FOMC Preview: QE3 vs. Forecast Extension; Economic Trends to Watch

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Zero Bound Fed Funds Rate 0%
(St. Louis Fed)
Will the Fed enact QE tomorrow, stay put, or extend its forecast until the market crashes, unemployment rises, or a recession finally gets realized? Below are charts of economic trends to keep an eye on (backward looking of course). The FOMC meets again on September 12-13. Look at the Federal Funds rate since 1954. It is currently at the zero bound (0%), a level never seen before on the chart. The rate was just under 20% in the early 1980s. See a table of daily Federal Funds rate data at the New York Fed ("by trading government securities, the New York Fed affects the federal funds rate, which is the interest rate at which depository institutions lend balances to each other overnight"). 

Here are some views on what to expect in tomorrow's policy statement.

    Markets Watching U.S. Earnings, ECB, Fed, German Constitutional Court (7/30/2012) - Updated

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    Interesting catalysts lie ahead for U.S. and European markets through the end of the year. The catalysts will mainly be initiated by governments and central banks, but some investors are watching U.S. equity earnings and valuations closely (John Hussman and Peter Tchir on Bloomberg TV - see below). Also, the U.S. jobs report is on Friday.

    Simon Derrick, Chief Currency Strategist at BNY Mellon, held a Eurozone crisis call on BNY's website on July 20, which is currently available to the public. During the call, Derrick mentioned there will continue to be uncertainty over the Eurozone bailouts until September 12th, when the German Federal Constitutional Court votes on whether to release taxpayer money to fund 27% of the ESM (€500 billion). The permanent European bailout fund (links are to Spiegel).

    John Hussman's Views on Profit Margins, Forward Earnings (July 30, 2012)

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    Here's a quotation from John Hussman's Weekly Market Comment this week ('No Such Thing as Risk?') on profit margins and forward earnings estimates. He runs the Hussman Funds.

    "I recognize that many analysts consider stocks to be cheap on the basis of “forward operating earnings,” but I continue to believe that the 50-70% elevation in profit margins relative to historical norms is an artifact of extreme deficit spending and depressed savings rates, and that as a U.S. recession unfolds, profit margins and forward earnings estimates will collapse. This is currently seen as heresy (as was my assertion just before the tech-collapse that technology earnings would turn out to be cyclical), but that’s how earnings and profit margins work."

    It's been an interesting cycle so far. Let's see if the Federal Reserve can backstop earnings and margins during the next recession. The FOMC meets on July 31-August 1 and September 12-13. Hitting the debt ceiling and approaching the fiscal cliff at the end of the year will be interesting as well.

    U.S. Treasury Bonds Are Doug Kass's Favorite Short For the Next Decade (Barron's Interview, 7/28/12)

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    Doug Kass, founder of hedge fund Seabreeze Partners, who I remember being a lone bear publicly on CNBC's Kudlow & Company back in late 2006 (along with Peter Schiff and Gary Shilling), mentioned his favorite short for the next decade in an interview with Barron's over the weekend: U.S. Treasury Bonds. I put up a 20 year chart of the 10-year Treasury Note Yield ($TNX) below to show the current trend.

    Boaz Almog Demonstrates Quantum Levitation, Quantum Locking With Superconductors (Future of Transportation!)

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    via Boaz Almog's TED slides below
    Quantum levitation and quantum locking is the future of transportation on rails! Watch Boaz Almog's TED talk below (hat tip @Scrataliano).
    "But what is the future of quantum levitation and quantum locking? Well, let me answer this simple question by giving you an example. Imagine you would have a disk similar to the one I have here in my hand, three-inch diameter, with a single difference. The superconducting layer, instead of being half a micron thin, being two millimeters thin, quite thin. This two-millimeter-thin superconducting layer could hold 1,000 kilograms, a small car, in my hand. Amazing. Thank you." - Boaz Almog ( transcript)

    Howard Davidowitz: Retail is a "Train Wreck", Earnings Will Get Worse (DG, DLTR, TJX, SPX, KSS, ROST, JCP, SHLD)

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    Dollar Tree, Dollar General, TJX vs. S&P 500 (via
    On Yahoo's Daily Ticker on July 16, retail expert Howard Davidowitz, chairman of Davidowitz & Associates, explained why retail sales in June (-0.5%) were down for the third month in a row, and why earnings are about to get much worse in the next few quarters. He essentially said what he's been saying for the past three years now: retail continues to be a "train wreck", the American consumer will "continue to get poorer", and worries over the fiscal cliff at the end of the year is making things worse.

    Look at this chart comparing Dollar Tree, Dollar General, TJX (owner of T.J. Maxx), and the S&P 500's performance since October 2007! That's why he said "we spent $5 trillion to get this and we shouldn't congratulate ourselves." His overall reasoning makes sense.

    • Household net worth is down 40%;
    • Consumer income is down 10% over the last few years;
    • We are going through the worst housing crisis since the great depression;
    • The jobs numbers are terrible;
    • "Earnings this quarter are going to be the worst in years. It's going to get worse in the next two quarters, and then worse after that." ("top line is bad, bottom line is bad)

    The Drop Like a Rock Scenario for U.S. Markets; Third waves are "wonders to behold" (by Elliott Wave International w/ Chart)

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    Guest post by Elliott Wave International (DV is an affiliate partner)

    The Drop Like a Rock Scenario for U.S. Markets
    Third waves are "wonders to behold"
    July 27, 2012

    By Elliott Wave International

    Financial markets always have and always will pose two basic questions that investors seek to answer:
    1. What's the direction of the main trend?
    2. How far will it go?

