Market Talk

Oh no they didn’t.

Yes, they did. FOMC meeting minutes say: “Stresses in European financial markets remained broadly contained but bore watching going forward.”

Contained? Uh oh, there’s that word again.

“Contained” has popped up a couple times in meeting minutes during the past two years, in references to inflation, but we haven’t seen it in this context since the central bank’s infamous observations that the subprime mortgage turmoil looked “relatively well contained” back in 2007. Gulp.

As a refresher, here’s what the meeting minutes said back in May 2007 (italics emphasis ours):

Members continued to view the risks to economic activity as weighted to the downside, although with turmoil in the subprime market appearing to have remained relatively well contained and business spending indicators suggesting a more encouraging outlook, these downside risks were judged to have diminished slightly.

Not hard to understand why we flinch when we see/hear the Fed say things look ”contained” in reference to something in which containment is consistently a troubling question, and very far from certain.

Let’s hope Germany or France doesn’t have a leg wound like Brad Pitt had in “Seven Years in Tibet.” Oof da.

From Edward Hugh at a Fistful of Euros, a long post but worth the time if you’ve got it (hat tip naked capitalism):

According to one popular analogy currently going the rounds, the Euro Area countries could be likened to a group of 16 Alpine climbers scaling the Matterhorn who find themselves tightly roped together in appalling weather conditions. One of the climbers – Greece – has lost his footing and slipped over the edge of a dangerous precipice. As things stand, the other 15 can easily take the strain of holding the Greeks dangling, however uncomfortable it may be for them, even if they cannot quite manage to pull their colleague back up again. But as the day advances others, wearied by all the effort required, start themselves to slide. First it is Ireland who moves closest to the edge, and gets nearer the abysss with each passing moment. But just behind comes Portugal, while some way further back Spain lies Spain, busily consoling itself that it is in no way as badly off as the others. But if all three finally go over, dragged down by the weight of those who precede them, then this will leave 12 countries supporting four, something that the May bailout package only anticipated as a worst-case scenario. In the event that this is finally what happens, Mr Reglin will find he has plenty of work to do, as will Mr Trichet’s successor at the ECB. In the meantime all the rest of us can do is wait and hope, firm in the knowledge that having come this far, we can only go forward, since there is no easy way back down to the point from which we started. But for heavens sake, the only thing we don’t need to be told at this point is that the danger has already past, even as we slide, inch by inch, onwards and downwards.

So which one of you beauties will be first to "restructure"?

“As the summer draws to a close, it is becoming increasingly clear that neither the European sovereign debt crisis nor the banking sector crisis has been resolved,” Morgan Stanley economist Joachim Fels writes.

So far, it seems the euro and the single currency’s frequent escort, US stocks, haven’t received that memo yet. They show no signs of the turbulence ignited by the last flare-up in May. But that probably won’t last.

“The sovereign and banking crises continue to mutually reinforce each other because governments need to backstop banks, while banks own large amounts of peripheral government bonds,” Fels writes. “So, not much has changed since we last described (in June) this vicious circle, called for a circuit-breaker, and concluded that the obstacles to a real solution of the banking and sovereign crisis were formidable,” he says.

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Irish eyes are not smiling this morning.

So equities traders here in the old USA aren’t worried about European debt today, it seems judging by stock futures, whereas yesterday they were all in a tizzy about it. Does that make sense? No, it doesn’t, so you should ignore the stock moves (unless, of course, you’re actively trading, in which case, all that matters are the numbers,) and focus on, you know, the news. And the news is still coming out of Europe.

The cost of credit default swaps on Irish debt hit a record today on increasing worries over the state of Irish banks. This after the government extended its blanket guarantee of private banking debt (was supposed to run out the end of this month, now they’re extending it to the end of the year. Just seems like nobody can get those exit strategies kicking in, can they?)

Neil Shah reports over at MarketBeat:

Ireland, which is grappling with an increasingly costly bailout for troubled lender Anglo Irish Bank, isn’t alone. Concerns about the health of Europe’s banking system have unleashed a wave of risk aversion that is engulfing other countries on Europe’s fringe too. Portugal’s credit-insurance costs have jumped to $342,000 from $330,000, while Greece’s costs have hit $916,000 from $895,000.

It’s not just Irish CDS, either. Spreads on bond yields between Germany and some of the so-called periphery countries are rising. The spread between Greek bonds and German bonds is at a four-month high of 948 basis points, very close to the record 973 it was sitting at before the Europeans unveiled their grand bailout plan.

That tells you that despite the near trillion dollar safety net the Europeans threw at their collective economies, investors are still worried. It’s not at panic levels, but beads of sweat of forming on the collective European brow.

