Preview from Europe: The Great Bond Massacre Spills Over onto Stocks

As I’ve written in this column before, the Fed was always playing a dangerous game of chicken with the market, with its half hearted attempts at Quantitative Easing. To date, Quantitative Easing has failed miserably and the rise up in 10 year bond yields to 3.72% from 2.5% in March, sending mortgage rates soaring has completely neutered the Fed.

This sell off in bond prices, resulting in higher yields, was caused by a lethal combination of over supply fears, a weakening Dollar, speculation of diminished sponsorship from China at bond auctions, the possibility of the U.S. losing its coveted AAA credit rating and the spectre of future inflation. These factors combined yesterday finally spooked the equity markets triggering a late sell off, erasing Tuesday’s ill gotten gains.

Market Moving Stories

• JP Morgan warns that credit card losses could reach a staggering 24%. Ouch.
• The number of companies setting up corporate head-quarters in Ireland continues to increase, with the announcement that Accenture (ACN) is to move its corporate headquarters to Dublin. The Obama administration’s clampdown on tax havens has seen Bermuda lose out and Ireland win in this case, as companies move to add more legitimacy to their tax status while maintaining a low tax bill
• The outgoing and outspoken Bank of England’s Monetary Policy Committee member Blanchflower stated in a Times interview that there could be “many false dawns”. He doubted any strong growth for 2010.
• The WSJ reports that the US government’s planned program to rid banks of bad loans – the Legacy Loans Program - may soon be put on hold, according to people familiar with the matter. It notes that prospective buyers and sellers have expressed reluctance to the FDIC about participating, over fears that rules will change in a political atmosphere hostile to Wall Street. The WSJ also reports that the Obama administration is close to recommending that Congress create a single regulator to oversee the banking sector

More Car Trouble
The German government's deal on Opel funding is being delayed as GM raises new demand over US $415mn. Add to that the fact that Germany’s idea to link subsidies of Opel to the maintenance of domestic production sites may constitute a breach of EU internal market rules. As the German government considers whether to extend a multi-billion euro guarantee to Opel, the main consideration in the choice between the three bidders seems to be who can maintain the largest numbers of jobs in Opel's four large German production sites. One of the bidders has already indicated that they will the close Opel Antwerp site to meet the German government’s demands.

As General Motors (GM) moved a step closer towards a Chapter 11 filing – expected next week – the European Commission has organised a meeting of ministers whose countries are directly involved with Opel and Vauxhall, the FT reports. GM has already said it had three plants more than it needs, and each of the potential bids only make commercial and financial sense, if accompanied with drastic plant and job cuts. Belgium’s PM Herman van Rompuy wrote to the Commission that a one-country solution for a European company seems neither in tune with the idea of a single market, nor its law.

Der Spiegel reports this morning that a 12-hour marathon in Berlin to include the German and US governments, GM, Opel, and the three bidders has failed to reach the goal, as the German government said it had not received the assurances it wanted. The article also reported that GM claimed another financing gap of €300m, which has angered the German side. Another meeting has been scheduled for Friday. The two most likely bidders are Fiat (FIATY.PK) and Magna (MGA).

More news from Japan

After a revised fall of 1.1% in March, retail sales rose 0.6% mom in April - their first monthly rise since last August, leaving April sales 2.9% down from a year ago compared with the consensus forecast of -3.3% and March’s -3.8%. large store sales fell 6.7% yoy down from -8.1% previously. Citing Naokazu Takemoto of the LDP’s lower house finance committee, IGM reports that the government may yet scrap a bill that would set aside JPY 50 Tn for stock purchases. The report notes that the plan is no longer ‘essential’ since stocks have stabilised.

Battles in the Boardroom at Elan

In news related to Elan (ELN): BIIB shareholder activist Carl Icahn is again waging a proxy fight ahead of the company’s AGM on June 3rd. Icahn has campaigned for change at BIIB for two years now, and his most recent suggestion is to break up the company into its oncology and neurology components – essentially a reversal of the Biogen merger with IDEC in November 2003. BIIB successfully rebuffed Icahn’s attempts to nominate directors to the Board in 2008. However, the complication this year is that one of the main proxy advisors, RiskMetrics, has recommended that shareholders vote for two of Icahn’s four nominee directors. Should Icahn prove successful in obtaining Board representation, any subsequent corporate transaction could potentially allow Elan to crystallise value on Tysabri, via sale or renegotiation of its stake.

Equities

• European stocks are soft out of the gate with banks (Barclays (BCS) and Deutsche Bank (DB) among others) suffering.
• Miners Anglo American (AAUK) & BHP Billiton (BHP) are also reverberating as copper prices are down.
• German semiconductor maker Infineon (IFX) is weaker on stories that it has asked the German Federal government for loan guarantees.
• Meanwhile Europe’s largest publicly traded hedge fund The Man Group is down sharply on a 43% profit decline and a decline of 1/3 in assets under management.
• Also suffering is heating and plumbing supplier Wolseley (WOS) whose pretax profits have fallen 80%.

