Thursday, June 30, 2011

US Treasury Debt Demand Weakens

This week saw several auctions of public debt issuance. The results are a possible signal that there is less demand for US debt than in the past. Here are results for the 2 year note, 5 year note and 7 year note. Highlights are written by Econoday.
On the 2 Year Note auction:
This week's run of coupon auctions is getting off to a slow start. Coverage of 3.08 for today's $35 billion 2-year auction is on the low side of trend and is well below May's 3.46. The stop-out rate of 0.395 percent is one basis point higher than the one o'clock bid. In another sign of weakness, dealers were awarded 65 percent of the auction which is the most in more than two years. Demand for Treasuries is easing following the results. Tomorrow the Treasury auctions $35 billion of 5-year notes.
On the 5 Year Note auction:
Buyer resistance may be appearing for Treasuries, judging by yesterday's soft 2-year note auction and today's even softer 5-year auction. Coverage is 2.59, the lowest of the last ten auctions, all $35 billion in size. In another sign of weakness, the high yield of 1.615 percent is more than two basis points above the one o'clock bid. Dealers ended up taking down 52 percent of the offering for the highest rate of the last four auctions in yet another sign that demand is soft. Demand for Treasuries is falling in reaction to the results which point to trouble for tomorrow's $29 billion 7-year auction.
On the 7 Year Note auction:
Treasury supply may finally be getting ahead of demand. That's a conclusion that can reasonably be drawn from this week's poorly received string of coupon auctions including today's $29 billion offering of 7-year notes. Coverage of 2.62 is light for this issue while the high yield of 2.43 percent is three basis points over expectations. In a sign of weak retail demand, dealers ended up taking down an outsized 56 percent share of the offering. Demand for Treasuries is sinking following today's results.

Here is a look at the IEI daily graph (iShares Barclays 3-7 Yr Treasury Bond index):

Monday, June 27, 2011

Market Data: Week Ending June 24, 2011

Market Index 12/31  Close 6/24    Close Week Change Simple YTD %
Dow Industrials Avg 11,577.50 11,934.60 -0.58% 3.08%
S&P 500 1,257.64 1,268.45 -0.24% 0.86%
Fed Funds Rate 0.10% 0.10% -0.01% 0.00%
10 yr T-note Yld 3.29% 2.86% -0.08% -13.07%
5 yr T-note Yld 2.01% 1.37% -0.16% -31.84%
5 yr TIPS - 'Real' Yld -0.06% -0.48% -0.02% -700.00%
Implied 5 yr Inflation % 2.07% 1.85% -0.14% -10.63%
2 yr T-note Yld 0.59% 0.33% -0.04% -44.07%
2-10 Yr Slope 2.70% 2.53% -0.04% -6.30%
90 day T-bill Yld 0.12% 0.01% -0.02% -91.67%
Gold ($/oz) $1,421.40 $1,500.90 -$38.20 5.59%
WTI Oil ($/brl) $91.38 $91.16 -$1.85 -0.24%
VIX "Worry Index" 17.75 21.1 -0.75 18.87%

Credit Spreads 12/31  Close 6/24    Close Week Change Simple YTD %
Inv Grade Credit Idx 4.78% 4.40% -0.04% -7.95%
Low Grade Credit Idx 8.32% 7.57% -0.05% -9.01%
Markit CDX Inv Grd Idx 85 99 -1.98% 16.47%
Markit CDX Mid Grd Idx 131 160 -1.23% 22.14%

Monday, June 20, 2011

Market Data: Week Ending June 17, 2011

Market Index 12/31  Close 6/17    Close Week Change Simple YTD %
Dow Industrials Avg 11,577.50 12,004.40 0.44% 3.69%
S&P 500 1,257.64 1,271.50 0.04% 1.10%
Fed Funds Rate 0.10% 0.11% 0.01% 10.00%
10 yr T-note Yld 3.29% 2.94% -0.03% -10.64%
5 yr T-note Yld 2.01% 1.53% -0.03% -23.88%
5 yr TIPS - 'Real' Yld -0.06% -0.46% 0.03% -666.67%
Implied 5 yr Inflation % 2.07% 1.99% -0.06% -3.86%
2 yr T-note Yld 0.59% 0.37% -0.03% -37.29%
2-10 Yr Slope 2.70% 2.57% 0.00% -4.81%
90 day T-bill Yld 0.12% 0.03% -0.01% -75.00%
Gold ($/oz) $1,421.40 $1,539.10 $9.90 8.28%
WTI Oil ($/brl) $91.38 $93.01 -$6.19 1.78%
VIX "Worry Index" 17.75 21.85 2.99 23.10%

