The FOMC Meeting: No tools left

Yesterday the FED released a statement on market conditions and its strategy to ease economic stress. The core issues like unemployment, lack of credit for small caps, mid caps and consumers and depressed housing and CRE markets are still there, with European debt crisis spicing things just a bit more.
Here are some of the highlits of today's release:

• Economic growth remains slow. Recent indicators point to continuing weakness in job markets
• Household spending has increased only at a moderate pace.
• Investment in nonresidential structures still weak and the housing sector remains depressed
• There are significant downside risks ro the economic outlook, including strains in global financial markets (I think it's pretty clear they're talking about Greece the European Union's debt crisis)

It's important to stress that the only sector the FED has seen with constant growth since two years ago is business investment in equipment and software, which sounds logical when we see the quarterly reports from Intel, Microsoft, Micron, Oracle, Kla-Tencor and Marvell, among others (yeah, in a subtle way I'm telling you to look at these tickers and buy 'em... at the right time)

Now, here's why the Standard & Poor's 500 yesterday fell 3% and today 3.19% : FED's "new" strategy is a demerol. Sure, it helps to relief the pain, but it's an opioid. Works just for the moment, thought the disease is still there.

It's one's opinion that buying long term-assets and sell short-term ones to lower the longer-term interest rates is absolutely pointless if the guy at the counter doesn't have any money, nor does he have a job or a credit line.

So from one's point of view, the FED is unwilling to do something big like it did with the TARP. Then again, they had the same attitud during 2008 untill markets collapsed, so my guess is, they won't do much until things get really, really bad. Which shouldn't take long since fellows like Mohammad El-Erian (PIMCO's CEO) today said Europe is already in a recession.

Update on Europe

On Tuesday I posted an article on European debt crisis stressing out the importance of the Italian debt and the eventual default of Greece. Today, as things keep getting worse, I wanted to share the market's reaction.

As you can see on Tuesday's blog, Italian CDS' were at 488 and now stand at 522. Just in a couple of days.

Mama Mia! Things gettin' ugly Santino

Last week I posted a review on Italy's current debt situation and the Chinese intervention. And yesterday evening the country saw its credit ratings downgraded by Standard & Poor's to A from A+ with a negative outlook "on concern that weakening economic growth and a fragile government mean the nation won't be able to reduce the euro-region's second largest debt burden".

Also, Italy's GDP has grown at an average rate of 0.2% from 2001 to 2010, vs 1.1% in the Euro Zone. This year only, its first quarter GDP showed a slight growth of 0.1%, and the second quarter +0.3% 

So what does this mean? Well, it means we're walking on thin ice. You see, Italy is bigger than Greece. Yeah, of course some banks (mostly French) have Greek paper, but Italy is a different story since it has 2.2 trillion Euros in outstanding debt; that's 25% of the total debt issued by the European Union.

The point is, Greece will default, they're done, and that will only translate into lack of funding and therefore insolvency for countries like Italy; then obviously financial institutions hold all these bills, and that means there will be writedowns... and well, kind of the story we saw three years ago, only this time it isn't mortgage-backed securities, it's "country-backed securities".

To get the picture, please look at the graph shown below. That's a World Countries Debt Monitor taken from Bloomberg LP. You'll see displayed the outstanding debt of each country in USD, from most to least. Next column you have the 5 year CDS', then credit ratings, exchange rate, and finally (I find this column very interesting) the percentage of Debt in relation to each country's GDP.

So, there it is. As you can see Italy is the third country (developed markets) with the biggest debt of $2.16 trillion dollars. Its 5 year CDS' are already showing a spread of 488 (bigger than Spain's 405) And here's the interesting part: Italian debt represents 118% of its GDP. There are only other four with a simmilar situation: Japan (226%) Singapore (102%) Iceland (124%) and Greece (144%) As we can see, Spain isn't such a huge problem; I'd rather pay more attention to France...

I'm not saying Italy will default, I'm just saying we're in for a bumpy ride. I wouldn't get into equity markets yet, even with valuations as attractive as they are. I'd stay liquid and amount even more liquidity. Normally I'd say "put it all in T-Bonds" but then again, Will the U.S. fall into a double-dip?

China to Italy: "We'll make 'em an offer they can't refuse"

I find this graph quite interesting. These are the Italian and Spaniard 10 year bond spreads vs the German 10 year bond. I thought some might find interesting the volume and increase in spreads, mostly hoy the Italian spread is now at almos 400 pts, surpasing the Spaniard spread for the first time.
Actually the only reason yields dropped more than 100 basis points was because of the European Central Bank's intervention when they bought Italian and Spaniard bonds on August 8th. Nevertheless, this help has already been forgotten since yields are back where they were before the ECB's intervention.
That auction helped the country to pay 9 billion Euro of bills maturing on Aug 31, but Italy still faces another 75 billion Euro just this year, and let's be honest, these guys aren't raising enough money to pay those bills.
Don't get me wrong, I'm not saying Italy will default, I'm just saying it's a fact that bad news from Europe will keep on coming in the next months, including possible downgrades.
Besides, let´s not forget that Italy's 1.6 trillion Euro debt represents 25% of the total debt in the EuroZone. So yes, it's far from Greece stands today, but unless they fix it right now, there's a strong chance of big trouble ahead.

These are the 10yr spreads between Italy and Spain bonds vs German Bonds

...And to get some perspective (just to show things are far from Greece's eventual default) here's a comparison between those same spreads, and the Greek spread vs German 10 year bonds



Bernanke's Speech Signals Slower Growth, Way Slower

Following are a few excerpts from Bernanke's speech Yesterday in Minnesota.
Basically the main subject was confirming that economic conditions have deteriorated to a fragile point. But on the other hand, data gathered by the FED still shows growth in some sectors of the economy.
I think the most important subject mentioned was the importance of a recovery in the housing market in order to get America back on track.

Chairman Ben Bernanke:

• Where do we stand? There have been some positive developments, our banking system and financial markets are significantly stronger. Credit availability has improved, thought it remains tight in (certain) categories.
• Nevertheless, the recovery from the crisis has been much less robust than we had hoped. From recent revisions from of economic data, we have learned that the recession was even deeper and the recovery weaker than we had previously thought. 
• Aggregate output has not returned to the level attained before the crisis... economic growth has been insufficient to reduce the unemployment rate.
• Some of this weakness can be attributed to temporary factors: run-ups in the prices of oil and other commodities, and the effects of the disasters in Japan.
• With commodity prices coming off their highs, growth in the second half looks likely to pick up. 
• However, incoming data suggest that other, more persistent factor also have been holding back the recovery.
• FOMC now expects a slower recovery over coming quarters WITH GREATER DOWNSIDE RISKS TO THE ECONOMIC GROWTH
• One striking aspect is the unusual weakness in household spending... decelerating in the first half of 2011. Households are struggling with high level of unemployment, slow gains in wages, falling house prices and debt burdens... People have become more pessimistic
• Business sector presents a more upbeat picture.
• Manufacturing rising importantly by exports
• Business investment in equipment and software has also continued to expand and corporate balance sheets are healthy.
• Some surveys by the FED point to weaker conditions recently.
• Although banking and financial conditions in the U.S. have improved significantly, financial stress continues to drag the recovery.
• Volatility and risk aversion have reemerged in reaction to concerns about European sovereign debts.

So basically, what the FED is telling us is: "new problems are emerging and situation is quite fragile"