Inflation

According to RBA statistics, base monetary inflation has been runninng at 6.7% per year for the last 7 years, while broad monetary inflation has been running at 13.1% per year. The difference between these is the rate of increase of leverage within the economy - and the former number is the rate of printing. That printing may, in the case of Australia, be justified by population growth and the view that the total productive output of the country has truly been increasing. The latter number is the effective real rate of increase in money supply, for determining the nominal cost of everything.

In the past year, however, base monetary inflation has been running at 13.3%, while broad monetary inflation ran at 13.8%. This shows a few things - the economy has not been deleveraging and the RBA has been printing very hard to keep inflation going and prevent deflation from showing up anywhere.

On a related note, total credit growth has gone from 15.5% YoY 2 years ago to 3.4% YoY now, of which housing has gone from 12.9% to 7.1%, personal credit from 16.1% to -7.0% and business credit from 19.1% to 0.5%. We could go into 2nd derivatives, but the point is fairly clear - the credit train has almost stopped.

Of course, this is nothing like the US inflation - 98.4% inflation of the base in the last year and 8.8% broad inflation, demonstrating massive economic deleveraging and/or a Liquidity Trap.

As a final thought, an increase in inflation improves business and prosperity for everyone. At least according to the government, anyway. History shows that Roosevelt's inflation and New Deal didn't work so well.

US bond auction "failure"

The US is trying to spit out $235 Billion in debt this week to the bond market. The bond market has taken everything so far, but today the bid-to-cover ratio was 1.92. This is not a failure - anything over 1 means that all the debt sold. However, the Primary Dealers in the US must offer to swallow all debt issued, as a condition of being able to sell it - much like underwriting a share offering.

In short, anything less than 2 means that there was insufficient demand, and Primary Dealers were actually forced to swallow a portion of the debt. It's not that bad yet, but they should start running for the door. Dresdner Kleinwort fled a month ago.

Failed bond auctions - China

China has been failing bond auctions all week - now we have a third separate incident. China stimulus has been causing resources to soar, but they have to stop the stimulus, or do one of two things - print faster or sell US Treasuries. It's a very complex web, but suffice it to say, this places upward pressure on interest, which in turn rips down unsuccessful and fraudulent businesses.

The Recession is "Over"

According to the RBA's forecasts as of May:

The central bank predicts that the negative economic growth recorded in the December quarter will be repeated in the March and June quarters, with the economy shrinking by a total of 1.25 per cent before beginning to pick up from the middle of this year.

According to Merrill Lynch, it is now over:

"The recession is over" Merrill declared in a report Tuesday authored by Michael Hartnett, chief global equity strategist.

The brokerage’s famed horned mascot is snorting again: "We are bullish on global equities," Hartnett says in the report.

According to news articles quoting US Treasury Secretary Timothy Geithner, it will be over in a matter of months. Of course, he never actually says anything solid, he simply alludes:

"We have a powerful set of policies coming on stream," he said. "We have a very good chance of seeing the US economy and the global economy get back to the point where [they are] growing again over the next few quarters."

According to Dennis Kneale, it has been over since the start of this quarter.


The market has certainly reacted accordingly. That is to say, the stock market reacted, the futures market's message is plainly unchanged. I'm unaware of a history of successful predictions from any of these sources, and quite aware of a lack of success, so I'll add my own prediction to the pot:

The global economy will be out of "green shoots" in a matter of months - that is, the hope of an imminent recovery will melt away to be replaced by fear and then panic.

Futures spreads

I've been a bit out of things lately, a little dismayed at getting done by this rally. It appears that my experience is insufficient for predicting the timing of the future, so for this I turn to a source vastly better at making timing predictions - the futures market.

As I explained earlier, the futures market is chained to the stock market because it will be forced to match upon expiry of the contract, and so it never seems to drift more than about 35 points apart. From this I'll define a scale from -50 to 50, where -50 is "The End of the World approaches" and 50 is "Everlasting World Peace any time now".

The September spread is -35, or "Oh my god didn't there used to be an economy", the December spread is -30, or "Well, looks like the economy is still here... maybe we really have bottomed" and the March spread is slightly different because betting on it is less liquid - but it's between -36 and -60, which places it somewhere between "The economy is no more" and "The world is no more". I really hope it's the former.

Rates and Ratings

The outlook for UK credit rating was cut to negative by S&P.
There's talk of something similar coming down the line for the US by the head of a major investment company that specialises in bonds.

