C.M.O. 12.5.2011

Agreeing to work towards an agreement is not the same as agreeing to agree and both of those are very far away from actually agreeing but it was considered a good first step by the markets this past week when the Fed along with the ECB, BOE, SNB, BOJ and BAC eased the terms of the dollar-swap lines between the central banks just named.  For the record the World Bank recently put global GDP at $63 trillion of which $40 or so trillion or 65% comes from the economies represented by these same central banks.

The actual agreement, in which Germany would like to have a mechanism to ensure budgetary discipline and France becoming more willing to go along with anything that allows it to keep its AAA sovereign debt rating, would amount to what Mario Draghi, the freshly minted head of the ECB, called a “fiscal compact”.  Mr. Sarkozy indicated his shift in stance while speaking to supporters in Toulon this past week saying, “There cannot be a single currency without economic convergence.  Or the euro zone will explode.”  I’m not sure whether implode might have been the better word to use there but it doesn’t change the sentiment.

Mr. Draghi has indicated that should this compact become concurrence the ECB might be inclined to increase the bank’s bond buying.  This should, ceteris paribus, go a long way to reducing the yields on Spanish and Italian sovereign paper.

Proving that not only can they not get along with themselves but appear more and more not to be able to play nice in anyone’s sandbox, the U.S. Congress has already threatened to stand athwart one of the proposals being bandied about which would include the ECB putting around $270BN in the hands of the IMF, of which the U.S. is already the largest contributor at around 17%, for eventual disbursement to the EU’s economically precarious.  It’s not that our boys and girls in D.C. don’t like deficits; nor do they mind the fleecing of the American public, it’s just that they want that money used to buy votes right here at home.

All of this agreeing to agree to agree is supposed to come to a head on December 9th when the EU summits once again.  The frequency of which would make even Edmund Hillary jealous.  Dario Perkins, director of global economics at Lombard Street Research in London, believes the sentiment might improve at that meeting but the tension is here to stay.  “I still have major doubts about what genuine commitments we will get next week”, he was quoted as saying.  Stephan Massocca, a fund manager at Wedbush Equities Management spoke from a similar standpoint when he said, “liquidity is the symptom and the disease is solvency for some countries”.  On the liquidity front the ECB is expected to cut its benchmark rate by 25bps to 1% on December 8th.  The day before the EU leaders gather.

Seemingly insulated, until now, from all of the furor around it; Germany is starting to feel the heat as the yield on the 10-year Bund exceeded that of the British Gilt of the same maturity this past week.  One cause of the uptick in rates could be that the Bundesbank’s leverage ratio now stands at 153:1 versus 75:1 in pre-apocalypse 2007.  Likewise the Bundesbank’s exposure to the ECB’s discount window has ballooned from E84BN in late 2007 to E462BN at the end of September.  It is maybe not surprising then that Gilts have returned 15% in U.S. dollar terms in 2011 while Bunds have returned 6.8%.

Helping to add fuel to the rally fire was news that the PBOC reduced reserve requirements by 50bps effective today, December 5th, and that Brazil announced a fiscal stimulus package which will include a number of tax breaks focused on increasing domestic demand.  “We won’t allow the global crisis to contaminate the Brazilian economy,” Guido Mantega, Brazilian Finance Minister said.

As a result of all of the international good cheer the DJIA was up 7.01% last week, the largest percentage gain since July 2009 while the 787.64 point gain was the biggest since October of 2008.  Jonathan Golub, chief U.S. equity strategist at UBS AG, characterized the week’s move thusly, “The closer you are to the precipice, the more the market rallies when you get good news.”  But it would appear Jon’s not wearing his rose colored glasses as he continued, “There is a relatively large disconnect between the level of strain in the equity markets and the level of strain in the fixed income markets.  Normally, you’d want these things to be in sync with each other, and as an equity guy, you’re always worried the bond guys are right.”

There is much to be cautious about but the strength of Black Friday and Cyber Monday sales shows some resilience by the consumer and a report that U.S. auto sales hit a 13.6MM  annual pace in November, the strongest in two years, adds some credibility to it.  Especially when one considers that sales of SUV’s topped cars at many auto makers.  Ford Motor Company (F) saw the most drastic difference as cars sales were down 9% while trucks were up 26%.  Sales were up 13% overall for the month at Ford.  Industry wide the average cost of a vehicle sold rose 4% last month to $30,317.

Higher stock prices, a healthy consumer appetite and folks still smoking their “hopium” for a deal from Punch and Judy as Nicolas Sarkozy and Angela Merkel have come to be affectionately known.  It could be the right recipe for a robust Holiday season and that euphemism known as the “Santa Claus” rally.

Speaking of smoking, a quick aside before I let you go.  A working paper published by D. Mark Anderson and Daniel I. Rees for the Institute for the Study of Labor in November found that the fifteen states and the District of Columbia that have passed medical marijuana laws since 1996 have seen a 9% reduction in overall traffic fatalities.  The reason the paper finds was a drop in alcohol related traffic deaths.  Put that in your pipe and smoke it.

Enjoy the week.

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