    Systematic approaches to these questions commonly belong to either fundamental or technical analysis. Let's consider each one briefly.

    Fundamental analysis studies how a market behaves in response to external influences such as earnings, sales, competitive outlook, economic outlook and the like.

    Technical analysis studies a market's internal behavior -- mainly price, but also internal measures like volume.

    Elliott wave analysis is a branch of technical analysis, specifically pattern recognition.

    Infographic on Facebook's Q2 Earnings, Ad Revenue Growth (and an infographic on FB's S-1 Filing) via Statista

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    I found these infographics at Statista (Facebook's Q2 Earnings at a Glance). Hat tip.

    Facebook Makes New Low in After Hours, But "Sponsored Stories" Make $1 Million a Day (Q2 Earnings) - Updated

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    FB after hours trading 7/26
    (source: optionsxpress)
    Facebook followed Zynga's crash yesterday. The stock was down 11% at $23.84 in after hours trading yesterday (broke through the June low last night), which is down 37% from its $38 IPO price. ZNGA lost 38% in after hours trading on 7/25.

    Facebook reported a GAAP operating income loss of $743 million and GAAP net income loss of $157 million in Q2, which was mainly due to "share-based compensation" after its IPO.

    "Costs and expenses — Second quarter costs and expenses were $1.93 billion, an increase of 295% from the second quarter of 2011, driven primarily by share-based compensation expense. As previously noted in the company's initial public offering prospectus, share-based compensation expense related to pre-2011 restricted stock units (RSUs) was not recognized in advance of the initial public offering, and as a result of the initial public offering during the second quarter, the company recognized $1.3 billion of share-based compensation and related payroll tax expenses. " (earnings release)

    Facebook's total revenue hit $1.184 billion in Q2, up 32% from $895 million in Q2 2011. However, year-over-year revenue growth has been slowing every quarter for the past year. Using revenue data from Facebook's conference call slides (see slides in the videos below), I broke out y/y growth of 'total revenue', 'advertising revenue', and 'Payments and other fees' since Q2 2011. Back when Facebook filed its S-1 to register for its IPO, Bloomberg TV reported that Facebook's revenue per daily active user was trending down. So the warning signs were there. Based on the after hours print of $23.84 ($51 billion using 2.14B shares outstanding on Yahoo Finance), FB was trading at 11.8x sales ($51B/$4.32B revenue ttm). UPDATE: According to Henry Blodget at Business Insider, Yahoo Finance calculated Facebook's share count wrong. It was supposed to have 2.74B shares outstanding instead of 2.14B, so it is worth $65B and trading at 15x sales. It went public at 26x sales. LinkedIn is currently trading at 16.89x sales. Crazy ride these social media stocks are having.

    Draghi: "ECB is Ready to do Whatever it Takes to Preserve the Euro." -Reuters

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    Mario Draghi, president of the European Central Bank, just squeezed some euro shorts after that statement. EUR/USD is up 1.20% at 1.22745. That was quick. Read more at Reuters (Draghi sends strong signal that ECB will act). It just pierced through ceiling resistance and sold off bit (now up 1.08%). See what kind of base it builds off this pop. It is still in a downtrend. So, when does the ECB start printing euros?

    The Most Important Financial Links for July 26

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    Here it goes...

      ZNGA: Zynga Crashes in After Hours Trading; Draw Something Expectations Lowered

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      Zynga lowers Draw Something 
      expectations (via Flickr)
      Zynga (ZNGA), an online social gaming/app company that generates 12% of Facebook's revenues (via Facebook's S-1 filing, see below), reported a huge earnings miss and then cut its outlook substantially. ZNGA closed down 38.16% at $3.14 and Facebook (FB) closed down 7.6% at $27.10 in after hours trading. FB reports its earnings tomorrow, so we'll see if it gets hit next.

      Below is more on Zynga's miss from its earnings release ending June 30, as well as its lowered outlook. Zynga lowered its expectations on Draw Something, a social game like Pictionary, which was one of the fastest growing apps earlier this year. The game's daily active users essentially peaked right when Zynga bought OMGPop for $200 million on March 21, 2012.

      First, here is more information from CNBC's Julia Boorstin and Zynga's CEO Mark Pincus from the conference call (via Bloomberg TV):

      "But what really dragged on Zynga's stock is the fact that the company lowered its outlook for 2012, saying it now expects bookings in the range of $1.15 billion to $1.225 billion, far short of the up to $1.5 billion Wall Street expected. (source:"

      XLB, XLI Put Options Active on July 23 (Materials, Industrial ETFs), XLI Trend Watch

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      XLI Sep $30 Put (Yahoo Finance) Transparency...
      Yesterday, after watching $XLI (industrial ETF) complacently trade on an uptrend line that originated at the March 2009 low (see chart), I wanted to see if option traders were buying puts to hedge against a potential breakdown. Interestingly, I saw that 38,160 September $30 out-of-the-money puts traded with 33,722 of open interest. The put contract closed up $0.05 at $0.21. I wasn't sure of the exact nature of the trade. I thought the activity could have been closing out previous open interest, or perhaps it was a large hedge. So I checked out some options blogs to see what was up.