This is definitely a risk on/risk off market. US stocks fall as the risk trade abruptly turns off, after the old fears over Europe reignite.

DJIA loses 107 (1%) to 10341, S&P 500 falls 13 (1.2%) to 1092, Nasdaq Comp drops 25 (1.1%) to 2209. NYSE volume is very low, so it’s hard to draw any real conclusions. But while stocks fall, gold hits fresh record high. The euro fell almost a whole two cents. The 10-year Treasury yield fell to 2.61%. That all ought to tell you something.

WSJ story says European banks hid sovereign-debt risk from stress tests, but who really bought those tests in the first place? Not us. Report that German manufacturing orders slipped didn’t help matters. But what really should be catching your eye is the rising costs of credit protection for both public and private debt in Europe. In some cases, they’ve gone back to the pre-bailout levels. Ireland’s hitting up its neighbors for “support” as the state-owned Anglo Irish Bank craters (I love how absolutely everybody describes the bank as “troubled.”

Um, is anybody really surprised? Surprised that Europe’s version of the Great Recession Bank White-Wash, i.e., the “stress test,” is being exposed as the Potemkin Village we all knew it was? The Journal’s David Enrich reports today that the way the tests were conducted allowed the banks to mask a substantial portion of their sovereign-debt risk (it’s still unclear just how much.) It may be a bit surprising that the truth is coming out just now, but it’s not at all surprising that it’s coming out.

The day the results came out, we wrote:

Let’s be frank: there is no way, no way, these tests were designed to rigorously test the strength of the European banking system. Like their American counterparts, the tests were rigged exercise designed to shore up public confidence. The truth never entered into the calculations, and why should it? Everybody already knows the truth. American banks failed a very real stress test in the fall of 2008, when the government had to come in and save the entire industry. European banks similarly failed their very real stress test this past spring.

The tests were a carefully orchestrated exercise designed to shore up public confidence. To that extent, they worked. Temporarily. Because the fact of the matter is that what’s happening now, the unraveling of that carefully orchestrated exercise, has the potential to be more damaging than if they had just come clean from the start if the public perceives that a fast one was pulled. Fool me once, shame on you. Fool me twice?

From Enrich’s story:

The findings undermine a primary goal of the stress tests—namely, to reassure investors and bankers world-wide the soundness of Europe’s financial system. “That would certainly be unhelpful to people’s perceptions” of the tests’ credibility, said UBS banking analyst Alastair Ryan. Reducing banks’ reported holdings of government debt “was clearly helpful for the thing [regulators] were trying to achieve: convincing you that there’s not a problem.”

You’re seeing already in the credit markets that debt insurance costs are rising, for both private and public debt. As Wolfgang Munchau notes in the Financial Times, which I saw via naked capitalism, spreads between German debt and debt for the “periphery” countries (as if they’re not really part of Europe) is rising at an “alarming rate,” going back to where it was before the big EU bailout fund was unveiled. This means, simply, people are worried. Again.

Only two?

A couple of data points highlighted today by Gluskin Sheff’s David Rosenberg that might interest you.

First, Rosenberg notes that railroad car loading have started falling from their pace earlier this year, after rising steadily through the first half of the year. This is an area we’ve been pointing to for some time, back when it was trailing the recovery, and then when it was chugging right alongside. If railroads aren’t being loaded, goods aren’t being sold.

“There has been a sudden and sharp turndown in railway car loadings in the latest data that came out for the week of June 5th,” Gluskin Sheff’s David Rosenberg points out. Lest you think this is just a bear crying wolf, weekly reports from Association of American Railroads back it up.

The trade group reported that for the week of May 27, loadings leveled off after 12 straight weeks of gains, still up 10.6% from a year ago. But for the week of June 5, they’re down 8.9% from mid April. “Remember – this metric is closely linked to the only to areas of the economy that have been major contributors to the recovery: exports and inventories.”

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Just keep playing, boys. Keep playing.

This upcoming week is going to be light on the data front in the U.S., and we’re still between earnings periods. That’s not really good for domestic investors and traders, because it means, for one thing, they won’t be able to wash out the nasty after-taste of Friday’s dour jobs report and, for another, there won’t be any big counterweight to the continued rumblings and crisis talk emanating out of Europe.

People desperately want to see the U.S. recovery gaining momentum and speed. That’s a must-have if it’s to avoid getting caught in the European storm. Friday’s report cast doubt on just how sturdy the recovery really is. But while the jobs report is the most important data point, it’s not the only one casting doubt. The Economic Cycle Research Institute’s leading indicators’ index hit a 43-week low last week. When this index was rising a year ago, everybody and their mother was touting its predictive powers. Now that it’s rolling over? Crickets.