Credit Spreads 12/31  Close 6/17    Close Week Change Simple YTD %
Inv Grade Credit Idx 4.78% 4.44% 0.03% -7.11%
Low Grade Credit Idx 8.32% 7.62% 0.17% -8.41%
Markit CDX Inv Grd Idx 85 101 3.06% 18.82%
Markit CDX Mid Grd Idx 131 162 1.89% 23.66%

Thursday, June 16, 2011

Economic Condition Review: June 2011

The last economic review I did for the blog was in January 2011. At that time conditions for the US economy felt hopeful with corporations getting ready to announce good to great business results and guardedly optimistic business outlook messages. Food and energy inflation were an established factor in the US and the rest of the world. QE2 was adding fuel to inflation and to the prices for most commodities, especially the money hedges, gold and silver. The US$ was weakening, reaching a recent low near 73 (see graph below). A review of the weekly market data for January 14 is linked here. Company share prices elevated for much of the early part of earnings season before hitting a ceiling in mid February and suffering a March pullback in sympathy with Japan's enormous tragedy trio, earthquake, tsunami and nuclear power plant catastrophe's. The US markets recovered to the year-to-date high at the end of May.

Now in June, the world is captivated with concern about the bank and sovereign debt crisis in Greece. The concern is over the terms by which it will be resolved and when. The political forces are at work, the ECB, the IMF, and the US Fed are all applying pressure. The Financial Times describes the situation as "A Defining Moment for Greek Debt". A play on words since the article is about the definitions given to what everyone perceives to be a 'credit event' in Greek sovereign debt, involving credit default swaps. Eurozone forces feel the resolution is to deepen the austerity of the Greeks putting the problem on the back of labor as well as insisting that the government sell prime assets, such as state owned transportation and valuable land assets. Bloomberg describes the situation here. The proposals are being met with resistance from Greek labor unions. It remains to be seen how the government decides what to vote. Will they shun the political force representing the banking/eurozone interests or will they adopt an Iceland type reform to protect their assets from fire sale and force losses on the financial system. If they choose the latter, the potential exists for wide ranging credit related losses for European banks and possibly other money center banks around the world too.

The US Fed has announced they do plan to end QE2 as planned at the end of June. Until then, they are still in the markets supporting asset prices. A widely held view, that I share, is that there will be some form of market manipulation choreographed by the Fed until they get enough political support for the next QE. It will take a good financial scare to move the political will, so this is the time to be patient, waiting to take on risk. John Hussman writes that more QE will be politically aggressive in the face of a discouraged populace and critical global community. In addition, the lack of evidence that QE has been successful would support its abandonment. But the final decision likely revolves around the determination of Fed Chairman Bernanke to maintain the practice.

Tuesday, June 14, 2011

Residential Real Estate Priced in Gold

Here is a chart, from Chart of the Day, illustrating the long-term historical performance of real estate converted to gold. Yes, things have changed. It might appear that gold is nearing a peak in value and/or that real estate is near the bottom in its swoon. It could turn out to be that way, though there is a higher probability that the issues surrounding the US $ and other major currencies will dictate the rise and fall in gold. I share the opinion of others, gold goes higher. A lot higher.

Declining real estate prices continue to be a concern for investors. For some perspective on the magnitude of the decline in home prices, today's chart presents the median single-family home price divided by the price of one ounce of gold. This results in the home / gold ratio or the cost of the median single-family home in ounces of gold. For example, it currently takes a relatively low 106 ounces of gold to buy the median single-family home. This is dramatically less than the 601 ounces it took back in 2001. When priced in gold, the median single-family home is down over 80% from its 2001 peak (to a level last seen in 1980) and remains well within the confines of a six-year accelerated downtrend and continues to close in on its 1980 trough.