      Support and Resistance Levels for EUR/USD; Lower on Greek, Spanish Worries (Update)

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      Here's an update on the euro's longer-term channel. It looks like the next support level to crash through is 1.1875, which was the low on 6/11/2010. It might want to gravitate towards the lower bound of the descending channel as well, at some point. New resistance is 1.2288 (1.23). It is moving lower this morning on Greek bailout worries, as well as fears over the financial stability of Italy and Spain (watch an interview with IMF's José Viñals below). According to Gavan Nolan of Markit, Spanish 5Y CDS made a new record high (or wide) today at 635bps.

      Deutsche-Welle and The Telegraph on Greek bailout worries:

      Roubini: Risk of "Global Perfect Storm" in 2013

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      In an interview with Chrystia Freeland of Reuters on July 17, Nouriel Roubini, chairman of Roubini Global Economics, warned that a "global perfect storm" could hit the global economy in 2013. By next year, he warned that 1) the "eurozone slow motion train wreck" could accelerate; 2) the U.S. economy could reach "stall speed" growth and possibly contract if there is fiscal tightening at the end of the year (fiscal cliff); 3) there could be a hard landing in China; and 4) the market's fear premium could rise on the risk of military confrontation with Iran. Watch the 16 minute interview below.

      Ritholtz on the S&P's Secular Bear Market (Bloomberg TV)

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      Barry Ritholtz, of FusionIQ and The Big Picture financial blog, discussed previous secular bear markets, the current move in the S&P 500, and what to expect going forward with Bloomberg's Adam Johnson yesterday. And if interested, here's an update on the "ultimate death cross" (50 and 200 month moving averages). QE vs. the ultimate death cross?

      July 19, 2012: The Most Important Financial Links

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      UBS Issues Hyperinflation Warning For US And UK, Calls It Purely "A Fiscal Phenomenon" (Zero Hedge)

      "Hyperinflation is more closely related to deflation than to "normal" high inflation, as hyperinflation can be viewed as the result of a failed attempt at printing money to avoid the deflation that would be caused by austerity."

      Peter Schiff - This Is My Single Greatest Fear (KingWorldNews via Business Insider)

      "My biggest worry is that capitalism and the free markets will get the blame when it really hits the fan. When we get the real crash and everything implodes, and it’s really Armageddon style collapse, my fear (again) is that capitalism and free markets take the blame for problems that were created by government."

      Spanish 10-Year Note Yield Pierces Through 7% Again

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      Spanish bonds pulled back and yields rose after demand slipped at a Spanish bond auction this morning (1, 2, 3). Also read this Guardian article:

      "IMF calls for 'decisive action' as Spanish bond yields near danger level. ECB must cut interest rates, start large-scale QE and wade into bond markets to drive down borrowing costs, says critical report."

      The trend is not Spain's friend. Take a look at the 6-month chart. Spain's 10-year note yield hit 7.01% a moment ago, but just pulled back to 6.988%. Follow the links to watch the yield in real-time.

      Gasparino: Insider Trading Investigations Winding Down, SAC's Case Still Obsession For Authorities

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      On Fox Business today, Charlie Gasparino mentioned that insider trading investigations are winding down. So that might mean Steven A. Cohen, founder of the $14 billion hedge fund SAC Capital, is off the hook. But, he said that SAC's case still remains an "obsession" for government authorities. To read more about Steven Cohen and his hedge fund, read this Businessweek article from 2003 that I always thought was interesting: The Most Powerful Trader on Wall Street You've Never Heard Of.

      It looks like SAC Capital has a bunch of $300-$500 million hedge funds under its umbrella that have independent teams trading on their own information (some via "expert networks", which have been involved in these cases). So when the line finally got crossed, a few former SAC traders pleaded guilty to insider trading. This activity wasn't connected to Steven Cohen himself.

      S&P Ultimate Death Cross Watch (50 Month Moving Average/200 Month Moving Average)

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      S&P 500 - Source:
      Since Societe Generale strategist Albert Edwards brought up the ultimate death cross in his recent research report, I'm going to check it out again. After the S&P crashed last year and was saved by the 200 month moving average, I saw that the 50 and 200 month moving averages were converging with each other, which was worrisome. Now it looks like they finally met up, so the S&P is at an important inflection point. Check out charts of the S&P 500 going back to 1971 and 1997 with the 50 and 200 month moving averages.

      In my opinion, if the 50 month moving average crosses below the 200 month moving average, it would show that the secular bear market is getting old, and that a final battle (or battles) could soon decide its fate (like a 2008 event). But, it would also show that the secular bear market's force is still strong and intact, which could mean there is another lost decade ahead. But, if the S&P can confirm a break (with retests) above the 2007 high (1,576), that would be the ultimate catalyst for a new secular bull market, in my opinion. At this point, the Fed's quantitative easing program would have to backstop a new recession and falling EPS. Any thoughts? Albert Edwards found interesting historical data on the monthly moving averages. Here are a few quotes from his report via Zero Hedge and Investment Week:

      PIMCO's Gross: US Economy Approaching Recession (Tweet)

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      Read what PIMCO tweeted yesterday. Bill Gross manages the $263 billion Total Return Bond Fund at PIMCO.

      David Rosenberg Still Likes Corporate Bonds (Consuelo Mack Interview, 7/13/12)

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      David Rosenberg, chief economist and strategist at Toronto-based wealth management firm Gluskin Sheff (and former Chief North American Economist at Merrill Lynch), was interviewed by Consuelo Mack on July 13, 2012 on WealthTrack. He told her that corporate bonds are still attractive during this deleveraging period (watch his November 2011 interview). He's a fan of "staking a claim" in healthy balance sheets that have quality debt/equity and interest coverage ratios, and have debt maturity schedules locked-in. He also thinks high yield bonds that are already priced for a downturn are attractive as well.

