The Axis of Weeble (Tchir)

Thursday, May 10th, 2012

by Peter Tchir, TF Market Advisors

Weebles wobble, but they don’t fall down. Europe, and the Euro in particular might fall, but right now they are close to the bottom of this current wobble and are about to start another upswing (seriously, as I kid, you could make a Weeble fall down, but it was hard).

Greece is a basket case. It may or may not have a government. The eventual government may or may not want to stay in the Euro. That is all true, but will take time. Greece will and should attempt to renegotiate the bailout package. Our analysis yesterday might be a good place for Greece to start. The results of the renegotiation will determine the timing and necessity of Greece leaving the Euro. Until the Greek’s have had time to attempt to renegotiate and have actually planned for an exit back to the Drachma they will not risk a hard default where they really don’t know the consequences. So look for more hard-line headlines but expect May payments to go smoothly. I think the post PSI bonds, down a touch again today, offer good risk/reward opportunities.

Spain may be less of a basket case than Greece, but it is a far bigger basket. Spain nationalized Bankia, the 4^th largest bank. So far the market is reacting positively. I think that this will turn out to be a “head fake” over time. While encouraging that Spain was willing to act a lot is left uncertain. Is this even enough to fix Bankia? Problem banks have a tendency to be bigger money pits than anyone at first realizes. Look for doubts to creep back in about the success of this recapitalization. Then there is the question of how many other banks need how much money? The figure will be staggering. That brings us to the last question, how will Spain get all the money? Spain will be back to test the lows, but with the IBEX index at 9 year lows, a lot has been priced in and these little actions should be enough to provide a decent pop. I recommended long IBEX vs short DAX into the European close yesterday.

Germany has its own set of problems. The people voted and made it clear that the bailout programs Germany is creating don’t sit well with the people. So Merkel cannot easily back down and make things easier for Greece or Spain (or Italy, or Portugal, or Ireland, for that matter). She has to talk tough, but there is no way she has gone this far and will let it fail easily. She is likely to insist on the same level of budget cuts, but may be less concerned about the timing. She has to pander to her base, so look for disruptive statements from Germany, but their bark will be worse than their bite. Behind the scenes she will be a little more conciliatory and flexible.

France has been surprisingly quiet since the elections. Mr. Hollande is not forced to embrace the policies of Merkozy and is free to carve his own role in Europe. The French elections seemed to have less to do with bailouts and more to do with a renewed focus on France and a push for growth. So while he has to spend more time on domestic issues than the previous government, he also has the ability to push the growth agenda throughout Europe. He can be a leader in a “new” European plan, one focused on “growth”. Since “growth” is just code for spending, most of the politicians will get behind him. The equity markets love growth and are always happy to drown out the screams and protests of the fixed income markets. The failure of the “growth” agenda will become apparent and markets will sell off, but that could take some time. Fortunately for the bond market and the sovereign debt crisis, the fallacy of the “growth” argument will become apparent before more debt has been issued to fund elaborate spending projects. It does continue to amaze me that “austerity” is so hated and not an option, when in spite of all the votes, and approvals, very little actual austerity has occurred.

Jobless Claims have the potential to move the markets. To me, the revision is key to how the market will respond. If we get another upward revision to last week’s data, the market will show little enthusiasm for the number unless it is below 350k. If we get 365k and even a small downward revision to last week we could see a significant pop. That’s because the market largely ignored last week’s number with so much else going on, and because after Friday, the “we have jobs” portion of the rally took a serious beating. If we get a 365k print will another upward revision, expect the market to be rather blasé about it. I like being a little long U.S. risk coming into the number, but will take my read more from the revision than the data itself.

Credit is mixed this morning, but by and large unchanged. Spanish and Italian bonds are trading much better. There is still pressure on CDS, but even there I think it is less of a warning sign than a market that is about to get squeezed badly. U.S. CDS is trading a bit better with both IG18 and HY18 trading fractionally tighter. Futures have managed to retrace back to almost session highs, and given how many people seemed to expect overnight problems in Europe, expect buying to continue, especially if jobless claims are good.