Monday, June 13, 2011

Market Data: Week Ending June 10,2011

Market Index 12/31  Close 6/10    Close Week Change Simple YTD %
Dow Industrials Avg 11,577.50 11,951.90 -1.64% 3.23%
S&P 500 1,257.64 1,270.98 -2.24% 1.06%
Fed Funds Rate 0.10% 0.10% -0.01% 0.00%
10 yr T-note Yld 3.29% 2.97% -0.02% -9.73%
5 yr T-note Yld 2.01% 1.56% -0.04% -22.39%
5 yr TIPS - 'Real' Yld -0.06% -0.49% 0.01% -716.67%
Implied 5 yr Inflation % 2.07% 2.05% -0.05% -0.97%
2 yr T-note Yld 0.59% 0.40% -0.02% -32.20%
2-10 Yr Slope 2.70% 2.57% 0.00% -4.81%
90 day T-bill Yld 0.12% 0.04% 0.01% -66.67%
Gold ($/oz) $1,421.40 $1,529.20 -$13.20 7.58%
WTI Oil ($/brl) $91.38 $99.20 -$1.02 8.56%
VIX "Worry Index" 17.75 18.86 0.91 6.25%

Credit Spreads 12/31  Close 6/10    Close Week Change Simple YTD %
Inv Grade Credit Idx 4.78% 4.41% 0.01% -7.74%
Low Grade Credit Idx 8.32% 7.45% 0.14% -10.46%
Markit CDX Inv Grd Idx 85 98 5.38% 15.29%
Markit CDX Mid Grd Idx 131 159 6.00% 21.37%

Thursday, June 9, 2011

Balance of Payments Math, Priced in Gold

  • International US dollar debt: $4.4792 trillion (approximately 32% of total US debt of $14.32 trillion)
  • Portion of international US dollar debt held by China: $1.1449 trillion
  • 90% of total US international debt less portion held by China = 0.90 * ($4.4792 trillion – $1.1449 trillion) = $3.00087 trillion (A)
  • 50% of international US dollar debt held by China = 0.50 * $1.1449 trillion = $0.57245 trillion (B)
  • Total foreign currency reserves held by People’s Bank of China (Central Bank): $3.045 trillion. Therefore, A + B = $3.57332 trillion (C)
  • Total US holdings of gold = 8,133.5 tonnes = 8,133.5 * 35,273.9619 = 286.900770 million ounces (D). Therefore, C/D = $12,454.8986 per ounce ~ $12,455 per ounce
Balance of Payments is an account of financial flows between a country and the rest of the world. It consists of the Current account and the Capital account. Current account consists of the trading account (exports minus imports of good and services), income account (factor payments from abroad minus factor payments to abroad) and the transfer payments account (foreign aid received minus foreign aid disbursed). Capital account, which is in surplus on account of increasing foreign investments in US treasury securities and in deficit for increased US investments in foreign securities and reserves. A surplus in the current account should always be balanced by a deficit in the capital account and vice-versa. That is, the balance of payments must always balance.
Suppose the balance of payments account does not balance. Then there are two options to balance BOP, first, the Central Bank of the country (in this case US Federal Reserve) should increase/reduce its reserves, that is the Central Bank’s holdings of foreign currencies and gold to bring BOP to balance. Second, if the Central Bank cannot increase/decrease its reserves or has decided against changing its existing reserve holdings, then the exchange rate of the country’s currency will be decided by the market and the government will not have any control over its currency.
Now, US has a current account deficit and the BOP is balanced by capital account surplus. If the BOP was not in balance and if US wanted to keep the existing exchange rates fixed, assuming it had a BOP deficit (international debt we calculated above), then it would either have to sell foreign exchange reserves or appropriate amount of gold to the tune of $12,455 per ounce. Thus, to balance the US government balance sheet, its holdings of gold should be valued at $12,455 per ounce.
Present market value of gold = $1,528.80 per troy ounce = $1,528.80 / 1.09714286 per ounce = $1,393.44 per ounce. This means that gold is heavily undervalued at it existing market price. Thus the price of gold has to be raised 8.94 times ($12,455/$1,393.44) ~ 9 times to the present price of gold for US balance sheet to balance.

1. Link:
2. Link:
3. Link:
4. Link:
5. Link:

Credit to:
Ayan Kole, intern to employer
Michael F. Price College of Business,
University of Oklahoma

Isaac Matzner 
Research Coordinator
Auerbach Grayson & Company, employer
25 West 45th Street
New York, NY 10036 USA