      Corn Future Tests 2011 High On Severe Drought Damage (ZC)

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      The corn future is testing the 2011 high(s) this morning after corn farms experienced the worst drought since 1956. Let's see if it can take out 800. The corn futures curve is in crazy backwardation.

      Corn Future (ZC) - Source: CME Group

      The corn ETF will probably test the 2011 high at the open.

      July 16, 2012: The Most Important Financial Links

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      • Jeff Gundlach's Presentation On 'Financial Expressionism' and the Economy (Business Insider)
      • Citi: "The Market Will Form A 'Terminal' High" (Zero Hedge)
      • Deutsche Bank's David Bianco: The Next Big Move In Stocks Will Be Down (Business Insider)
      • Goldman Sees Another US Downgrade In 2013 (Zero Hedge)
      • Deciding The Fate Of The Euro- Goldman's Thomas Stolper (ZeroHedge)
      • Krugman Interview: The Government Has To Do More Deficit Spending To Avoid A Full-On Depression (but says "using the printing press to deal with the debt" is risky) (Business Insider)
      • Buffett Says Muni Bankruptcies Set To Climb As Stigma Lifts (Bloomberg)
      • Revisiting the debt ceiling - again [in September? See Bianco Research's Chart] (Sober Look)

      U.S. Mortgage and Housing Market Update For July 2012 (Charts), 30-Year Fixed Mortgage Rate Hits New Record Low

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      Source: St. Louis Fed/Dvolatility Designs
      U.S. mortgage and housing market update for July 2012

      According to Freddie Mac, the U.S. 30-year fixed-rate mortgage (avg) hit a new record low last week at 3.56%.

      "30-year fixed-rate mortgage (FRM) averaged 3.56 percent with an average 0.7 point for the week ending July 12, 2012, down from last week when it averaged 3.62 percent. Last year at this time, the 30-year FRM averaged 4.51 percent."

      According to Frank Nothaft, Freddie Mac's chief economist, the low jobs number was responsible for the recent move. Here's a quote:

      "Following a lackluster employment report for June, long-term U.S. Treasury bond yields eased somewhat this week allowing fixed mortgage rates to reach yet another record low. Only 80,000 net new jobs were added to the economy last month, not enough to lower the unemployment rate from 8.2 percent. This was the concern of the Federal Reserve's monetary policy meeting held June 19-20. Minutes released from that meeting on July 11, revealed that a few members felt further monetary stimulus was needed to promote satisfactory growth in employment to meet the Committee's goal."

      Look at charts of the 30y fixed mortgage rate going back to 1976 and 2007.

      PFG's CEO Explained Details of 20 Year Fraud in Suicide Note (Text)

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      Source: PFG brochure
      Russell Wasendorf Sr., Chairman and CEO of the bankrupt futures brokerage firm PFGBest, which currently has $215 million of customer funds missing, explained in his suicide note how he embezzled millions of dollars from customer accounts for 20 years by forging "bank statements" with "Photo Shop, Excel, scanners, and both laser and ink jet printers". And he also forged "official letters and correspondence from the bank, as well as transaction confirmation statements." He failed to kill himself though, and was eventually arrested. He made his first court appearance on Friday. Below is a snapshot of his suicide note and the FBI's criminal complaint and affidavit charging Russell Wasendorf Sr. with "making and using false statements" to regulators. It's getting volatile in futures brokerage land. Any more shoes to drop? Here are links to more articles to read. It was weird finding this 20th anniversary graphic in PFGBest's brochure.

      Details on PFGBest's Fraud (Part 1)

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      source: Youtube (see below)
      In other financial fraud news, according to the CFTC and FBI, PFGBest's Chairman and CEO Russell Wasendorf Sr. has been embezzling millions of dollars from customer accounts for 20 years by occupying the brokerage firm's mail room, forging bank statements on photoshop, and then sending them off to PFG's accountants. The firm currently has $215 million missing from segregated customer accounts.

      Below I embedded freaky videos of Wasendorf talking about "sustainable investing" 5 months ago and PFGBest's grand opening 2 years ago. After MF Global misappropriated $1.2 billion of customer funds before going bankrupt, PFGBest's President and COO, Russ Wasendorf Jr., released a statement that said "an independent, certified audit is conducted annually in addition to periodic, regular audits by NFA and information requests from the CFTC and exchange representatives. It is our policy to keep extra funds on deposit in our customer segregation accounts to protect you. Bernie Madoff duped his son as well. It's insane how long these frauds can go on for hidden at the very top.

      Moody's Downgrades Italy to Baa2 from A3, Maintains Negative Outlook (Text), Watch 10Y Italian Bond Yield

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      Keep an eye on the Italian 10-year government bond yield to see if it tests the 2011 highs.

      Moody's downgrades Italy's government bond rating to Baa2 from A3, maintains negative outlook

      Global Credit Research - 13 Jul 2012

      Frankfurt am Main, July 13, 2012 -- Moody's Investors Service has today downgraded Italy's government bond rating to Baa2 from A3. The outlook remains negative. Italy's Prime-2 short-term rating has not changed.

      The decision to downgrade Italy's rating reflects the following key factors:

      1. Italy is more likely to experience a further sharp increase in its funding costs or the loss of market access than at the time of our rating action five months ago due to increasingly fragile market confidence, contagion risk emanating from Greece and Spain and signs of an eroding non-domestic investor base. The risk of a Greek exit from the euro has risen, the Spanish banking system will experience greater credit losses than anticipated, and Spain's own funding challenges are greater than previously recognized.

