the next disbursement. We will monitor very closely the strict implementation of the programme based on the regular assessment by the Commission in liaison with the ECB and the IMF.

We'll cut Greece's interest rates because, let's be honest, they are pretty immaterial against never getting your money back. Now then IMF. It's pay back time. Lagarde will get on and do what we put her there for.

3. We have decided to lengthen the maturity of future EFSF loans to Greece to the maximum extent possible from the current 7.5 years to a minimum of 15 years and up to 30 years with a grace period of 10 years. In this context, we will ensure adequate post programme monitoring. We will provide EFSF loans at lending rates equivalent to those of the Balance of Payments facility (currently approx. 3.5 percent), close to, without going below, the EFSF funding cost. We also decided to extend substantially the maturities of the existing Greek facility. This will be accompanied by a mechanism which ensures appropriate incentives to implement the programme.

We will push Greece's debt forward up to 30 yrs as unfortunately we can't push it on any further. We don't mind charging low rates against EFSF funding (see 2), but we ain't going to take a "real" loss on it. Oh, and if you don't agree we will levy you.

4. We call for a comprehensive strategy for growth and investment in Greece. We welcome the Commission's decision to create a Task Force which will work with the Greek authorities to target the structural funds on competitiveness and growth, job creation and training. We will mobilise EU funds and institutions such as the EIB towards this goal and relaunch the Greek economy. Member States and the Commission will immediately mobilize all resources necessary in order to provide exceptional technical assistance to help Greece implement its reforms.
The Commission will report on progress in this respect in October.

Panzers start your engines. Bearing 135 degrees. We expect to have complete control of Greece by Oktoberfest or heads will roll.

Private sector involvement

5. The financial sector has indicated its willingness to support Greece on a voluntary basis through a menu of options further strengthening overall sustainability. The net contribution of the private sector is estimated at 37 billion euro. Credit enhancement will be provided to underpin the quality of collateral so as to allow its continued use for access to Eurosystem liquidity operations by Greek banks. We will provide adequate resources to recapitalise Greek banks if needed.

We have persuaded those nice kind banks to contribute E37bio using a menu of threats of levies, banking licence revokements, electrodes and wet sponges.

6. As far as our general approach to private sector involvement in the euro area is concerned, we would like to make it clear that Greece requires an exceptional and unique solution.

Look, we have only just managed to cobble this together because Greece is so small. Don't go thinking any of the rest of you are going to get this sort of deal.

7. All other euro countries solemnly reaffirm their inflexible determination to honour fully their own individual sovereign signature and all their commitments to sustainable fiscal conditions and structural reforms. The euro area Heads of State or Government fully support this determination as the credibility of all their sovereign signatures is a decisive element for ensuring financial stability in the euro area as a whole.

Your bosses agree to this too. Well, they say they do, like Greece did. So this is serious right?

Stabilisation tools

8. To improve the effectiveness of the EFSF and of the ESM and address contagion, we agree to increase their flexibility linked to appropriate conditionality, allowing them to:
• act on the basis of a precautionary programme;
• finance recapitalisation of financial institutions through loans to governments including in non programme countries;
• intervene in the secondary markets on the basis of an ECB analysis recognizing the existence of exceptional financial market circumstances and risks to financial stability and on the basis of a decision by mutual agreement of the EFSF/ESM Member States, to avoid contagion.
We will initiate the necessary procedures for the implementation of these decisions as soon as possible.

We agree to turn the EFSF into a sub-prime leveraged mortgage lender, borrowing and spending like a crack-house ho in the 2006 housing boom, including bunging some still-wet money into the bottomless pits of the European Banks.

9. Where appropriate, a collateral arrangement will be put in place so as to cover the risk arising to euro area Member States from their guarantees to the EFSF.


We will ask our accountants to give the contributing countries a bit of paper saying "trust me, what can go wrong?"

Fiscal consolidation and growth in the euro area

10. We are determined to continue to provide support to countries under programmes until they have regained market access, provided they successfully implement those programmes. We welcome Ireland and Portugal's resolve to strictly implement their programmes and reiterate our strong commitment to the success of these programmes. The EFSF lending rates and maturities we agreed upon for Greece will be applied also for Portugal and Ireland. In this context, we note Ireland's willingness to participate constructively in the discussions on the Common Consolidated Corporate Tax Base draft directive (CCCTB) and in the structured discussions on tax policy issues in the framework of the Euro+ Pact framework.