Meanwhile, US 10 year treasury interest rates went up 0.21% overnight, from 3.16% to 3.37%, continuing a recent run up from a bit over 2%. This is the rate that the US pays to borrow money. This is particularly significant, since most other debt is seen in the light of "is x% less safe than US government debt". This is directly and immediately impacting Australian government debt, which has gone from below 4.4% to 5.2% in the last month, with an expected translation from there into all long-term debt rates in Australia.

What this really means is that anyone refinancing debt now will have a much harder time, whether it be a personal loan, home loan, or large corporate loan, and they'll have to pay a higher rate. A number of on-edge companies will be pushed over really soon should this trend continue, and a number of on-edge individuals will find themselves in foreclosure/bankruptcy proceedings.

Australia swirls

Business Speculator has a nice article on the direction of the Australia:

The forward estimates period will produce government debt of at least $200 billion with no further fiscal stimulus or infrastructure spending.

With a conclusion that is exceedingly negative on Australia's outlook:

As a result the Australian dollar will fall. At 70 US cents it looks fundamentally overvalued.

Australia is in recession

Apparently Australia is in recession, and has been since the start of the year. And here I was thinking Australia was strong...

In real news, major US banks have been making profits - but by less than the markup on their own debt. This is a piece of accounting genius: Suppose company XYZ sells $15 Billion of debt due in 5 years for a total of $10 Billion. Next, the market realises that there's a real risk that XYZ will not last 5 years and the debt is going to be paid only partially and only through bankruptcy proceedings, so the debt falls in value to $7.5 Billion. XYZ records a profit of $2.5 Billion because the present value of their outstanding debt has fallen.

In theory, XYZ could buy its debt back for $7.5 Billion - but there were any way it could do this, the market would not have discounted the debt quite so harshly. This windfall profit comes with the catch that it is guaranteed to go away over time - firstly, if the health of the company improves, an equal amount of loss is incurred, and secondly, as the debt matures the present value approaches the face value, making an equal amount of loss.

And on the dangerous side, let's take a look at CDS rates. Rio Tinto is currently around 7.25%, while Macquarie Bank managed to hit 12.65% at the market bottom. Loosely speaking,
CDS rate = Risk of bankruptcy per year * Expected recovery on debt after bankruptcy
At a recovery rate of 2/3rds (probably low for Rio, high for Macq Bank unless they're telling the truth), this gives a market expectation of over a 20% chance on Rio bankruptcy this year and briefly rated almost 40% on Macquarie Bank.

Disclosure: Currently short Macquarie Bank and Rio Tinto in a variety of ways.

Futures spreads

One thing that is fantastic about derivatives is the ability to bet on just about any aspect of the future, so long as there is someone willing to bet against you. The end result of this is that you can get odds on many things, and a consensus bias on many more.

On the way down, the futures spread on the ASX 200 index (both March and June) were around 1% below the index, indicating a consensus of "falling". At the bottom it flipped around, with a spread of 0.5% above the market (June only - March had expired), indicating a consensus of rising, something I bet against to my great detriment. In the last week, the June contract has slipped to between 0.1-0.2% above the market, indicating an expectation of a very mildly upward drifting market until June, however the September contract is trading 1% below the index. After September, the bets get less precise, but imply no recovery even through to June 2010.

To complicate this further, there is an activity called arbitrage. A big player could make bets against all stocks now and buy futures for a guaranteed profit, which will move the market down and the futures up. I believe this results in around 1% being the maximum possible difference between futures and the market while the market is open - otherwise financial institutions with nifty maths and powerful programs will step in and take free money.

In summary, the futures market is predicting a massive market fall between June and September. Bet against it at your own risk.

Earnings & Bankruptcy

Wells Fargo pre-announced that it was going to have massively successful earnings - of course, they're not real. The timing was a surprise. Goldman Sachs had good earnings, which were meant to come out in the morning but came out the evening before - again a surprise impact on the market - but then they flipped into capital raising mode before the market knew what hit it. Good earnings, but still need more money somehow. JP Morgan's earnings were decent, and were also released on time. None of this should really be a surprise given the previous posts here.

At the same time, we have the US's largest commercial real estate bankruptcy - GGP. It appears that the company was worth $18 Billion at the peak in April 2007. The CEO mantains they were fine, simply couldn't roll over debt, and stories appear to indicate how this is positive for Commercial Real Estate because of the opportunity to acquire assets at firesale prices. This is true, if the large CRE companies are cashed up and the economy is poised for recovery...