      Negative Bound: Danish, German Government Bond Yields Are Negative!

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      According to (GDBR2:IND), investors are paying the German government -.034% to hold on to its 2-year debt! This means that German bunds are still considered a safe haven to protect against the euro zone sovereign debt and banking crisis. However, the German bund rally could end soon if Germany decides to sacrifice its credit quality to save the euro zone (or there's inflation risk). But, we'll see if a huge "euro quake" shakes the earth first. Below are links to more German bund yields to watch and snapshots of the negative 2-year German bund yield. They already went negative in the beginning of June (Global Zero Bound: 2-Year German Schatz Yield Goes Negative, 10-Year Treasury Yield Hits Record Low, 10-Year JGB Yield at Nine Year Low).

      I listened to Jeff Gundlach's conference call at DoubleLine Capital's website today and he showed a chart of Danish 1-year government bond yields at -0.32%. Read the full DoubleLine presentation at Business Insider.

      2yr German Bund Yield intraday (

      France is also joining the negative-boundathon:

      EUR/USD at 1.219 -0.4% on ECB's Statement on Inflation, Growth

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      After breaking the symmetrical triangle to the downside after the ECB lowered rates on July 5, the euro is continuing its descent after the ECB said:

      "Inflationary pressure over the policy-relevant horizon has been dampened further as some of the previously identified downside risks to the euro-area growth outlook have materialized.”;


      "Economic growth in the euro area continues to remain weak, with heightened uncertainty weighing on confidence and sentiment." (h/t BusinessWeek)

      EUR/USD might be headed towards the lower bound of the descending channel on the chart (eventually). It needs a strong positive catalyst at this point to turn it around. Austerity measures and the sovereign debt and banking crisis are putting a cap on growth and inflation in the euro zone. The September E-mini S&P future is trading at 1325.75, -0.79%.

      Barclays' LIBOR, Euribor, Interest Rate Derivative Fraud Scandal Seems Serious (CFTC, FSA PDFs)

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      1M Euribor/Submission (h/t SoberLook)
      The LIBOR, Euribor, and interest rate derivative fraud scandal at Barclays has been flooding the media for weeks now, so I thought I'd post all of the details for archive purposes. I embedded CFTC and FSA (UK's Financial Services Authority) documents that explain what happened. Barclays was fined $200 million by the CFTC, $160 million by the USDOJ, and £59.5 million by the FSA. Now it looks like "taxpayer-owned banks Lloyds and RBS could face Libor fines."

      As noted in my previous post, these interbank lending rates are tied to trillions of loans and interest rate derivatives. So they are kind of important. Now banks have big lawsuits and litigation costs to deal with. Does Dick Bove still think we are in a new golden age of banking?

      August Crash Protection in VIX Options (August 50-60 Calls Active This Week)

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      According to the OptionMonster Volatility Sonar Report yesterday (via DRJs Blog), big activity occurred this week in the August 50 and 60 VIX calls. They were "big August upside buyers looking for crash protection." Watch the video below. You can watch the August and September VIX future trade at CBOE, and VIX options trade inside chains at optionmonster. The same type of activity occurred in July 2010 before QE2 saved the markets, which is interesting.

      The Warning (PBS): Brooksley Born vs. Alan Greenspan, Lawrence Summers, Robert Rubin on OTC Derivative Regulation

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      Img: Time
      The Warning, a PBS documentary that aired in 2009, is about how Brooksley Born, former chairperson of the CFTC, fought against the financial lobby and financial regulators Alan Greenspan (former Fed Chairman), Lawrence Summers (former Treasury Secretary), and Robert Rubin (former Treasury Secretary) to try to regulate OTC derivatives between 1996-1999. They eventually shut her down and got congress to pass the Commodity Futures Modernization Act of 2000, which excluded all OTC derivatives from regulation.

      According to the Bank for International Settlements, the total outstanding notional amount of OTC derivatives stood at $647 trillion at the end of 2011, up from about $80 trillion in 1998. And the total outstanding notional amount of OTC credit default swaps grew from 918 billion in 2001 to $62 trillion in 2007, and then fell to $28 trillion in 2011. Of this amount, the top 25 banks held a notional value of $14 trillion CDS in 2011. This is why we are stuck in too-big-to-fail bank zombie land after all of the banks (less Lehman) got bailed out by the government and Fed. They are too big and interconnected to fail, and can't adapt with the modern times of transparency. So the game will continue as planned until tech and banking entrepreneurs reinvent the financial system, or a huge crash occurs that knocks down the aging financial infrastructure and clears away the inefficient dark markets filled with fraud.

      How did Alan Greenspan seriously believe that an unregulated, illiquid, interconnected, and non-transparent over-the-counter derivatives market, controlled by investment banks, insurance companies, and hedge funds, would prevent control fraud (Janet Tavakoli, Bill Black) and be sophisticated enough to manage risk and leverage to avoid systemic risk? LTCM already proved that financial institutions leveraged 25-to-1 with large OTC derivatives positions on with banks, would need to be rescued if they collapsed to prevent a financial crisis. And LTCM's collapse didn't even involve fraud (right?). Look what Greenspan said to Brooksley Born about fraud during a lunch meeting in 1996.