We have bought off Ireland and Portugal with lower interest rates in return for which they will sensibly promise us their support for the introduction of a pan-european tax to fund our plans for global domination. Mwuahahaha...

11. All euro area Member States will adhere strictly to the agreed fiscal targets, improve competitiveness and address macro-economic imbalances. Public deficits in all countries except those under a programme will be brought below 3 percent by 2013 at the latest. In this context, we welcome the budgetary package recently presented by the Italian government which will enable it to bring the deficit below 3 percent in 2012 and to achieve balance budget in 2014. We also welcome the ambitious reforms undertaken by Spain in the fiscal, financial and structural area. As a follow up to the results of bank stress tests, Member States will provide backstops to banks as appropriate.

We know we need something in return, so member countries have kindly agreed to some crippling budget constraints that have little chance of being implemented. Even Spain has promised, but they might have had their fingers crossed behind their back.

12. We will implement the recommendations adopted in June for reforms that will enhance our growth. We invite the Commission and the EIB to enhance the synergies between loan programmes and EU funds in all countries under EU/IMF assistance. We support all efforts to improve their capacity to absorb EU funds in order to stimulate growth and employment, including through a temporary increase in co-financing rates.

We have included a clause that could mean anything and will be interpreted at a later date to encompass anything else we might think of, but it contains the phrase "growth and employment", so you can't say no to it.

Economic governance

13. We call for the rapid finalization of the legislative package on the strengthening of the Stability and Growth Pact and the new macro economic surveillance. Euro area members will fully support the Polish Presidency in order to reach agreement with the European Parliament on voting rules in the preventive arm of the Pact.

Can we get this wrapped up and signed off please? We have appointments with sun-loungers in Antibes for the whole of August.

14. We commit to introduce by the end of 2012 national fiscal frameworks as foreseen in the fiscal frameworks directive.

We really must try and do what we said we'd do before (but haven't done), but it won't be for ages yet.

15. We agree that reliance on external credit ratings in the EU regulatory framework should be reduced, taking into account the Commission's recent proposals in that direction, and we look forward to the Commission proposals on credit ratings agencies.

Luigi will be popping round to the homes of S+P and Moody's with a couple of horses' heads. Costa's boys will sort us out some new ratings, they are pretty creative with numbers.

16. We invite the President of the European Council, in close consultation with the President of the Commission and the President of the Eurogroup, to make concrete proposals by October on how to improve working methods and enhance crisis management in the euro area.

You are meant to be the bosses, we've had enough of sorting your shit out for you. Next time do it yourself.

Going Over The Top

Here we sit in our trenches, waiting for the whistle to sound as we are all led over the top by a pistol touting lieutenant to our certain death. Cpmppi is scratching out a farewell letter to his loved ones hoping it catches the last carrier pigeon home, Nemo is weeping out a mournful lament on a battered mouth organ and Polemic is polishing his boots so at least he looks smart in death. TMM can hear similar preparations in the trenches around them.

The rest of the Macro Platoon, battered and worn fighting decay and regulators are writing letters to their investors explaining why they have to say goodbye.

The bond boys, knowing that fiscal policy dominance over monetary in their key indebted nations' markets lament the day they could rely on their central banks to move short term rates and prepare for their last charge upon the debt of Europe. Death or glory.

The Equity boys, haven't had any rations delivered for months and are so malnourished they need to make this final push or face starvation.

The commodity boys, took a pounding from enemy artillery in the spring offensive and are now stunned and gibberish in their fox holes.

The young lads in the quant RV trenches. Poor souls, some as young as 12, only just out of their mothers arms and thrown out to the front lines to face annihilation at the hands of the broken correlations.

Meanwhile the venture capitalists' biplanes drone overheard scouting for new opportunities. Their relevance to the greater effort at times questionable and their average lifespans pitifully short. Death comes all too soon in the tangled wreckage of their machines.

And yet we all sit here, awaiting the call to go over the top on the orders of Generals who sit in their comfortable salons in Brussels and Frankfurt, playing with our cheap lives as but part of their parlour games. Oh, the futility.

"Nemo, are my boots shiny enough?"...

"Yes Polemic - Your Mum would be very proud of you"

Another Cunning Plan

TMM think that the news coming out of the Eurogroup pre-meeting discussions is pretty positive and hints at a cunning plan.

