C.M.O. 8.22.2011

Were Hunter S. Thompson alive today I’m not sure if he would title his next book “Fear and Loathing on Wall St.”, “Main Street” or maybe “The World” as the degree with which the fearful are loathing risk these seems truly global.

Bill Gross, co-CIO of PimCo, has to be loathing his March decision to sell Treasuries as the yield on the 10-year note broke through the 2% level on Thursday to a low of 1.974%.  “The problems that drove us to lower yields are still here.  The economy is slowing nut just in the U.S. but also globally, and the euro-zone debt problems are not getting better”, was how Mary Ann Hurley, VP of Trading at D.A. Davidson in Seattle described it.  David Rosenberg, chief economist at Gluskin Sheff & Associates, thinks it’s not over yet as “the macro landscape as it stands today coupled with the Federal Reserve’s pledge to keep rates where they are through mid-2013 suggests we could bottom somewhere between 1.25%-1.50% range.”  I’m sure that’s making Gross grouse.

The impetus behind Bill’s bond bail was the thought that with Ben’s bid to keep rates low, inflation was sure to follow and given that long rates are primarily short rates plus inflation expectations the resulting higher rates would reduce bond prices.

Unfortunately, Bill was wrong for the right reason as the Consumer Price Index figures released Thursday showed a 0.5% jump in July equating to a 3.6% YoY increase.  Well above Ben’s behest of 2.0%.  “There’s more inflation that the Fed has been expecting.  That’s got to come off for them to take a lot more comfort in the inflation data”, said UBS economist Drew Matus.

The price increases are not just on the consumer side as the Producer Price Index also climbed a seasonally adjusted 0.2% in July after a 0.4% fall in June.  “There is clear evidence in this report of growing pipeline pressures more broadly, with gains in passenger cars, men’s apparel, furnishings and pharmaceuticals”, said Peter Newland, a senior economist with Barclays Capital.

It would appear that Mother Nature is also contributing to the price pressures as a prolonged drought and wild fires have scorched about 118,000 acres of privately owned timberland across southeast Georgia since March of this year and destroyed a total of about 306,000 acres in total between January and June resulting in a rise to $8-$9 a ton for younger timber that is used by pulp and paper mills.  Timber prices are up about 20% since 2006.

That same southeast heat has affected another major crop from that region, rice.  July futures at the CBOT hit 3-year highs this week and “a poor fall harvest in the U.S. and continued constraints on Asian exports have analysts predicting the rice prices could climb an additional 15%” according to Tom Plansek in Barron’s this week.  “There’s definitely a chance to run to $20 and maybe a little higher”, Jack Scoville, VP with Price Futures Group said.  The September futures contract for Rough Rice closed Friday at $16.745 per 100 pounds at the CBOT.

The other thing that won’t stop rising are rates on European sovereign debt.  Barry Norris, a fund manager at London-based European equity specialist Argonaut Capital said, “There seems a distinct lack of leadership in trying to resolve the issues of the sovereign crisis both in terms of euro-zone politicians and ECB officials.”

A few weeks ago I noted that 129 U.S. companies had cheaper credit protection than Uncle Sam.  In truly global fashion there are now 125 European companies with CDS spreads lower than France, the world’s 5th largest economy.  The cost of protection against a France default has risen 8% in August alone as the proposal by Mr. Sarkozy and Ms. Merkel announced last Tuesday did little to assuage investor’s fears that they have the political guts to do what needs to be done to stop the spreading contagion of lack of confidence.

Instead of announcing, as the market had hoped, that the Eurozone would issue “Eurobonds” and thus create a collective liability across the region the President of France and Chancellor of Germany proposed with holding access to billions of Euros in EU funds as a key stick to keep euro-zone country’s spending in line.  “In the future, payments from structural and cohesion funds would have to be suspended for euro-zone countries that do not follow recommendations of excessive deficit procedure.”  Kind of like telling a person that is having a heart attack that they need to change their diet.

Finland took matters into its own hands as it requested E500MM in collateral from Greece in order for the Nordic country to make good on its pledge to contribute to the Hellenic hand out.  Needless to say this did not go over well with the other contributors and could threaten the whole package.

All this while analysts extended the length which they believe Greece’s recession will last.  “I am absolutely convinced we are headed for further recession in 2012”, said George Kyrtsos, a political commentator for the City Press newspaper.  He continued, “As such, it is a mathematical certainty that the budget deficit will increase next year, while just to keep our debt dynamics stable, Greece needs to have growth of at least 3.5%-4.0%.”  The IMF, European Commission and the ECB recently announced that they believe Greece’s E325BN a year economy will grow at an annual pace of about 0.6% in 2012.

One thing is for sure, if Hunter S. Thompson were alive today there would be no shortage of subject matter for his “Fear and Loathing”.

Enjoy the week.

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