      The Trillion Dollar Bet: Documentary On LTCM (Long-Term Capital Management)

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      Watch The Trillion Dollar Bet, a NOVA documentary film on the rise and fall of hedge fund Long-Term Capital Management between 1994-1998. LTCM was founded by John Meriwether, former vice-chairman and head of bond trading at Salomon, and partners Robert Merton and Myron Scholes, the co-authors of the Black-Scholes-Merton model, which was used by the firm to "eliminate risk" entirely on their positions. Merton and Scholes won the Nobel Prize in Economics in 1997. The Black-Scholes model is used by option traders to price options (implied volatility).

      LTCM was a huge player in fixed-income and statistical arbitrage, and had a gang of former Salomon arbitrage traders as partners (list). LTCM made big money at first (+40% annualized), but its massively leveraged portfolio ($125 billion in assets/$4.72 billion in equity in 2008 + $1.25 trillion in off balance sheet interest rate derivatives via Wikipedia) collapsed when its models failed to hedge against unforeseen volatility and a "global flight to liquidity" during the 1997 East Asian and 1998 Russian financial crises (via sovereign default). The Fed organized a $3.62 billion rescue of LTCM with large banks that had existing claims against the company because they thought that LTCM was too-big-to-liquidate its positions in the market, which would destabilize the financial system and put bank portfolios at risk (think 2008 as well). Read Myron Scholes' follow up on the bailout below. But first, this is funny. Look who was at LTCM's emergency meeting.

      BusinessWeek: September 25, 1998, exactly 10 years before Lehman's big meeting:

      "But just now, details of the meeting are getting out. According to one participant, the meeting was held in a big, wood-paneled room with pictures of past Federal Reserve presidents on the wall. The guest list included Wall Street's most powerful leaders. In attendance: CS First Boston CEO Allen Wheat; CEO James Cayne, along with Warren Spector, from Bear Stearns; Morgan Stanley CEO Phillip Purcell; Lehman Brothers CEO Dick Fuld and Tom Russo, chief legal officer; Goldman Sachs CEO Jon Corzine and CFO John Thain. Travelers CEO, Sandy Weill was there in the morning, as well as the co-CEOs of its Salomon Smith Barney unit, Jamie Dimon and Deryck Maughan. President Herb Allison and CEO Dave Komansky from Merrill Lynch were there, too. Their former Merrill colleague, Edson Mitchell, representing Deutsche Bank, was on the phone."

      It's like these bank CEOs wanted this to happen again. Unfortunately, we still haven't learned from LTCM or the TBTF bank bailouts.

      Warren Buffett's Views on LTCM's Collapse, Brooksley Born's Testimony Concerning LTCM (10/1/1998)

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      It's amazing how the same thing happened exactly ten years later, but on a larger scale. Read Long-Term Capital Management's promotional brochure, which on the first page said, "LTCM currently has assets that exceed $120 billion with equity around $5 billion, in line with a large financial institution." And then look at LTCM's performance chart (vs. the Dow and U.S. Treasuries) after its collapse. Same exact thing happened to the banks. I also embedded Warren Buffett's views on LTCM's collapse. These were geniuses running this firm. And what about the combined brainpower at the banks that failed?

      Diagnosing the LIBOR: Strategic Manipulation and Member Portfolio Positions (Abstract of Report)

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      3/10/2006 Barclays (source:, 6/27/2012)
      Here's an interesting read on LIBOR manipulation from 2009 given the current LIBOR and Euribor scandal at Barclays, and soon to be other banks. The report has some nice charts in it (tweeted by @carney). To your right are snapshots of emails from Barclays' interest rate derivative traders to their LIBOR submitter on March 10, 2006 (via the Financial Services Authority).

      Diagnosing the LIBOR: Strategic Manipulation and Member Portfolio Positions

      Connan Snider

      Thomas Youley
      University of Minnesota

      February 7, 2009
      Preliminary and Incomplete


      The London Interbank Offered Rate (Libor) is a vital benchmark interest rate to which hundreds of trillions of dollars of financial contracts are tied. We provide new evidence that panel banks may have misreported actual borrowing costs when quoting rates to the Libor survey. This evidence stems from discontinuities involved in the Libor's construction. We introduce a simple model where banks' possession of Libor indexed contracts leads them to quote rates that are clustered at discontinuities and show that such clustering has been severe in the 3-Month U.S. Libor throughout 2009. We then present suggestive evidence that several banks have large exposures to the Libor through their interest rate derivative portfolios and have recently profited from the rapid descent of the Libor.

      Continue reading here or here. And read this by the authors: Does the LIBOR reflect banks' borrowing costs? (April 2, 2010).

      Barclays' LIBOR, Euribor and Interest Rate Derivatives Scandal VIX is Spiking, On Cover of The Economist

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      The Economist (source: Google+)
      I haven't officially posted about the LIBOR (London Interbank Offered Rate) and interest rate derivative trading scandal yet, but it's definitely crazy that $350 trillion of notional interest rate swaps and $437 trillion of CME Eurodollar futures notional volume (in 2009), all tied to LIBOR, have been manipulated by LIBOR "submitters" and interest rate derivative traders at Barclays (and other big banks?) from 2005-2009 (CFTC vs. Barclays). The CFTC document also said that Barclays manipulated Euribor for its traders and colluded with other banks. And not only that, Barclays manipulated its rate to be perceived as a healthier credit during the credit crisis. And was the Bank of England involved with that? So, this is why the scandal is perceived as such a big deal, even if it just involved a few basis points at a time. It is also another blow to the credibility of the bailed out too-big-too-fail financial system now that (legal) credit fraud contagion has officially spread to interest rates (to the public at least). According to the CFTC, LIBOR sets the rate on $10 trillion of variable rate loans.