Another biggie hedge fund bites the dust.

So, Can the Fed Stop the Bleeding?
The surge in mortgage rates will upset the Fed, which has placed mortgage rates at the centre of its credit easing strategy (the FOMC raised on 18 March purchases of agency mortgage bonds by $750Bn to $1.25Tn.).

It is imperative that the housing market has to stabilise, if the financial industry - and the economy - is not to fall further into the mire. Yet the fall in house prices shows no sign of slowing if the Case-Schiller report earlier this week is to be believed . That makes this surge in mortgage rates all the more unwelcome.

So what can the Fed do? It can place stories in the press. Today we read “Fed May Buy More Assets to Prevent Balance Sheet From Shrinking”. A somewhat
surprising angle, as the market increasingly believes that the Fed’s balance sheet could be source of inflation.

Indeed chat in the market yesterday was blaming the Fed for the sell-off given a “lack of Fed participation on the buyside in mortgages”. Talk like this contributed to the MBS sell-off. And even if there are widespread fears that the Fed’s buying is overextended. There are schizophrenic markets at the moment, it seems.

The Fed’s decision to purchase Treasury securities seems to have led many investors to think that inflation has already been preferred to higher taxes.

Yet the plan to purchase $300bn of Treasuries (of which about $105bn have
already been bought) just merely takes the size of the Fed’s portfolio of US government securities back to where it was before the crisis ($775bn vs. $790bn
in July 2007). As a consequence, do not be surprised to see Fed officials trying to correct fears of monetisation in the near future.
Such views certainly do need to be countered. The Fed cannot stay silent for long about the talk of Quantitative Easing endangering the long-term inflation outlook.

The 30 year TIPS break even has increased to 237bp. That level is still acceptable by historical and the Fed’s standards. However it is the highest level seen since last summer, before the fall of Lehman Brothers.

So the Fed needs to reaffirm strongly its anti-inflation commitment (on the lines of Fisher this week in the WSJ). And the Fed needs to provide a more credible plan for its exit strategy. One possibility is a conditional commitment on the size of its balance sheet (e.g. link a winding down of the balance sheet once unemployment stabilises).

Data Ahead Today
Euro area economic confidence, May (10:00). All times UK. Sentiment should tick up to 68.2 (consensus: 69). Consumer confidence should rise to -30 and industrial confidence should increase to -33.

US durable goods orders, Apr (13:30): I expect orders to shrink by a further 0.8% (the market expects a 0.5% rise).

US new home sales, Apr (15:00 ): The jury is still out on whether sales are improving and we expect broadly no change at 350K.

Earnings to watch for today include Costco (COST) ($0.53), Dell (DELL) ($0.23) & Novell (NOVL) ($0.06)

And Finally
Worth watching.

Disclosures: None

Comments

[doubleguns:]

Japanese 10 trillion yen stock purchase on hold...yea right for how long!! Take notice if you thought our govt was not involved in our market. The Japanese always copy America.

Plunge protection team is THE reason for this rally we HAD!!!

Sign of car over clift should have congress with big smiles on board still professing green shoots. Barney Frank as driver!!!

Guess that toilet paper roll is not in the crystal ball much longer. Coming to an economy near you!!

As the dollar value plunges any demand destruction in oil and other commodities is not going to be evident to Americans.

If you are planning a refi on your house better get with it now. Of course that is going to get everyone screaming green shoots again.

24 freaking percent potential credit card default. Holy $hit bat man. That can't be good fertilizer for green shoots.

Looks like we are stuck half way down between a cliff and a rocky bottom.

May 28 07:34 AM

[TeresaE:]

JP Morgan, while raising interest rates to 39% for PAYING customers, announces *shock* 24% default rates.

You think?

Triple my payment and don't take anything off the principal, throw in a layoff or salary cut and it shouldn't take a genius to figure out WHY the defaults are so high.

If the banks were working WITH the economy, instead of sucking every available non-necessary dollar FROM the economy, might be leading us to a semi-recovery.

Instead, they are fueling the coming crisis.

May 28 08:21 AM

[LKofScotland:]

Coming crisis TeresaE? It's bungle in the jungle time . As Jethro Tull said, "well that's all right by me." And it's only a "mistake if we disagree."

May 28 12:41 PM

[sandspider:]

The choices for the bandits should be they can do the honorable thing and "Jump" out the window. Or we can buy some rope and do it the old fashion way. Never seen so many criminals running around free to continue their destruction and plundering and folks say it is okay? It will not be okay until the criminals are twisting slowly in the wind.

May 28 02:19 PM

[TeresaE:]

I firmly believe we ain't seen nothing yet.

Not even close.

We will fondly look back at these months as the "good times".


On May 28 12:41 PM LKofScotland wrote:

> Coming crisis TeresaE? It's bungle in the jungle time . As Jethro
> Tull said, "well that's all right by me." And it's only a "mistake
> if we disagree."

May 28 05:37 PM