As Baldrick would ask "Is it as cunning as a fox what used to be Professor of Cunning at Oxford University, but has moved on and is now working for the U.N. at the High Commission of International Cunning Planning?". Not quite - but close.

TMM are looking forward to their first royalty cheque from Mangler and friends as they appear to be turning to the preferred options we posted last November. We have already seen an agreement to expand the EFSF, but now there are whispers that they plan to use the EFSF to recapitalise the banks. To us, this is a most important step because as money multipliers work through banks and not sovereigns, you create a leveraged marginal buyer of EU govt debt. These buybacks are also helpful for debt sustainability as it spreads the pain with the private sector and unblocks the bank credit channels. Problem No 1 solved (for now).

The second issue is how to raise additional revenue and that is likely to come from a mooted bank levy. TMM think this is pretty consistent with the usual decision process of credit crises we have generalized below.

1) Identify problem
2) Deny the problem
3) Get called out by market
4) OK, admit you have a problem
5) Get confused as to how to cover the cost of solving the problem
6) Market REALLY calls you out
7) Quick! we need a readily persecutable minority group with lots of money! Merkel: vait I know I know.... Sarko: Don't you start!
8) All together now: BANKS
9) Recovery returns except to watch boutiques, Stringfellows or to bank employees' pay packets (unless they are based in Asia).
10) Everybody lives happily ever after so long as your CB can be a bit soft on inflation (the Swerve tells Mr T or, rather Mr D, to "walk with me")

The bank levy plan could also be seen as its own bit of cunningness. You raise a levy on the banks and use said money to give back to the banks as a bail out by buying the toxic waste off them at par. The banks are in effect forced to a take a loss (the levy) on their holdings, but it doesn't appear as a haircut and so avoids a default or credit event. Et voila!

Now TMM may think that the plan is more than a sticking plaster on an aortic aneurism, and may even be seen as the cardiac surgeon saying "Now then, lets see what we have here then". It will not solve the key problems of overspending in the peripheries and all the rest of the Euroblx but it should be enough to divert the market hordes for a bit longer and even to repel Hannibal. The problem now will be selling it to the rest of Europe and already the French and the Finns are up in arms:
KATAINEN: FINLAND DOESN'T SUPPORT INCREASING EFSF SCOPE
SARKOZY ACCUSES GERMANY OF "SELFISHNESS" OVER GREECE

But to TMM this secondary problem is analogous to the Democrats vs Republicans over the debt ceiling. There IS a bandage to strap over the gushing wound, but now its just down to internal bickering and it will go to the wire before it is applied. But, just as in the US, it will be. No long term solutions, but enough to keep the patient alive a bit longer.

In the Baldrick league of cunning this plan is up there, but TMM don't think it's quite as good as his original solution for Europe:



Now, as to markets. Some people including commentators on this blog may say that TMM getting excited at this point makes us some of the biggest spivs around. To that we quote Keynes: “when the facts change, I change my mind. What do you do, sir?”, and note that if Eurocrats were less spivvy then we would be too. The thing we have had difficulty with has been playing decoupling in the context of Italy, which similar to its politicians has far reaching roots that are difficult to ignore. But yesterday's seeming relaxation of the budget impasse in the US coupled with leaked EU headlines suggesting that the Eurocrats have finally realised that they need to implement a systemic solution firmly marks a turn in the newsflow. Add to that a lack of positioning, burned P&Ls and a confluence of technical levels, and there is nothing to suggest that markets do anything other than march higher. The turn ties in nicely to our old TMM theory about the 16th/18th July generally being a market turn date (think we mentioned that this time last year). But what to buy? (Yes, folks, back long again after having been whipped like a Iranian blasphemer at Captain Bligh's whip party on National Whip Day).

US equities - have always liked them relative to Europe on our theory that the two regions can trade on their own merits or demerits.

We have been mumbling about CHF over the past few days and think it's worth loading up on short CHF. Soothsayer signals showed a 13/9 buy complete on Monday, there was an outside day in usd/chf too and a load of other reasons TMM will go into re Switzerland at some other point.

We are also looking at Irish bonds, which look cheap and now appear to have hit the circuit breaker we've all been waiting for; although Irish bank seniors and Greece and Portugal are ripe for a No. 2 on the back and sides.

But, as with every cunning plan that Baldrick has,.. there is a chance that it may not work.