      I've covered LIBOR on this blog before. LIBOR is the "trimmed average" of interbank lending rates submitted by banks to price short-term credit risk in the banking system (overnight, 1-week, 1-month, 3-month, 6-month etc). Read more details at the British Bankers Association's website. LIBOR was the most important rate to watch during the 2008 financial crisis to see if the Fed could save the financial system (unfreeze liquidity) when all of the banks were headed to zero (see posts: 1, 2, 3). And LIBOR also moved higher when the sovereign debt crisis in the euro zone started to flare up (1, 2). So these rates are no joke. And I think we now know why the Eurodollar COT predicts the S&P 500 one year in advance! Ha. So, after knowing all of this, how did the banks not profit from their own credit crisis in 2008?

      Euro Gets Slaughtered After ECB Cuts Rates (EUR/USD)

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      EUR/USD is getting slaughtered after the ECB cut rates (trading at 1.2383, -1.14%). It also broke (or pierced) through symmetrical triangle support just now. We'll see what kind of relief rally there is today. Below I quoted the ECB's rate decisions via E-mini S&P is up 0.18%. Interesting morning so far.

      5 July 2012 - Monetary policy decisions

      At today’s meeting the Governing Council of the ECB took the following monetary policy decisions:

      1. The interest rate on the main refinancing operations of the Eurosystem will be decreased by 25 basis points to 0.75%, starting from the operation to be settled on 11 July 2012.

      2. The interest rate on the marginal lending facility will be decreased by 25 basis points to 1.50%, with effect from 11 July 2012.

      3. The interest rate on the deposit facility will be decreased by 25 basis points to 0.00%, with effect from 11 July 2012.

      The President of the ECB will comment on the considerations underlying these decisions at a press conference starting at 2.30 p.m. CET today.

      EUR/USD Ahead of ECB Meeting (1.25011)

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      EUR/USD is down 0.20% at 1.25011 ahead of the ECB's rate decision. Economists expect the ECB to lower its benchmark rate by 25 basis points to 0.75%. Watch for a symmetrical triangle breakout.


      Previous post: EUR/USD Testing Ceiling Resistance In Symmetrical Triangle In Overall Descending Channel (Chart)

      Chart of LTCM's Performance vs. Dow, U.S. Treasuries (1994-1998)

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      Source: Wikimedia Commons
      More from Wikipedia:

      "The company, which was providing annual returns of almost 40% up to this point, experienced a flight-to-liquidity. In the first three weeks of September, LTCM's equity tumbled from $2.3 billion at the start of the month to just $400 million by September 25. With liabilities still over $100 billion, this translated to an effective leverage ratio of more than 250-to-1.[22]"

      Former CFTC Chair Brooksley Born Warning About Systemic Risk in OTC Derivatives Market In 1999 After Hedge Fund LTCM Blew Up (Text)

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      source: Wikipedia
      Former CFTC Chair (1996-1999) Brooksley Born continued to warn about systemic risk in the OTC derivatives market even after the hedge fund Long Term Capital Management L.P., which was managed by mathematical geniuses, "nearly defaulted on $1.25 trillion in notional value of exchange-traded and OTC derivatives contracts" in 1998. Maybe it's time to stop listening to Alan Greenspan and other seasoned pro-TBTF finance professionals and OTC traders brainwashed by TBTF bank academia, realize internal bank fraud (control fraud - Bill Black, Janet Tavakoli) destroys the free markets and risk management practices, and breakup the too-big-to-fail banks before finance gets destroyed. At the end of 2011, the total notional value of OTC derivatives outstanding stood at $647 trillion, with insured commercial banks holding $222 trillion of derivatives (less $8 trillion of exchange traded derivatives). *I added text from her last testimony before the U.S. House Committee on Agriculture on May 18, 1999 where she talks about OTC derivatives and hedge funds.



      24TH ANNUAL

      Boca Raton, Florida
      March 18, 1999

      It is a pleasure to be here this morning to address the members of the Futures Industry Association. I look forward to an extremely interesting conference this year as the industry addresses many of the issues confronting it in this era of profound change.

      It is difficult to imagine a time of greater change in this industry. Electronic trading systems are replacing floor trading at exchanges around the world. The ultimate role of intermediaries in these new systems is not yet clear. Moreover, instantaneous international communication and transactional capabilities are creating truly global markets. Consequently, domestic exchanges and industry professionals are eager to offer their products and services to customers abroad, while foreign exchanges are just as eager to offer their products to U.S. customers. While futures exchanges are grappling with these technological developments, the number and type of derivative products offered over-the-counter continues to mushroom even as the volume of transactions in that market increases exponentially. Furthermore, technological and market developments are driving many OTC derivatives market participants to express an interest in adopting trading and clearing systems that would cause the OTC market to resemble more closely the exchange-traded markets.

      EUR/USD Testing Ceiling Resistance In Symmetrical Triangle In Overall Descending Channel (Chart)

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      Here's a quick technical update on EUR/USD (Euro/US Dollar). As you can see on the chart below, EUR/USD has been trading in a descending channel since August 2011. More recently, EUR/USD broke through the January 13 support level of 1.26244 on May 23, bottomed out at 1.22822 on June 1, and is now trading at 1.25879. EUR/USD pierced through the new ceiling resistance level (1.26244) a few times in June, but there was no confirmed breakout.