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E-mail: tchir@tfmarketadvisors.com

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Tags: Axis, Bailout Package, Basket Case, Bonds, DAX, Doubts, Drachma, Last Question, Lows, Pits, Problem Banks, Psi, Recapitalization, Renegotiation, Risk Reward, Spain Money, Tendency, Tf, Upswing, Yest
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Guest Post: Some Thoughts On The Policy Bias Toward Inflation

Thursday, June 16th, 2011

Submitted by JM, Via ZeroHedge.com

Some Thoughts on the Policy Bias Toward Inflation

Banks fear deflation.  They should:  sustained deflation will most likely kill the banks.  Also, since banks provide high-paying jobs to Federal Reserve types as kick-backs for well-aimed support while they are at the controls, the Federal Reserve fears it as well.  As long as they keep banks going, they will be well-taken care once they are no longer with the Federal Reserve.  Also, the only thing our current central banker in chief knows how to do to stimulate a basket-case is suppress nominal interest rates, or monetize debt.

I don’t really care much about the inflation/deflation debate much anymore, because to me it is aside from the point.  What I care about is what the yield curve looks like because rates drive everything.  Not much to chase away the gloom in this, just a way to think about stuff.

If you accept these curves, then a lender probably couldn’t care less about inflation either:  steep yield curve, very high inflation, hyperinflation (CPI up 50% a month), none of it matters.  This is because they can borrow at the short end of the yield curve lend farther out, and as a secured lender, they get recovery of the underlying asset in the event of default. The latter covenant is the most compelling reason in the world own banking stocks if (hyper) inflation is on your mind.

Consider that many risky ventures are financed with three to five year notes.  The borrower may receiver a longer term amortization schedule to pay down principle more, but the bulk of the note will end up as a balloon payment at the end which will need to be rolled.  In the very high inflation scenario, more cash flow will go into purchasing inputs, and if this input cost (programmer salaries, cost of fuel for travel) increase offsets the interest cost reduction, then a risky venture is worse off.

Now consider a risky venture that faced a giant balloon payment that they can’t possibly pay out of cash flow.  A lender will offer refi terms based on market rates—rates that are expected to compensate for inflation.  The business now has lost most if not all benefit from inflation-adjusted interest costs.  It may be that the business prospects are so poor based on rising input costs and now interest burden that the terms will be adjusted for the risk, putting the business in a death-spiral.  What recourse does the lender have in the event that this risky venture cannot afford to refi or make the balloon payment when the note term expires?  The bank takes possession of the assets.  They most likely are not experts in the venture, so they have tow choices:   subsidize the venture for a while with better terms than the market requires just to keep it running, or they will have to sell the business whole or in parts to recover a fraction of their investment.  Either way they lose a chunk, but they do not lose everything.

If a bank locks at least some funding needs in long term financing at a fixed rate, then banks will benefit from the erosion of this burden.  At the same time, their costs of inputs (mainly capital) will rise much less than most business lines simply because they borrow at fed funds or some interbank lending rate like it.  All they have to do is shorten their term risk.

If the yield curve ever did look like the hyperinflation scenario above, it is of course unsustainable and short lived.  But there will be little capital left after it is over.  Lenders will recover the real assets in the event of default, because there is no point in subsidizing a business that cannot possibly turn a profit.  Then they will liquidate the asset to the highest bidder.  Liquidation on a large scale will pretty much ensure that no business can turn a profit.  A sustained yield curve like the one shown above will reduce all activity to only short-term activities and ones that increasingly reduce to barter type transactions.  Nominal recovery may be higher, but there is not much they can do with the cash, other than move out of cash.

Tags: Amortization, Amortization Schedule, Ballo, Balloon Payment, Basket Case, CPI, Curves, Federal Reserve, Gloom, High Paying Jobs, Hyperinflation, Inflation Deflation, Jm, Kick Backs, Nominal Interest Rates, Offsets, Programmer Salaries, Risky Venture, Risky Ventures, Yield Curve
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