It's a New Dawn

"It's a new dawn, it's a new day, it's a new life for me,
Yeah, it's a new dawn it's a new day it's a new life for me ooooooooh,
And I m feeling...errrrrrrr... a gut wrenching panic?"

Now as many commentators to this blog have been kind enough to point out, TMM have been Edward the seconded on their timing of a few pertinent trades recently but accept graciously their bowel toasting. What they do stand fast on though is their decoupling theory. Though the US markets and European markets are both getting toasted they are doing so for their own independent reasons but they do have one important thing in common - the current markets are not being driven by short term economic news, or central bank rate policy or by all the other things that economists are trained to watch and predict. Instead, it now all rests upon that most unpredictable of breeds - the politicians. In the US we have politicians in charge who appear to be happy to pull a nuke at a knife fight and in Europe the same breed are locked in, well , locked in denial.  So having learned from the financial crash and from our comments column that your losses are ALWAYS someone else's fault, TMM lay the blame for their losses at the doors of the politicians.

This dramatic swing to political issues is why TMM are so scared at the moment. What "should" have happened, applying common sense and logic, doesn't because some power hungry, seat protecting, blind stupid dum-ass politicians find the ball in THEIR court and rather than kick it in the right direction, squabble over it to the point that it bursts in a game ending BANG. Worryingly, the longer this takes the more national interests condense and scapegoats are looked for. Today TMM hear that Asian names are selling peripheral debt and, if that is the case,  it's game-over as the Asian Bid Life Boat turns out to be an Asian "save my own skin" Offer. It's one thing to rig your FX, it's another thing to not be a patient creditor. Last time around China and others got paid out at par despite selling GSEs, but TMM aren't so sure the Europeans are going to see it the same way this time and wish to send them on their way via the barber accompanied with the cry "should never have let them join the WTO" (as far as TMM were concerned open trade, and hence WTO membership, should be prerequisite upon open capital accounts).. But China isn't immune internally from any political fallout either.  If the EU does blow up, the politics in Asia is going to be very, very interesting: How smart does currency intervention look when the portfolio starts blowing up?

TMM are coming to cringe-worthy realization that Bill Gross may be right and we may be headed towards a world of yield caps - or wholesale default and disorder. In the case of the former it is abundantly clear that Mr T and the A Team are going to have to give up on inflation targeting in a big way if the Euro is to survive. TMM are with Roy Schneider on this one: "we need a bigger boat" line because that boat has got to fit Italy and frankly it is hard to see that happening while still having a credible inflation targeting policy. Meanwhile the Beard is not in a great position to do anything and can hardly step up until AFTER it all goes to hell.

And what of our old friends the ratings agencies? TMM think they have turned rabid. TMMS worst nightmare starts with them downgrading The London Clearing House or the Mercantile Exchange because that ends with the worst possible outcome -  Zerohedge is right about everything.

________________________________

Stressless (Deja Vu Edition)

So the stress tests, Italy and the budgetary farce playing out in the US continue to bubble in the background against the increasing signs that the second half of the year is looking like it will be a good deal stronger than the first half. The trouble with this dichotomy is that, as TMM have experienced to their chagrin, attempting to play this as a decoupling doesn't really work for Italy because it is too big and too unpredictable. At least the Spanish government seem to have some modicum of responsibility and cohesion. Amongst Tuesday's panic, TMM noted that only Italy can help Italy, and without confidence returning to the BTP market in the form of much reduced volatility and spread tightening can we truly signal the all clear. And let's face it... would you trust the global economy with this guy?

As readers will recall, TMM's survey-based ISM model wrong-footed them due to it being based upon the Philly Fed and Empire surveys which, it seems, were distorted by being a long way from Japan (who knew...?). A confirmation of a V-shaped rebound in these over the coming week should cement views of the US recovery, but as above, this is purely dependent upon the Italian situation improving. With such divergent outcomes, it's hard to have too much conviction, and TMM's guts suspect that the pain trade after the weekend is a squeeze higher in Spooz, especially given event risk being cleared. They are too scared (and scarred) to put this on just yet though...

Moving onto other things, TMM's radar has picked up increasing chatter related to the possible imposition of exchange controls in Switzerland, something last tried in the 1970s that (briefly) led to a reversal of the post-Bretton Woods CHF rally.

