The job numbers were a surprise for the market with only 18k jobs created against 97-105K expected. Meanwhile the important data is not the 9.2% unemployment rate but the participation rate at 64.1 percent. The employment-population ratio decreased by 0.2 percentage point to 58.2 percent yet this data does no not include the so called “discouraged workers”. Besides a week economic reality, the greater the economic concerns the better chances for a quick fix stimulus. Therefore, counter-intuitively the short term view on the market is rather positive assuming more stimuli is to come allowing assets to inflate for an other round.
Following we will interpret the most relevant market-moving headlines:
• ECB's Trichet, Eurogroup's Juncker to join Monday meeting
• Concern grows over 2nd Greek bailout, threat to Italy
• Getting private sector role in Greece may require default
ð Since the Greek rescue package is almost a done deal, the way to open for a second bailout in September is first to increase the European Financial Stability Facility (EFSF) which is the asset purchasing program in Europe. There is a possibility of the EFSF to double in size. This would also allow Europe to put a safety net under Italy and calm the Markets.
Treasury Secretary Timothy F. Geithner said the Obama administration wants the most comprehensive deficit-cutting deal possible and reiterated that failing to raise the debt limit could have “catastrophic” consequences. ð As far as the US is concerned, this week-end, T. Geithner said he expects the debt ceiling to be raised by the end of next week. The debt ceiling needs to be raised before the eventuality of QE3. In fact, once they raise the debt ceiling, the problem of “who is going to buy the debt” will begin. To avoid interest rates to go out of control, the fed could launch a QE3 in a form of Interest rate cap.
An, Interest rate cap is even worse than a defined QE program. Interest rate caps could mean a yield curve predefined by the Fed, where the Fed would buy as much US debt as necessary to meet the desired yield. Effectively, rather than a defined amount of QE we can suppose an unlimited budget, the last round of asset purchases was around 600billion. Note QE2 did not end since the amount is reinvested as maturity comes due… Here is the issue, The Fed representing already 70% of US Debt purchases:
- An unlimited program would allow the remaining US Debt holders to exit US treasuries by dumping them to the Fed.
- In this case there would be a systemic risk if the Fed end up buying more than 90% of Treasuries, this would mean a phony market or no market at all and could be the beginning of a greater crisis based on subprime governments across the world. Meanwhile, this could take some time, first to materialize and then to be pointed out.
Warning: Risk Premium.
“No incentive in holding CDS and the ECB accepting junk bonds as collateral adds a risk premium to the market.”
Ø ECB Suspends Ratings Threshold On Portuguese Debt As Collateral – Nasdaq: The governing council of the European Central Bank has decided to suspend the application of the minimum credit rating threshold in the collateral eligibility requirements for euro-system credit operations involving marketable debt instruments issued or guaranteed by the Portuguese government, the ECB said in a statement Thursday. The suspension will be maintained until further notice… ð After raising Interest rates to 1.50% on July 7th, Jean Claude Trichet also revealed a change in the rules binding the EFSF and the ECB. Suspending the rating requirement for the bailout fund gives a clear message to the market: The ECB rejected the assessments of the rating agencies and The ECB is willing to bend their own rules to rescue the Euro.
ð During the question session J. C. Trichet reiterated:”No credit event, no selective default”. To the question: Is the ECB denying evidence or do they have a backup plan? We can argue that they have a plan which could be to increase the bailout facilities as this is in line with their latest proceedings.
ð First we can question how “voluntary” the restructuration is. Rolling over is reinvesting at maturity whereas in this case the maturity is prolonged without necessarily considering the liquidity neither the solvency of the Bonds. The liquidity issue is fixed but not the core problem which is the long term insolvency.
ð Second, we can question the message sent to the markets: Because of the European countries and the ECB seem to be willing to bailout Greece at no matter what cost and given that such rollover wouldn’t be considered as valid to trigger CDS it clearly becomes less attractive to hold CDS. By following this logic there would be no incentive in seeking protection through CDS.
Market Recommendations:
Long term, buy on Dips: BG, FRES, XTA & BRBY,IMT, EMG
Longer Term:
è We could see a progressive money flow from bonds back to equities. We hope the liquidity injected by major Central banks to maintain bond prices will find a way into equities and other “hard assets”.
è Recommended to hedge against inflation and a relative appreciation of emerging market currencies; shares of companies having a large part of foreign operations and with high pricing power (ability to raise prices easily due to a non elastic demand and very price elastic products) such as luxury goods operating in emerging markets and tobacco companies. Energy companies are limited to this effect due to government price regulation. In this case The underlying commodities such as Oil and Gas as well as Corn and other agriculturals are better off. Since they benefit directly from the ongoing "money printing" and stimulus.
For the end of July- August: ≈26/08/11
Ø If the debt ceiling is raised and QE3/Yield Cap materializes bond and particularly US Treasury rates could go back to near October lows based on growing recession fears and negative Economic numbers.
Ø More stimulus would turn “risk on” trades and inflation concerns where of more risky investments such as high yield emerging market bonds and Stocks could benefit.
Ø Most importantly commodities and precious metals will benefit from the unintended consequences of the stimulus: Inflation
Macro Forecast for the next 2 months:
Economic concerns, jobs and debt crisis => Central banks solution: EU QE2 (double EFSF), Fed Cap Yield (QE3)
“When the debt ceiling is lifted, the US Treasury will need buyers. There are still no jobs and growth objectives are not being met, a good reason to launch QE/Cap yield plan while the European debt crisis makes America look good.”
From the previous report we are ending the 1st Phase:
1st phase: Recession Fears - June ~ Mid August 2011
ü Fears that the Debt ceiling will need to be approved with deep cuts in government spending which can lead to a revision of GDP growth (less stimulus)
ü The Market will anticipate interest rate hikes from the ECB and/or the BOE. This can have a negative impact on growth prospects and exacerbate debt concerns (Greek restructuring…) in the EU
ü Most importantly, the end of QE2 was a strong test on how strong the recovery was and how much has been an artificial effect of the stimulus.
We have seen a counter- intuitive effect, whereas the stimulus is in the money market (bond purchasing program…) Equities and commodities were the ones dropping over recession fears (Less Stimulus or artificially low interest rates = less cheap credit = less consumption èless growth)
We are now heading to:
2nd phase: A Short Term solution –~ Mid & End August 2011
- The Debt ceiling is raised but not enough cuts in government spending are done despite what republicans will certainly display as a “win”. The government is allowed to keep going into debt and push consumption (rather than production)
- Major Central banks lack of rigor and do not raise interest rates despite the potential inflation for the UK. As far as the ECB despite having rates at 1.5% the European Debt concerns will exige an other round of bailouts and a bigger EFSF fund which in effect adds further potential monetary injection (EU QE2)
- An increasing propaganda of QE3in a form of a Yield Cap is announced as a possibility and a “good thing” to ensure economic growth.
We could still see one or two weeks of downside, the real trigger will be either an increase of the European bailout fund or the US debt ceiling being lifted. Due to disappointing economic numbers and less inflation, Bernanke will have more arguments to push QE3/Yield Cap as a “necessary measure” to “ensure a recovery and for JOBS” whereas the real reason will be to stop the stock market fall, push inflation, depress the US dollar and try to boost exports. Perhaps QE3 could happen in August after a more disappointing economic numbers.
The Market Strategy:
• Phase 1 was: Good for Bonds and Currency.
• Phase 2: Is very good for Commodities (blue) and Precious metals (Yellow) and positive for the Equities (to a certain extent between 0 and 5% inflation.
Mini Charts 12-07-2011
(Click Image to Enlarge)
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