Friday, May 1, 2009

Morning Update/ Market Thread 5/1

Good Morning,

Futures are up slightly after climbing slowly overnight (now down as I post):

Long bonds are getting slammed again, and the dollar is up slightly with gold down again. I hope everyone’s paying attention to the bond market, this is a very significant breakdown, one that has to have Bernanke’s attention, I know it has the rest of the world’s attention as rates are going higher:

World Bank Bonds Show What Happens When Governments Rush Rescue

By Gabrielle Coppola

May 1 (Bloomberg) -- Federal guarantees by 13 countries on more than $400 billion of financial company bonds are punishing the AAA-rated World Bank Group with record borrowing costs -- an indication of what can go wrong when government gets in the way.

The Washington-based World Bank, founded in 1944 to rebuild economies after World War II, sold $6 billion of three-year notes March 26 priced to yield 30 basis points more than the benchmark for such borrowings. The so-called spread was the widest for a dollar-denominated bond offering by the supranational lender, said George Richardson, the institution’s head of capital markets, in an interview.

Just seven months ago, the World Bank paid a record low 35 basis points less than the midswap rate, a market measure for exchanging fixed- and floating-rate cash flows. The sudden rise in World Bank relative bond yields is an unintended consequence of sales of taxpayer-backed debt by more than 50 companies, including Goldman Sachs Group Inc., Bank of America Corp. and JPMorgan Chase & Co. While these special offerings were designed to bring stability to the credit markets after $1.4 trillion in losses and writedowns in the past 28 months, no one realized the World Bank would be depreciated by such government policies.

“Governments started announcing guarantees for their banks, and then the whole world changed,” said Richardson, a former Goldman Sachs banker.

Rising Sales
Rising risk premiums are also affecting the Washington- based Inter-American Development Bank, which lends to Latin American and Caribbean countries, and Germany’s state-owned Kreditanstalt fuer Wiederaufbau, whose credit supports housing, education and small business.

Banks and financial companies worldwide sold 320 billion euros ($424 billion) of state-guaranteed debt since October, denominated in euros, dollars and U.K. pounds, according to Leef Dierks, a fixed-income analyst at Barclays Capital in Frankfurt.

They may issue a total of 900 billion euros in bonds for all of 2009, Dierks said.

The total includes $235 billion of dollar-denominated debt in the U.S. with backing from the Federal Deposit Insurance Corp. as of yesterday, according to data compiled by Bloomberg.

Lenders backed by multiple governments, known as supranationals, have the flexibility to borrow billions in multiple currencies and at any part of the yield curve, making their bonds among the most liquid securities.

Financial Acumen
The financial acumen of the World Bank, which pioneered the first use of derivatives to obtain Swiss francs and German marks by exchanging cash flows with International Business Machines Corp. in 1981, hasn’t protected the institution from widening borrowing spreads.

Average yields relative to midswap rates on dollar- denominated supranational debt rose to 164.4 basis points, as of yesterday, from 46.8 basis points at the start of October, according to the Credit Suisse Liquid U.S. Corporate Sovereign Spread Over Swap index.

The midswap index, which contains bonds sold by the World Bank and the IADB, reached a record-high of 217.4 basis points on Jan. 2, Credit Suisse data show. A basis point is 0.01 percentage point.

A benchmark for borrowers, the midswap index lies between the bid and asking yields on contracts exchanging fixed for floating interest-rate cash flows.

Double Borrowings
The World Bank, which now finances AIDS prevention in Botswana, will more than double borrowings to as much as $35 billion this year to help provide food, health and education services through the International Bank for Reconstruction and Development, Richardson said.

Robert Zoellick, the bank’s president, recently announced plans for $100 billion of new loans over the next three years to relieve the recession. The lender issued $1.5 billion of five- year notes on Oct. 1 at 35 basis points below the midswap rate, a record low for that maturity, according to Richardson.

The International Monetary Fund, a Washington-based agency of the United Nations that monitors the global economy, may sell its first bonds to China and Brazil to raise money to combat the downturn. IADB borrowings will total $15 billion to $20 billion this year, up from $6 billion to $7 billion in 2007 and $11 billion in 2008, said Soren Elbech, the bank’s treasurer.

While development lenders’ spreads more than tripled since October, the yield premiums on World Bank and other supranationals’ bonds have narrowed since their sale as corporate credit markets begin to heal.

Passed On
The three-year notes sold by the World Bank on March 26 rose to 100.4 cents on the dollar as of yesterday to yield 50.8 basis points more than Treasuries, according to Bloomberg data. That’s down from 82.2 basis points when they were issued.

Increased financing costs are being passed to borrowers, according to Horst Seissinger, head of debt capital markets at Frankfurt-based KfW, which has a direct guarantee from the German government.

Well, that’s what happens (higher yields) when one stimulates every aspect of the world’s economy and guarantees every corporation on the planet then issues complex and opaque instruments in an attempt to squeeze ever increasing amounts of debt into the system.

I got a good chuckle this morning reading about the new government plan to provide “cash for your clunker.” I started thinking about my young son, just about to exit high school and how attractive it might be to be paid more than his paid for old car is worth as an incentive to buy a new one. Of course it is being sold as a pollution solver, but the truth is that if he were to do that, he would go from being free of debt to being a debt slave, all sponsored by the fine people of your government.

And the Senate just yesterday voted down a provision that would have let bankruptcy judges modify loan agreements for individuals filing bankruptcy and at risk of losing their homes. It’s a rule of law thing they said. Of course the rule of law only applies to ordinary citizens, evidently, and not to corporations. See, that’s the current problem. It’s not that there aren’t laws, it’s that the laws are blatantly being applied unequally and every decision favors corporations. I wish the rule of law applied to everyone equally, and especially to the banks and politicians. Armstrong is correct in that capital formation is much more difficult when it is perceived that there is no rule of law.

And the bankers argue over the “stress test” results and decide to delay their release so that they can massage and manipulate the wording just right. You see, the porridge must be neither too hot nor too cold for little miss market, she couldn’t handle the truth, and that certainly isn’t the point.

And speaking of rule of law, the administration finally allowed an automaker to enter bankruptcy. Congratulations. Notice how through all the hoopla the President and no one mentioned the fact that all the plants would be shut down immediately. No, he was touting how many jobs he was saving.

Let me ask you this… when was the last time America produced a major new auto manufacturer? Not in your lifetime? Why is that? Why are new manufacturers springing up in places like Korea and China, but not here?

I would contend that it’s for the very moral hazard reasons that are occurring now. Namely, the big corporations run the government. Chrysler should have been allowed to fold decades ago. They are now a two time loser and keeping them around may just net the world another K-car piece of crap, but it won’t net you new and exciting innovative products that are made in America. No, it will net you an indebted nation, one that cannot possible pay its bills and it will net you lazy and complacent management and a hammered down middle-class.

This is not the end of our problems in America people, they are truly just beginning.

In regards to the rest of the news, most of it is just a distraction. I’m going to say this to all those who follow my writing, it is now time to exit the market again. The risk of holding equities is too high. Yesterday’s 888 top may be a top that holds. If it doesn’t, the upside potential here is limited.

And as I’ve been typing the futures turned slightly negative. Keep in mind that at some point today the short term stochastics are going to reach oversold… there’s a key uptrend line to watch at about SPX 866. Below that is bearish.

Have a great day,