TMM aren't sure that this is imminent yet, but the extreme strength of the CHF is something they have been pondering for a while. But the fact that this issue is now being discussed could well make the seeming one-way moves a little more balanced. If not, the closer EURCHF gets to parity the more likely it is that the SNB LLC are forced into action give n that they are hurtling towards the point at which they will be forced to ask the politicians for a recapitalisation.

TMM don't really have much else to say, other than that the EU Stress Test results appear to already be out of date given that they do not include the scenario of a Greek restructuring, yet the Eurocrats have already moved on to discussing how to execute such a restructuring. TMM feel like they have been subjected to a more rigorous stress test this past week or so!

Breaking the Euro's Bonds

Konrad Lorenz once said:

"The bond with a true dog is as lasting as the ties of this earth will ever be."

It is perhaps good fortune, then, that Sarko does indeed have a pet dog to chase around the office, because that other bond, to Germany appears to be breaking. The 20d rolling correlation of French OATs to Bunds (see chart below) appears to have decreased quite significantly since the beginning of June, hinting that France is no longer the safe haven it once was. TMM expect a French downgrade is imminent. Now TMM have (painfully) found themselves on the wrong side of recent moves, so their musings should be taken in the context of the latter stages of the Kubler-Ross model (!), but we do find this all terribly worrying...

...as French OATs are plumbing spreads not seen since the early-1990s (see chart below) and liquidity in the BTP market has deteriorated to somewhere between "I'm sorry mate we can't put a price on that" to "I'm an axed seller". TMM occasionally see reports of the Cavalry (aka the ECB) buying BTPs, but even though they sit 20bps off their earlier wides, the past two days have been notable for the reports of long-only selling (i.e. - people just don't want the bonds), and the dramatic spike in bond volatility which (as many, especially the fine chaps at FTAlphavile) have pointed out) kills the risk-adjusted carry argument and exacerbates the sovereign-bank feedback loop. TMM cannot help but think that confidence in the Italian bond market has now gone the way of that of the rest of Club Med. Which, as they wrote on Friday, they find perplexing given Italy's much stronger fiscal position. But as punters saw back in 2008, once confidence is gone, a policy response is needed.

The trouble is, that the A-Team have shown themselves singularly unable to come up with a TARP-like solution that finally draws a line under the solvency concerns (that have got significantly worse over the past week). TMM are also unconvinced that the financial resources exist for such a solution (now that Italy has been dragged into the fray, and French bonds are showing weakness), even if the political will does. So is Italy on its own...? To date, Spooz and the US in general have traded pretty much on their own data - softening, but then again no one is ringing the air raid siren. Yesterday, TMM decided that given the move in the Itraxx European Financials 5 year CDS that the brown-underpants trading paradigm had probably returned as we are getting past the Dec/Jan wides. Failing some maturity and cohesion in Italian politics (teambuilding bunga-bunga party?) it's hard to see things getting all that much better all that quickly...

*STOP PRESS*: Just as we wrote this, the following headline came across the wire:

ITALIAN SENATE PRESIDENT SAYS WILL URGE PARTIES TO APPROVE AUSTERITY PACKAGE IN UPPER HOUSE BY THURSDAY

TMM reckon that unless Italy sorts this mess out themselves, that it risks snowballing into a true systemic crisis given the lack of credible coordinated policy responses from Team Europe. So that means, earlier spending cuts, no tax cuts, public support for Tremonti, a further recapitalisation of the banks (to replace the cash erased by this week's 7% fall in BTP prices) and - most importantly - a return of the domestic bid in the bond market. Something that, after the moves of the past week, will be timid.

Either way, TMM reckon it is worth loading up on September 109.00 Schatz calls just in case they manage to screw it up monumentally.

Macro Ain't Easy

If you’ve been befuddled by some of TMM’s missteps and confusion at the world well, apparently we are not alone per the WSJ. It has not been a particularly easy year for the industry thus far and looks to be getting no better. Some of this is no doubt due to there being way too much money in this space chasing far few trades but some of it invariably comes down to the set of opportunities available at the moment. Most investors require some kind of dispersion to make money or generate “alpha” in order to get paid. “Dispersion” is pretty broad but ultimately it comes down to how much of a spread there is between the stuff you trade. If things are all moving together all the time, there is only the business of when to be long and in what size rather than what to be long and short and in what size. Picking winners and doing research is irrelevant in a directional punters market and really, it is hard to have any distinctive edge.