Made available on Jim Sinclair's MineSet

Wednesday, June 8, 2011

More on Derivatives

  • By Huw Jones
    LONDON, June 5 (Reuters) - The world's top 14 derivatives dealers may need extra cash to handle a surge in transaction clearing, especially in choppy markets, the Bank for International Settlements (BIS) said.
    Clearing is being favoured by regulators because it is backed by a default fund that ensures a trade is completed even if one side goes bust, as with the collapse of Lehman Brothers during the financial crisis.
    World leaders have agreed that chunks of the $600 trillion off-exchange derivatives market must be standardised and cleared by the end of 2012 to broaden transparency and curb risk.
    Researchers at the BIS, a global forum for central bankers, looked at whether the "Group of 14" dealers (G14) that dominate derivatives trading would have enough capital to handle the anticipated surge in trades that will have to be cleared.
    BIS concluded in a paper published on Sunday that "it seems unlikely that G14 dealers would have much difficulty finding sufficient collateral to post as initial margin".
    "By contrast, dealers may need to increase the liquidity of their assets as central clearing is extended," BIS said.
    Central clearing covers about half of $400 trillion in interest rate swaps, 20-30 percent of the $2.5 trillion commodities derivatives, and about 10 percent of $30 trillion in credit default swaps.
    The G14 dealers comprise Bank of America-Merrill Lynch, Barclays Capital, BNP Paribas, Citi, Credit Suisse, Deutsche Bank, Goldman Sachs, HSBC, JP Morgan, Morgan Stanley, RBS, Societe Generale, UBS and Wells Fargo Bank.
    BIS said they could face a cash shortfall in very volatile markets when daily margins are increased, triggering demands for several billions of dollars to be paid within a day.
    "These margin calls could represent as much as 13 percent of a G14 dealer's current holdings of cash and cash equivalents in the case of interest rate swaps," BIS said.
    Clearing operators like ICE, CME, LCH.Clearnet and Eurex are vying to capture the huge increase in clearing volumes expected but policymakers are taking steps to make sure operators remain robust.
    Requiring clearing houses to be able to withstand a default by two major clearing members could also help financial stability, BIS said. Current rules require clearers to be able to ride a single member default.
    Clearers could also benefit from adjusting initial margins to market volatility levels or set them according to the highest level of volatility, BIS said.
    A more streamlined clearing sector would allow for multilateral netting across different types of derivatives to ease the burden of margining, it added. Linking clearers, known as interoperability, would also bring netting benefits.
    The European Union is set to effectively bar interoperability among derivatives clearers for at least three years, believing it creates contagion risk. (Editing by Erica Billingham)

Tuesday, June 7, 2011

10 Yr Treasury Shows Nominal GDP is Under 3%

Dr Ed Yardeni comments on the dynamics of bond market pricing in his post titled "The Bond Yield". He makes the point that bond yields and the expected nominal GDP rate have a lot in common. Yields tend to revert to the expected nominal GDP rate.

GDP is a measure of the output of goods and services produced by labor and property located in the United States. It is also an indicator of broad US based economic activity that is expected to be reflected in the stock market.

The article focuses on 'expected' rather than 'stated' GDP rate. According to John Williams at Shadow Government Stats, "GDP reporting remains the least meaningful and most heavily gimmicked/politicized of the major economic series, at least in the first year or so of reporting."

Expectations for GDP are useful to provide hints about the near term trend of consumer confidence and stock market sentiment. It is fuel for the bulls and the bears, depending on their bond yield expectation.

Monday, June 6, 2011

Market Data: Week Ending June 3, 2011

Market Index 12/31  Close 6/03    Close Week Change Simple YTD %
Dow Industrials Avg 11,577.50 12,151.30 -2.33% 4.96%
S&P 500 1,257.64 1,300.16 -2.32% 3.38%
Fed Funds Rate 0.10% 0.11% 0.01% 10.00%
10 yr T-note Yld 3.29% 2.99% -0.08% -9.12%
5 yr T-note Yld 2.01% 1.60% -0.12% -20.40%
5 yr TIPS - 'Real' Yld -0.06% -0.50% -0.11% -733.33%
Implied 5 yr Inflation % 2.07% 2.10% -0.01% 1.45%
2 yr T-note Yld 0.59% 0.42% -0.06% -28.81%
2-10 Yr Slope 2.70% 2.57% -0.02% -4.81%
90 day T-bill Yld 0.12% 0.03% -0.01% -75.00%
Gold ($/oz) $1,421.40 $1,542.40 $5.10 8.51%
WTI Oil ($/brl) $91.38 $100.22 -$0.37 9.67%
VIX "Worry Index" 17.75 17.95 1.97 1.13%

Credit Spreads 12/31  Close 6/03    Close Week Change Simple YTD %
Inv Grade Credit Idx 4.78% 4.40% 0.02% -7.95%
Low Grade Credit Idx 8.32% 7.31% 0.17% -12.14%
Markit CDX Inv Grd Idx 85 93 3.33% 9.41%
Markit CDX Mid Grd Idx 131 150 0.67% 14.50%

