I don’t think there is much doubt what is moving stocks higher right now. The run-up at the end of last week was touched off by Mario Draghi’s comments about unlimited monetary easing, persisting through what was at best a lackluster, though completely unsurprising, US GDP report. Perhaps stock investors were relieved that GDP was not worse, but there was not much there to provide optimism on the scale that we saw last week in stocks.
Earnings continue to “beat” estimates, but as Citigroup notes (courtesy of ZeroHedge),
“Undoubtedly, part of the reason that Spain and Greece have come back into focus is that the earnings of US companies continue to be so uneven. With more than half of S&P500 companies having reported, we’re only now starting to get the full picture, and viewed from the top down perspective it’s far less pretty than even last week led us to believe. Relative to expectations, top line revenues have been especially weak, with nearly all sectors surprising to the downside, even as EPS and EBITDA have tended to beat.” [emphasis added by JPS]
At least in 2011 there was the Japanese earthquake and tsunami that presented a challenge to analysts. No such bad luck in 2012. And as Citigroup notes, revenues have been the weakest link in the micro chain so far in Q2.
Joining global stocks, Spain’s sovereign issues have compressed in quite a volatile few days. The 2-year note, after touching 7% early last week, finds itself trading all the way below 5% today. That’s one hell of a volatile swing, but only bringing the 2-year back to its July 18 yield. So, which move was the outlier? Was it the fear-trade that flattened the Spanish curve almost to inversion, or was it the ECB’s threat to restart the SMP’s?
We know these rallies have not extended beyond markets most susceptible to central bank threats and interventions. The Swiss 2-year, in contrast, is only a few basis points above its record low. The German 2-year was bought heavily today, breaking through its record low to yield below minus 8 basis points. Ditto for Finland and Denmark. US Treasuries, for their part, sold off last week but have rallied back a bit so far today to remain only spitting distance from last week’s record lows.
Certainly some of the GDP “relief” luster was removed by this morning’s Dallas Fed survey, but even its contraction was relatively predictable given large-scale drops seen in the Philly and Richmond reports. The Dallas survey was simply confirmation of 1. that weakness has been very sharp and quick, the current business activity index fell 19 points in July alone; and 2. manufacturing weakness is widespread and not localized by region or industry.
Maybe stocks and certain credit markets really are disjointed now. It is absolutely possible for different markets to operate under different constraints at the same time, but the key to correlation is always money. Specifically, interbank markets are the skeletal structure of the whole financial system. Interbank stress can and does appear unevenly, so these disjointed results across different markets may not be all that remarkable given the high degree of “uncertainty” over threats of monetization. But that is only true so far as interbank “stress” is an ephemeral threat or concern. Real liquidity, or illiquidity is it may be, increases correlations like no other factor in the financial world. If there was an antidote to the Bernanke Put it is two words – DOLLAR SHORTAGE.
For the most part, the financial system in 2012 has been the breakdown of euro dispersions across the various regions. Not since the end of 2011 have we seen the dollar shortage make an unwelcome appearance. For the most part, the volume in the Fed’s dollar swap lines has been relatively tame. However, that may be changing.
Since early June, new borrowings of dollar swaps have outpaced maturities by a slight, but noticeable amount. Late last week, the volume of 7-day operations doubled to $8 billion – all of it with the ECB (this has not yet been posted to the FRBNY dataset yet, the ECB updates before the Federal Reserve System). The amounts are certainly not large enough to discern anything terrible apace in interbank markets, but the rising trend given the relative calm in dollar markets this year warrants careful attention. In a fully functioning dollar system, these swap arrangement should be $0. That they are over $31 billion still outstanding (mostly at 84-day maturities), especially since those are US dollars that are being swapped and collateralized at penalty rates, should capture the attention of US dollar markets to a far greater degree.
According to the ECB, 10 banks bid for that $8 billion in 7-day dollars. On a micro level, those are very significant amounts. It may only be 10 banks, but in the daisy chain of interbank liquidity and rehypothecation, 10 banks of sufficient scale can begin to shake loose weaker firms down the line.
Stocks are moving one way. The Paris CAC, for example, is up nearly 10% since the middle of trading on Thursday, which coincides with zero real economy reports or releases. Other markets move the opposite. It will be interesting to see how long this disharmony can be maintained before some kind of convergence takes place, and, of course, what form of convergence will ultimately play out. In any event, however some kind of harmony is restored it will be nice to get back to a form of investing that is not some distorted analysis of how and when and why some central bank may or may not do something. Unfortunately, that may be more far-fetched than believing dollar swaps will actually get back to zero.