Dispersion operates at a few levels: the typical macro stuff like different equity indices, FX, and rates but also within indices (sectors, subsectors, etc) as well as dispersion within those sectors. Different mandates and strategies require different types of dispersion to make money: market neutral guys can do great in range bound markets if there is a lot of change in the profitability within indices, opportunistic or thematic guys can do well out of long term industrial or technology trends and macro guys need to see some separation of indices and broader more liquid rates. A chart is below:

That sadly is what appears to be the case in big picture asset allocation land and most major indices. Dispersion is relatively short lived and there isn’t an awful lot that is consistently trending. As a result researching something that is durable and lasting is tricky. There are things, however, that do seem to work but they are increasingly looking like they are all the same trade – look at Eurobanks and EURCHF below.

The implication of which is that your positions are highly correlated, therefore you cannot be as leveraged and make less money on the trend.

This is not happening so much within sectors or themes. Take two examples close to TMM’s heart: the inevitability of Chinese clothing and footwear manufacturers getting squeezed as they cannot move up the quality chain to displace the likes of Nike and the wage pressure they get from a workforce with little slack left. TMM can say this has worked out pretty well and has been nice and low(-ish) volatility. Price performance of the basket:

Historical Vol:

And Bollinger bands to show how well it has trended:

Similar names would include a basket of large lithium producers / battery separator producers (PPO US, SQM US, FMC US, ROC US) or a basket of Chinese banks or Aussie banks, names associated with cloud computing… you get the drift. The baskets tend to be lower vol and as performance is pretty similar amongst the names, you get a better sharpe. If your mandate allows you to trade sectors and themes without having to slavishly stay market neutral then the pickings have been pretty rich this year though as always you have to go out and pick them.

With that in mind, what do TMM think is going to “work” in equities against what is regarded as a relatively tough longer term macro backdrop of rising input prices and higher funding costs if not in EM then generally? A few things seem to work to TMM:

1. Stuff with an inflation linked top line but relatively consistent unit costs. Railroads are one example, gas producers aren’t far off. These are often slow moving changes in margins but they tend to last. Pretty basket friendly, for the most part.
2. Picking the winner of a tournament where the winner gets monopoly rents. Who is the next Google / Microsoft? Facebook? Limit long – the incredible performance of Netflix and the fact that Google trades pretty rich despite being close to ex-growth says a lot about what people are willing to pay up for a “big moat”. Consumer brands in EM that establish supply chains and channels quickly would also fit in this bucket. The downside hurts if you lose a tournament though (ask Myspace) so this is definitely a situation where buying a basket of 10 gives you one 10 bagger and lots of disasters. This is single name territory.
3. Eat Somebody Else’s Lunch: Find an industry which is going to more or less inevitably replace something else because you can wait. The lithium names’ pricing relative to other mining names reflects this now but is indicative of what the market is willing to pay up for now. This is very basket friendly.

Aside from that, there is plenty to short so long as the data looks this awful. TMM look to earnings season with bated breath.

Repelling Hannibal

Yesterday, TMM ventured forth into the world of BTPs on a macro argument. Today the world has decided that TMM's position has a similarly unfortunate target-shaped birthmark to Gary Larson's deer in his cartoon "Bummer of a Birthmark Hal". We are beginning to hate this week. As you know, we really really really think that Europe is in a mess, but, and here's the big BUT, we don't see it falling just on a market whim.

The massed market armies have been on a crusade against Greece for the past 3 months and had reached the gates of Athens when they were repulsed by the Greek vote and the Euro package (however dodgy). But this has left the screaming attack mob somewhat frustrated and desperate for blood, so they appear to have instead turned their attention to snooping out and attacking anything vaguely euro-weak. TMM's IB chats and mail boxes are full of Euro negatives, many recycled old themes that are being dug up and recycled, but today's favourite lynch victim is Italy. The speculative hoards are crossing the Alps Hannibal-esque in order to give the Latins a good kicking. But like any good army General leading a campaign we need to keep our troops under control for an organised assault and pick when and where we wish to fight our battles. For TMM the battle for Italy is being engaged too soon against a well organised defence and so we are calling for a retreat.

First, for overlying strategy TMM believe that for Italy to get into real trouble EVERYTHING has to go wrong, whereas for Spain NOT to get into trouble EVERYTHING has to go right... So Spain before Italy PLEASE.

