The T Report: Today’s Debate Brought to You by the Letter E

Posted by on Oct 16, 2012 in Uncategorized | No Comments


ESM is finally up and running. It starts with €32 billion of paid-in capital. This money will be invested in short term, highly rated debt. So far it the story is they are buying EIB and KFW bonds.

The ESM should now be able to borrow as much as €213 billion (paid-in capital is required to be 15% of total borrowings). EFSF has €146 billion of public debt outstanding.

So in theory the ESM can perform its functions. There was a long list of activities the ESM could perform, so now it is time to see what they do. ESM bonds will likely trade better than EFSF bonds because of the sliver of paid-in capital.

At one extreme we will hear the chorus of naysayers screaming that this is more debt on top of more debt. It isn’t. At the other extreme, we will listen to bulls saying that this is enough to get Europe through the crisis. It isn’t.

Much of the ESM will be “replacement” financing. Money that Spain or Italy would borrow from the market will now be borrowed by the ESM and it will lend to Spain or Italy. That is just a shift in risk. It doesn’t change the amount of debt outstanding it just shifts it from a weak single obligor, to a new entity. As countries issue more debt because of their ever growing deficits, it is “new” debt, but it is wrong to double count ESM debt and the debt they wind up buying (whether in the primary or secondary market).

ESM, in theory, will have conditionality imposed on any lending. Each deal needs to be approved. Support to a country could be withheld. This is Greece all over again. Money will be made available. Each installment is likely to come with its own set of complex negotiations – none of which are really truly based on good financial practice. Countries will constantly get a little bit of money, do better, deteriorate, ask for more, face new demands from the lenders, and finally get another commitment, letting the cycle repeat.

We are popping on some headlines about the possibility of an ESM credit line for Spain. How that is surprising at this stage is confusing to me, but I continue to believe that limited support for Spain is largely priced in and there is little current upside left, while the downside from a weak program or further delays is more meaningful.


Ultimately, employment will be the key to the economy and to the markets. Europe is still on a negative trajectory. Nothing about any current programs there seem to be helping employment, so how the markets or economies can improve is beyond me.

Here in the U.S. we are either experiencing a massive surge in the job market or we are getting some bizarre data. In all likelihood it is a mixture of both.

The NFP report itself was marginal at best, but the household numbers were great. Looking at 3 month totals for NFP, Household, and ADP brings everything more in line. The result is okay, but not stellar job growth.

Last week’s unemployment claims were extremely low. A significant and healthy drop, but lots of questions being asked about quarter end effects. Allegedly one state didn’t properly adjust for the quarter end. Allegedly that isn’t the case. I suspect the data wasn’t as good as the initial headline. We will see over time, but with so many adjustments to account for seasonality, I’m just not convinced we do it “correctly”. The job market has remained a structural mess for so long, it is hard to believe seasonal patterns hold as strongly as they once did, and having an election that is spending record amounts also seems likely to give the economy a one time, short lived boost.

With QE now closely tied to employment levels this data will become trickier to read over time. For now, with inflation relatively tame, there is a lot of room from employment gains and QE can remain on the table. With any strong hint of inflation coupled with the improved unemployment rate, we might see pressure to back off the QE forever model.


This remains a wildcard. Volatility has increased. It isn’t as high as it was back in July, but much higher than when we had the sustained march higher in stocks from mid August until QE day.

Gasoline remains uncomfortably expensive.

Tensions in the Middle East remain high.

If there is one obvious area that would derail any economic gains and thwart the efforts of Bernanke to use QE, it will be this sector.

I don’t have a strong opinion here. With QE unable to do much for the real economy, I don’t expect to see demand pick-up so I don’t see any great inflationary pressures. With many investors having piled into commodities on fears that QE would cause great inflation there are a lot of longs that need to be shaken out of the market. So if anything, away from real economic growth or problems in the Middle East, energy prices should remain in control.

Demand and Illiquidity – May the Two Never Meet

It seems clear that in virtually every market, there is no or limited liquidity. Fortunately there has been almost no demand by either buyers or sellers. It seems that most investors have the positions they want and there is no real desire to change that positioning significantly.

That is great news, because if there was a real shift in demand, I think we could see a large move. I believe the move to the downside would be larger than that to the upside, but either could happen. There just isn’t real liquidity. The S&P was a great case study. It moved down about ½% then went to plus ½% then back down to -1/2% to finish up almost 1%. That reasonably large volatility was on relatively low volume (even by our much lowered volume standards).

It is worth watching.

I am back to being fully bearish here on the strength we have seen since 11am yesterday.