Then there’s the not very well known Consumer Metrics Institute, which is like a quant shop for consumer data (hat tip, John Mauldin.) They’re more numbers crunchers than economists, and their growth index is pegging 3Q GDP at, hold onto your hats, a negative 2% rate. “Perhaps the U.S. equity markets should obsess less about Greece and Spain and pay more attention to what is happening with consumers in their own domestic economy,” the firm writes.

Look, everybody expected growth to slow down once the various government props were removed. We’ve warned about a contracting money supply. We’ve warned that the only wage growth was coming from tax credits. Now, the props are falling away, and the table is still wobbling.

I was a guest on The John Batchelor Show last night – DJ columnist Simon Constable hosts it every other Saturday — along with Fox’s Alix Steele and Bloomberg’s Joe Brusuelas. Toward the end of our financial roundtable, Brusuelas noted that on Friday he was watching credit default swap spreads on France, Belgium and Austria spike higher, by as much as 30%, and warned that Monday could be especially rough. Austria in particular is one to keep a close eye on; the nation’s banks are especially exposed to Hungarian debt.

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This wasn’t the story I was looking to direct you to, but it hits on a theme we’ve been harping on here at Market Talk, so I had to mark it. Perk up your ears, Mouseketeers, because you’re going to be hearing this a lot more in the next couple years.

Real Times Economics picks up on the debt theme, noting that the $13 trillion in U.S. national debt equals 88% of projected 2010 GDP (in a post earlier this week, I compared it to 2009′s GDP and arrived at 90%, but little difference; at current growth rates for both it will soon be 100% of GDP.) That puts the U.S. in a dangerous situation. From the Journal’s Mark Whitehouse:

We’re borrowing to bail out consumers who took on too much credit and couldn’t pay, and to support social-security and Medicare systems we can’t really afford. We’re able to do this because financial markets have maintained a surprising faith that we will eventually get our spending under control, and because the dollar’s role as a global reserve currency has kept our borrowing rates unusually low.

The travails of Greece demonstrate the hazard such easy borrowing terms can create. After Greece adopted the euro, markets began to treat it more like any other European economy, allowing it to borrow at interest rates nearly the same as Germany or France. That, in turn, helped Greece get into much deeper debt trouble than it would have otherwise. As a result, it now has to implement austerity measures that will likely yield much deeper economic pain.

I’ll tell you, folks, we are crossing the Rubicon. We are going to be forced into some very hard choices, choices we have been putting off for years, no matter how the economy’s doing. That’s the real takeaway here, that soon no matter how fast the economy is growing, it won’t be able to keep up with our debts.

I disagree with Mark on one point, though. I don’t think our creditors and the markets are giving the U.S. a pass because they believe the government will eventually get spending under control. There simply is zero evidence that that’s going to happen. No, the markets are giving the U.S. a pass because the thought of a sovereign debt crisis in the world’s largest economy, which prints the world’s reserve currency, and which is in times of trouble the ultimate safe haven, is simply too terrifying to even contemplate.

But you’d be wise to do so.

The most important piece of news this week wasn’t the ADP report, or the weekly jobless claims. It wasn’t the ISM’s service-sector report, or the latest updates on BP’s Gulf oil spill. It wasn’t the Gore’s split-up, or even Armando Galarraga’s stolen perfect game, and it won’t be Friday’s jobs report for May. No, the most important piece of news this week, the one that will have the most lasting impact, was this:

The national debt crossed the $13 trillion mark.

It wasn’t a surprise, of course. Anybody who walks on 45th 44th Street by Sixth Avenue has seen the big debt clock there over the IRS office. It’s been rising steadily. But crossing another milestone, and so quickly after we crossed the $12 trillion mark, really should be yet another wake-up call for the nation. You think the Macondo well’s a real gusher?

Gross domestic product in 2009 was about $14.4 trillion. That puts the national debt at roughly 90% of GDP. That’s a danger zone beyond which nations don’t generally recover. Even for the world’s largest economy, we are passing the point at which we can still earn our way out of our debt, no matter how many jobs we create.

Now, obviously, nobody but nobody wants to call the government of the United States to the mat about its debt. A sovereign debt crisis in the world’s largest by far economy would be like dropping a dozen nuclear bombs on the global economy. Nobody would recover. So expect the world to nervously play along as our duly elected leaders pretend to have a firm grasp on this problem.

But we are at the point where some painful choices are going to start forcing themselves on us (indeed, at the state level, this is already happening.) Higher taxes. Cuts in services. Cuts in benefits and entitlements. Maybe even a shrinking of the military. All the options are going to have to be on the table, because very soon, if not already, we won’t be able to just jawbone this problem any more.

(Photo: Paul Vigna)