Now, let's look at what Italy has lined against the baying hoards:

1. The A-Team is focused on the firewall between Spain and Portugal/Ireland/Greece. And Spain is ahead of the queue from Italy so they definitely won't let Italy go.
2. The Risk premium priced into Italy is now enormous relative to a macro model ...fair value is 120bps over, currently 240bps. At just 36bps below Spain, that's just rubbish.
3. People getting all worried about domestics not turning up to buy... they have no choice, they will turn up.
4. Italy runs a current account of only just above 3% and did not do fiscal stimulus in the recession. The starting base is better.
5. Today's IP number implies +1.7% qoq in Q2, or an annualised 7% print which is quite strong. People seem getting all beared up on the recent economic data, but it's just shockwaves from the Japan IP drop.
6. Open Interest in BTP futures has increased 14% over the past 3days, with today's shenanigans likely to post a further 5% increase ... Tourist Traders (i.e. - non-experts that are bussed in for the mugging) have put on sizable shorts.
7. Looking at articles from the Economist re: Tremonti results in a biased view given their public vendetta against Berletchsconi and Co.
8. BTPs yielding 5.3% vs. the ECB refinancing rate at 1.5% will have carry monkeys scratching their brows and thinking "hold on, I can make 11.4% leveraged 3x".
9. And finally, readers will recall TMM's attempt to price DEM/ITL NDFs with their creation of the END Market. TMM thought it was time for an update, and the 5yr synthetic NDF is implying DEM/ITL at 1000.49 (see chart below), which is -1.06% depreciation. Now, according to TMM's REER models, the Italian Lira is only around 12% overvalued, but accept that under a Euro break up DEM/ITL probably moves 20%. So that implies around a 5.3% (=1.06/20) probability of Italy leaving the Euro. That seems ludicrously too high to TMM. All back of the envelope stuff, but you get the idea.

So come on guys, leave Italy alone. We'll come back and revisit it if Spain goes.

A Tale of Two Sh1tties

We have been pondering for the past 4 days what to do and our preponderance has been based on our heads saying buy equities sell vol and gear for a phase of growth, especially in the US, but being tempered by our concerns that Europe can blow up again dragging everything down again. But our indecision on how to handle this has been simply rectified. Having yesterday asked the question of how contagious Europe actually is to the rest of the world, we are going to separate the two concerns and play this as a decoupling.

As far as we are concerned Europe can sink, but it needn't necessarily take everything else with it. So we are looking for the recent Italian noise (TMM have been receiving BTP yield charts from every Tom, Dick and Harry) to die down and return to the "not systemic" price action of decreasing intra-EMU spread correlations and a range for the bipolar currency. With such a (justifiably) large market risk premia priced into BTPs, TMM find it difficult to get bearish here with the country only running a Current Account deficit of a little over 3% and essentially running a primary surplus. TMM reckon the past few days have seen a spike in "Tourist Traders" getting short that reminds them of the Egyptian-driven Oil spike and subsequent stop loss sell-off back in February. For what it's worth, TMM's naive and simple macro model of the BTP-Bund spread shows Berletchsconi's IOU's around 100bps too wide (see chart below).

Now we don't know if our overseas readership is keeping up with the latest "its disgraceful" public outrage in the UK, but the newspaper News Of the World, owned by Murdoch's behemoth "News Corp" has been accused of tapping the phones of victims of crime in times of grief for salacious tidbits. The result has been a humongous backlash from the public that has destroyed the credibility of News of the World but, as importantly, has damaged the credibility of the parent group to the point of threatening other major projects the company has for expansion (e.g. the BSkyB takeover deal). Doesn't this sound remarkably familiar to the major market story we have been tracking for the last 18 months in Europe? Where a small subsidiary has wrecked the credibility of the whole conglomerate? TMM can not imagine that News Corp will now be preparing to follow the model Europe has employed over Greece. We can not imagine the Times, the Sun, Fox News and Sky TV, together with all sorts of overseas holdings, being cajoled into supporting a bail-out plan for the News of the World. We can not imagine News Corp arguing that the death of NoTW would mean the end of the whole of NewsCorp. and so will be kept alive at any cost. We can not imagine NC issuing moral guarantees backed by the high moral ratings of The Times of London and being on sold to Asian readers. No. TMM expect NC to amputate NoTW, probably after kitchen sinking every other dodgy deal into it, and rising forth morally cleansed. Which is exactly what Europe should have done and yet do with Greece.