Thursday, June 2, 2011

One Eye on the Euro

Here is a part of an interview dated May 23, 2011 and published in the online Der Spiegel, with Jean-Claude Juncker, the prime minister of Luxembourg and president of the Euro Group. To me, he is disguising his fear about the potential for another financial crisis if there were a technical default by Greece. A default will trigger credit default swap (CDS) claims. It seems that Juncker is acknowledging the danger in his veiled warnings of "the banks in Germany and Europe, would have an enormous problem -- with incalculable consequences for the financial market." and also "we would be letting a genie out of the bottle without knowing in what direction it will be flying." One alternative being discussed and getting traction is not technically a default. It calls for the current debt issuer to offer a voluntary restructuring of their debt with Greece. In other words, the lender says to Greece before you default let's agree on a new debt agreement that keeps you a sovereign nation for a couple more years and prevents a default from igniting a potentially widespread financial crisis. That would accomplish what Greece needs and prevent the world from experiencing another financial crisis in the immediate future.

SPIEGEL: The country's debt burden is so large that even tough austerity programs and loans are not enough to pull it out of the crisis. Why don't you finally admit that Greece is broke?
Juncker: Greece is not broke. That is what the experienced experts with the International Monetary Fund and the European Central Bank tell us. I am firmly convinced that, in a joint effort, we can lead Greece out of the crisis.
SPIEGEL: The total debt amounts to almost 160 percent of Greece's economic output. With such a debt burden, how is the country ever supposed to make any headway?
Juncker: The United States and Japan also have high debt levels, and yet no one would claim that those countries are bankrupt.
SPIEGEL: But Japan and the United States have their own currencies, which they can devalue, if necessary.
Juncker: That option is not open to Greece -- I'll acknowledge that. Nevertheless, it doesn't mean that the government is powerless. On the contrary, Greece can bolster its competitiveness, and it can pursue a reasonable economic policy and generate more growth.
SPIEGEL: Hope springs eternal.
Juncker: No, I am just considering the alternatives. If Greece were to declare a national bankruptcy tomorrow, the country would have no access to the international financial market for years to come, and its most important creditors, the banks in Germany and Europe, would have an enormous problem -- with incalculable consequences for the financial market.
SPIEGEL: But you exaggerate. The European lenders are in a better position than two years ago, and now many countries have established their own bailout instruments to protect against bank crashes.
Juncker: I would be cautious in that regard. We are still at the epicenter of a global crisis. We are dealing with largely irrational markets, nervous investors and rating agencies whose conclusions don't always make complete sense. I'll stick to my argument: In the case of a national bankruptcy with a subsequent debt restructuring, we would be letting a genie out of the bottle without knowing in which direction it would be flying.

Wednesday, June 1, 2011

Greece Debt is a Disaster, But for Who?

Martin Wolf appears on Yahoo Tech Ticker to describe his understanding of the debt problem of Greece and how it might impact investors and the government entities who have provided emergency bailout loans. One unknown is, who are the investors who get hurt. Wolf speculates that a debt crisis is less damaging when it is anticipated, like in the case of Greece. He feels that the debt holders are preparing now. Let's hope with him that the creditors to Greece are prepared for an inevitable writedown! He does not mention the potential contagion caused by credit default swaps being triggered and we learn again that they are useless in a default when one of the counter parties is unable to meet their obligation in the default of debt. Unfortunately, there is too little transparency in this market. The fact that the risk is not spoken about explicitly, and officials talk in couched terms about "massive contagion" and "incalculable consequences", should alert informed investors about the fragility of the resolution of the Greek debt. It may be a small contributor to world GDP, but it is now in position to be very influential to the stability of a financial system that has not recovered from the crisis it generated in 2008.

More Analysis of Greek Debt

This from Credit Suisse:
• We still think it unlikely that Greece would leave the euro: Greek net foreign liabilities are high at 88% of GDP (rising to c180% if Greece left the euro with a devaluation of c50%); cheap ECB loans are 33% of Greek banks' funding: without this, the loan book might have to fall c20%; a Greek exit could trigger capital flight from peripheral to core Europe, requiring considerable deleveraging in the periphery; the ECB owns cEu50bn of Greek bonds and the EU/IMF have lent Greece Eu53bn; leaving the euro could mean leaving the EU.
• We also think on balance Greece would choose to avoid early debt restructuring, given that: it would only be in a good bargaining position when it runs a primary budget surplus (vs. a 1% deficit this year); Greek banks' annual PPP is equivalent to 3% of loans, thus the longer the restructuring is postponed the less recapitalisation of banks is required; Greece has only a Eu27bn funding shortfall in 2012E.