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Frying Pan Into The Fire

Intro by Lee Adler of the Wall Street Examiner 

I was almost dumbfounded yesterday when the market seemed to put a huge exclamation point on a thought I had written in Tuesday night's  Professional Edition market update. 

The 6-7 week cycle low was overdue and this looks like the onset of what should be a brief up phase. The 4 week cycle has turned up. Time wise both are theoretically due to be in up phases for at least a few days, but with no indications yet of how far they will get. However, this market may be unusually subject to influences that have nothing to do with cyclical rhythms. In addition, the cyclical structures are, shall we say, "highly flexible" at the moment. It reduces us to following the indicators one day at a time, and even that period may not be short enough. If you are not trading futures on a 24 hour basis on bars of not more than 30 minutes, you stand to miss out, or get run over given how frequently large changes of direction occur overnight in response to events elsewhere around the world.

I wrote that just hours before any of the news of the central bank actions hit the tape.

Meanwhile, Russ Winter has a post up on his thoughts about the implications of yesterday's central bank interference in the market. I won't call it an intervention. That word implies legitimacy. The constant manipulation of the markets by the Fed in particular is anything but legitimate, in my view. 

Frying Pan into the Fire

Courtesy of Russ Winter of Winter Watch at Wall Street Examiner  

The latest central-banks-can-save-the-world rally was astonishing. All I can say is if, and when, it fails, perhaps once and for all this crackpot approach to speculation can go into the dust bin. Right now it seems to transcend everything including actual solvency. As I’ve said, this rally doesn’t have many shorts to squeeze, and as of now even less. There is zero public interest in stocks (14 weeks in a row of outflows) and far too much interest in bogus AAA Treasuries and in munis. To me, it is unclear who ramps these stocks, but it is not a free trading market.

It is also clear there is a collateral problem globally. There just aren’t that many high quality sovereigns left, and several of the key ones such as France and the US are up next for more downgrades. The central banks are already stuffed to the gills with dicey securities and dicey collateral backing credit extensions.  I submit that they have large losses on the books. Those portfolio losses are in turn borne by the sovereign states. There was a rumor before the ramp that a large European bank (or several) was failing. And if it were one or more of the following French suspects, what does that do for French sovereigns?

Source: Hugo Petersen

The problem is insolvency, and if the markets will only partially accept collateral on a large issuer such Italian government debt, that leaves an immense hole to fill. And when France is soon downgraded, which the only legitimate credit agency, Egan Jones, has already done (to A), then there will be another immense collateral hole. The CDS implied rating for France is BAA3, nine notches lower, suggesting a series of downgrades. Others are similar.

If the idea behind the central bank move is to temporarily stick save French banks (and others in the daisy chain, including the US), those central banks should be prepared for more huge portfolio losses. Egan Jones describes France’s problem.

Disastrous trend and the worst has yet to come. Over the past two fiscal years, the Republic of France’s debt has grown by 21% from EUR1.32 trillion to EUR1.59 trillion. Meanwhile, FYE GDP declined slightly from EUR2.13 trillion as of 2008 to EUR1.93 trillion as of 2010. As a result, debt to GDP rose from 61.8% in 2008 to 82.5% in 2010 and is near 90% currently. An item which is hard to quantify but is a growing concern is the health of France’s banks; the assets of the three largest banks equal 240% of France’s GDP. Given France’s propensity for supporting its banks, France might soon be confronting a substantial additional liability.

Obviously as a result, institutions globally have fled and have piled into phony AAA havens, specifically the US and UK, inflating those Treasury markets. The swap in my view opens up those inflated UK, US and Japanese collateral to use in lieu of tainted European issues. The problem with that is that the UK, US and Japan are up next. The value of that collateral will be diminished in the same manner as seen in Europe. Viewed this way, one can see this is not a rescue, but merely going from the frying pan into the fire by funding bad trades with impunity.

On a housekeeping note I am actively tweeting now, so if you prefer that method, use russwinter1. 

This post is reprinted from Russ’s premium service, Russ Winter’s Actionable. Click here for information.