To the consumer, the problem with such huge institutions losing credibility is one of substitution. Trying to find a news publication that isn't owned by N.C to move to in protest is difficult. The same applies for the ECB and Europe. Europe has spent the past 15 years selling the credibility of its single currency to the point that it has become the world's first choice reserve currency for many. If the credibility is threatened further where does one go with ones currency reserves? TMM have noted various papers suggesting that the likes of CAD, CHF and AUD should be considered as a separate reserve bloc and certainly they have been major beneficiaries of safe haven and reserve manager flows. But these countries are tiny compared to some of the flows being thrown at them and distortions affecting local economies are becoming more than worrisome.

We could ramble on now about the plights of CHF and AUD and the effect the current FX rates are having on the local economies but will do more on that soon. For now we will leave it at that as we await the predictable outcome of ECB rate rise foot in mouth insertion.

Come the Resolution

Our 36 hour "wait and see" has thrown up some interesting factors over that period. There has been a growing consensus that the background economic picture is picking up, led by the shipping times of Japanese components to global production centres. But against that has been renewed dung chucking in Europe. Yesterday's European PMIs were soft but interestingly pretty much ignored at the time, only to be wheeled out as ammo post the Portugal downgrade. Just as interesting is that this bombardment of Eurowoes has remained pretty much Eurocentric with little knock on (so far) into the usual risk suspects.

This leaves us thinking that either:-

A) This is a last death-twitch of the bears as they try their utmost to reverse the recent rallies using Euro ammo, but failure to make advances in non-euro risk components will mean they finally capitulate and everything rallies again.

B) It's all going to go Pete Tong (wrong) again and our "sell last Friday" theory is about to be rewarded.

Which is back to our heads vs hearts problem again. To us it is becoming clearer that there really is a supply chain led recovery coming via lorry or ship to a factory near you, which is good news for the private sector and equities. Against that, the public sector is still in a mess with western debt structure on a life support machine hoping the private sector pick up can come to the rescue before it dies (highlighted specifically by today's minor Euro-panic).

Our heads say buy equities, sell vol and buy commodities for a bigger recovery, yet our hearts know that it won't take much to burst the euro-rescue bubble.  But even then we need to ask how contagious Europe is to the rest of the world at the moment. If, as we suspect, the US markets are getting numbed to the European noise and are now getting more introspective towards their own recovery then we should see them come in and buy again today.

We may be sounding very short-termist when perhaps we should be being long-term Macro, but that's only because we believe we really are on the cusp of setting the next serious direction. Hold the line for another 24 hrs.

U-Turn or U-bend

The plan to sell the rally on Friday looking for "normal service to be resumed" after the Month End Noise and US holiday was going just fine until those ISM figures came out. Our cheapo TMM ISM model that we knocked up using tin foil and sticky-back plastic has been crumpled up and chucked in the bin. We hate to admit it but maybe it is worth paying up for the PhDs' versions.


The problem is that we have been blindsided by the stunning performance of the ISM which we feel really is the figure du jour when it comes to importance. Especially having come on the back of the bounce in various regional PMIs. On the face of it we should really press our thought and positional stop loss buttons and reassess everything. But we are a bit split re timing. If the ISM is a game changer then we should abort and buy for the next run up to 1400, however if there is a chance that this is just an uber-expression of the risk run up we were expecting last week then perhaps we should just wait to see how the next 36 hrs pan out. It is easy to see punters become comfortable with the mid-cycle slowdown coming to an end, but it is also easy to see the A-Team screw up somehow or this week's data disappoint with ISM being the "outlier". TMM have not yet reached a consensus on this.


Apart from the ISM how else has the world changed over the last week? Well the Euro-package is already having its stitching unpicked by S+P suggesting that the French 12yr olds' plan may still involve partial default. TMM are amazed that the Eurostriches feel that they can get away with another summer of head and debt burying combined with STFU policy.  But the market so far appears to be worryingly fooled.


China slow down figures continue to grind out which on the face of it fits in with TMM's DM vs EM master plan but, once again, the market appears to be completely off any argument that could halt the last week's risk rebound. But it's a slowdown none the less and will no doubt be resurrected as and issue as soon as markets roll over.


So where are we left for today? On this special day where the US celebrates the independence of its national debt from that of the British national debt, we should be out celebrating, but instead we are debating what to do.  The heart says hold but the head says fold.  We will try to hang on for 36 hours hoping the markets start to once again go down the U-bend before we follow our heads and do a U turn.