April recovery #2

Another thing that should not be underestimated in the "profits" for the first quarter this year is the effect of bailing out AIG. The money was drained into the global financial system, which was tallied for a few of the larger recipients by Yahoo News as follows:

Through three separate types of transactions, Goldman received an aggregate $12.9 billion. Among European banks, SocGen was the biggest recipient at $11.9 billion, Deutsche got $11.8 billion and Barclays was paid $8.5 billion.

Additionally, many states were bailed out through AIG, with the largest recipient, California, receiving over $1 billion.

Beware of April

April has many "surprises" in store, though a few of them have been telegraphed:

• Goldman Sachs and Morgan Stanley delayed their earnings announcements from mid-March to mid-April - it is currently still possible to find them referenced as earlier in old calendars.
• These delays shortly happened before the Mark to Market relaxing legislation in the US, affecting financial reports delivered after April 2nd. This change will allow banks to decide how much their assets are worth - a ball of string could be declared as worth $2 Billion after this if the bank so chose. The expectation is that the US banks will change their books to produce massive "write-ups" (accounting only profits) on their investments in things now worth not more than said ball of string.
• The "uptick" rule is expected to come out of the April 8th SEC meeting. This is supposed to be some magical rule that will ensure the market doesn't go down, or something, it's not entirely clear what chain of causation would result in an improvement in anything.
• The Federal Reserve is now buying longer term US government debt - $300 Billion happening right now. This is meant to keep interest rates down, which in turn is meant to stimulate the economy.
• There's plans for the Treasury and the FDIC to provide speculators money to buy the toxic assets from the banks. The most likely end result of this is that the banks speculate on their own toxic assets and transfer all future losses to the taxpayer.
  

There's 2 possible causes for this confluence. Either there's something truly awful coming out in April that they're trying to offset, or it's a coordinated attempt to force the stock market higher so the looting can continue just a little longer.

IMF: Iceland on the road to recovery

I'm not sure what they mean by "road to recovery". To a certain degree, having recently lost the 4th of their big four banks, they can't lose any more of them. The real content of this statement may be as little as is found in "we're heading in to the future".

Babcock and Brown down and out

Babcock and Brown found that leverage upon leverage and the practice of funding dividends from the money provided by new investors (aka a Ponzi Scheme) results inevitably in bankruptcy. While only $3 billion of debt was directly impacted, it should be remembered that all of its children, who are now running for cover, have a total debt load of over $50 billion. The question that has to be asked at this point is: Why was Babcock & Brown terminated this soon, and why before Centro?

Printing is safe

Apparently, printing is safe, according to the Bank of England's deputy governor.

Now if only central banks would release their statistics at the end of the month, rather than lagging 3 months we'd know how much "safety" has been added to the major economies.

GDP

Treasury's Forecast: 1.0%
IMF's Forecast: -0.2%
Official Statistics: -0.5%
Reality smashing up the stock market and currency: Expensive

Bank ratings - under threat

Moody's has been going hack & slash on the ratings of our banks. Firstly, it put ANZ, Commonwealth Bank and Westpac on negative credit watch (NAB got hit earlier). Then it downgraded St George and Suncorp, both in Bank Financial Stability Rating and in debt rating - note that debt rating is considering the risk of the company going bankrupt, which involves the share price going to zero.

Earthquake Warning

Looking at the ASX toward the end of day, you'll see a plunge, around 1%, from 3:40PM to 4:00PM. It was across the board, affecting all sectors equally, and it appeared to have no origin and no news behind it. On the futures market, it's a 1.5% plunge from 3:40PM to 4:10PM, a sharp spike up, another spike down and then settled. The volume on the futures had 10,000 contracts over half an hour, a record for the March SPI contract.

To me it looks like someone decided to short Australia via the futures market with A$800 Million nominal value, or at the very least A$50 Million margin, and the entire market was dragged down through arbitrage from that. There's no way the market would have supported that large a short after close, so it would seem that someone knows something going down over the weekend and is betting large, and at the last minute available.

Australia is strong - part four

Do you believe it yet? The propaganda machine is whirring at high speed now:

Australia is not about to lose its AAA credit rating, Treasury secretary Ken Henry says.

CBA loads up

Commonwealth bank, in addition to the acquisition of BankWest and probably repurchase of RMBS (Residential Mortgage Backed Securities) has acquired A$2.25 Billion of Wizard home loans. They're a fan of taking on debt too hot for others to hold. Many would call this "catching the falling knife".

In other news, AIG is to report a $60 Billion loss and is threatening bankruptcy if they don't get it this week. Also, the UK banks need £500 Billion government loss insurance to prevent everything from seizing up over there.