      It is finally time for EUR/USD to make a decision as it nears the apex point in a near-term symmetrical triangle (higher lows and lower highs will force a decision soon). If EUR/USD can confirm a breakout above 1.26244 (part 1 after Euro summit), I think it could rally to the overall downtrend line from August 2011 (1.29s it looks like, but it hits 1.28 towards the end of July). However, the overall trend for EUR/USD is still down. But if it can break through that downtrend line from 2011 and 1.30 ceiling resistance level, I think that would catalyze a strong move to the upside. It would break the descending channel. I'll do a new post on this when (or if) EUR/USD tests those levels in the future. The currency pair is currently reacting to the euro zone sovereign debt and banking crisis, Greece potentially leaving the euro zone, Spanish bank risk, Germany's involvement with the bailouts (watch German bunds), the *European Central Bank, the Federal Reserve, U.S. fiscal cliff risk, U.S recession risk, and a possible hard landing in China. *According to Bloomberg, economists expect the ECB to cut its benchmark rate by 25 basis points to 0.75% on Thursday.

      Ray Dalio on How Deleveragings Work (PDF Link)

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      Ray Dalio at Hedge Fund Industry Awards (video)
      Ray Dalio, founder of Bridgewater Associates, the largest hedge fund in the world with $120 billion under management, explained to you how the economic machine works in a research report (pdf) and on Bloomberg TV last year. Now I see he has a research report out on how deleveragings work (pdf from February). Read the intro below. I remember he said recently that the U.S. was going through a "beautiful deleverging" at the moment. Fiscal tightening could change that.

      "An In-Depth Look at Deleveragings
      Ray Dalio
      February, 2012

      The purpose of this paper is to show the compositions of past deleveragings and, through this process, to convey in-depth, how the deleveraging process works.

      Microsoft Takes $6.2 Billion Writedown On $6.3B aQuantive Acquisition in 2007 (Online Advertising)

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      In online advertising tech news, Microsoft is taking a $6.2 billion writedown on assets in its "Online Services Division" (a non-cash impairment charge on goodwill), which, according to the release, was related to its $6.3 acquisition of aQuantive in 2007. I did more research on aQuantive and saw that it owned the digital ad firm Razorfish, which MSFT then sold to French firm Publicis Groupe for $530 million in 2009. I actually just passed a Razorfish office in Chicago's Merchandise Mart. Here is a post I did a few days ago on how to reinvent internet advertising. How about hologram ads (see below).

      JPMorgan Global Manufacturing PMI Falls to 3-Year Low in June

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      The chart says a thousand words. Read the full release here.

      "Global Manufacturing Sector Contracts in June

      source: ISM
      The JPMorgan Global Manufacturing PMI™ — a composite index produced by JPMorgan and Markit in association with ISM and IFPSM — fell to three-year low of 48.9 in June, a reading below the neutral 50.0 mark for the first time since November 2011.

      Manufacturing production declined for only the second time in the past three years. Although the rate of contraction was only moderate, it was nonetheless the fastest since May 2009. Growth slowed sharply in the US to its weakest in the current 37-month sequence of expansion. Rates of decline gathered pace in China, Brazil and Vietnam, while Japan, South Korea and Taiwan all fell back into contraction.

      The Eurozone remained the main source of weakness for the global manufacturing sector. Production in the euro area contracted at a similarly sharp rate to May – which was the steepest drop in almost three years – with declines recorded in Germany, France, Italy, Spain and Greece...." (continue reading)

      PIMCO's Bill Gross: "U.S. Treasuries Are One Giant PIK Bond"

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      Source: PIMCO
      Bill Gross, co-founder of PIMCO and manager of the $260 billion PIMCO Total Return Fund, wrote in his July Investment Outlook that the global debt crisis, which is currently flaring up in the euro area, still hasn't been cured, and will eventually end up in the United States if debt/GDP and other government liabilities (some unfunded) keep trending higher. He provided a chart of U.S. Gross Federal Debt/GDP. And we have an economy that can't survive without stimulus, right? Markets will be interesting to watch during the fiscal cliff fiasco at the end of the year. Can't LIBOR fraud at the TBTF banks get us out of this mess?

      "But when debt as a percentage of GDP, or debt service as a percentage of household income, or the appropriateness of the term structure (short vs. long) on both borrower and lender balance sheets becomes imbalanced, then the well-oiled capitalistic engine may sputter and in some cases – as in Greece – freeze up.

      China's Manufacturing (PMI) Barely Expands in June, Input Prices Crash, Export Orders Contract (Interactive Chart)

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      China PMI, input prices, export orders (static)
      China's manufacturing activity barely expanded in June, according to the official PMI (purchasing managers' index) released by China's National Bureau of Statistics and CFLP. China's overall PMI fell to 50.2 in June from 50.4 in May, but was higher than both Bloomberg and Dow Jones' median economist estimates of 49.9 and 49.8 (under 50 = contraction).

      When breaking out the PMI data, China's input prices crashed to 41.2 in June from 44.8 in May, and export orders fell to 47.5 in June from 50.4 in May. If you've been watching the HSBC China Manufacturing PMI chart, this weakness was expected. I created an interactive monthly chart comparing China's overall PMI, input prices, and export orders from October 2011 to June 2012 using Thomson Reuters data (via Since the PMI showed that China's manufacturing growth was still trending down, and aggressive input price contraction increased deflation risk, traders will be watching to see if China's central bank lowers interest rates and the bank RRR (reserve requirement ratio) again in the third quarter to stimulate the economy.