STEALTH QE III?

Is the Federal Reserve already in the process of implementing a Stealth QE III?

GLOBAL MACRO TIPPING POINTS - SEPTEMBER 2011

8/24/2011

1 September 2011 Edition

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STEALTH QE III?
Is the Federal Reserve Already in the Process of Implementing a Stealth QE III?

GLOBAL MACRO TIPPING POINTS - SEPTEMBER 2011

TIPPING POINTS........................................................................................................................................................................................ 5
WE ARE HERE ................................................................................................................................................................................................. 5
SHIFTING TIPPING POINTS - CHANGES TO WATCH .................................................................................................................................... 6
TIPPING POINTS IN FOCUS: AUGUST 2011 .............................................................................................................................................. 10
I - SOVEREIGN DEBT .......................................................................................................................................................................................................... 10
II - EU BANKING CRISIS ...................................................................................................................................................................................................... 10
III - GEO-POLITICAL EVENT ............................................................................................................................................................................................... 11
IV - SOCIAL UNREST ........................................................................................................................................................................................................... 11
V - RISK REVERSAL ............................................................................................................................................................................................................ 12
VI - INFLATION & INTEREST PRESSURES ..................................................................................................................................................................... 13

GLOBAL MACRO -RISK LEVELS ........................................................................................................................................................................ 14

CREDIT METRICS - LIBOR-OIS SPREAD (Updated) ...................................................................................................................................................... 14
HOUSING - RATE OF CHANGE (Reference).................................................................................................................................................................... 14
DIVERGENCE (Reference) .................................................................................................................................................................................................. 15
MONEY SUPPLY GROWTH - M3 (Updated) ..................................................................................................................................................................... 16
BBANK LIABILITIES (Reference) ........................................................................................................................................................................................ 16
GLOBAL CREDIT DEFAULT SWAPS (Reference) ........................................................................................................................................................... 17
EU CRDIT DEFAULT SWAPS (Updated) ........................................................................................................................................................................... 18
COST OF MONEY (Updated) .............................................................................................................................................................................................. 19
EMPLOYMENT DIVERGENCE (Updated) ......................................................................................................................................................................... 20

GLOBAL MACRO......................................................................................................................................................................................22
EUROPE - THE EUROPEAN SUMMER ............................................................................................................................................................. 24
BANK STRESS TESTS ........................................................................................................................................................................................................ 24
FRENCH BANK STRESS TESTS ....................................................................................................................................................................................... 27
EUROPEAN FINANCIALS: Credit Default Swap Activity ................................................................................................................................................. 28
ITALY: Crisis Moves From Peripheral to Outer Core (Mezzanine Level) ........................................................................................................................ 31
IRELAND: Non Investment Grade (Junk) ........................................................................................................................................................................... 37
PORTUGAL: Non Investment Grade (Junk) ....................................................................................................................................................................... 38
GREECE: Non Investment Grade (Junk) ............................................................................................................................................................................ 39
SPAIN: Investment Grade ..................................................................................................................................................................................................... 40
GIIPS: Sovereign Notes versus CDS Yields....................................................................................................................................................................... 41
BRADY BONDS - The Final EU Solution When the Politics End and Reality Sets In ................................................................................................... 42

ASIA - ALL IS NOT QUIET! THE WEST IS JUST DISTRACTED. .......................................................................................................................... 43

CHINA: Chinese Shadow Banking....................................................................................................................................................................................... 43
JAPAN: Is the Carry Trade Unwinding? .............................................................................................................................................................................. 44

EMERGING MARKETS - INFLATION & SLOWING GROWTH ......................................................................................................................... 46

INDIA: Slowing Badly ............................................................................................................................................................................................................ 46

US ECONOMY ...........................................................................................................................................................................................47
KEY MONTHLY ECONOMIC INDICATORS HAVE A CLOSER LOOK AT WHAT THE MAINLINE MEDIA DOESNT DISCUSS. ...................... 48
PHILLY FED BOMBSHELL .................................................................................................................................................................................................. 50
CONSUMER CREDIT ........................................................................................................................................................................................................... 51

JOBS - CONFIDENCE - CONSUMPTION - GROWTH CYCLE................................................................................................................ 52

JOBS ....................................................................................................................................................................................................................................... 53
EMPLOYMENT TRACKING STATISTICS ................................................................................................................................................................... 61
CONFIDENCE & SENTIMENT ............................................................................................................................................................................................ 64
CONSUMPTION .................................................................................................................................................................................................................... 69
GROWTH ................................................................................................................................................................................................................................ 70

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STEALTH QE III AHEAD ............................................................................................................................................................................... 72

NBRs (Non-Borrowed Reserves) ......................................................................................................................................................................................... 73
REVERSE REPO MARKET ................................................................................................................................................................................................. 73
CONTINGENT LIABILITIES ................................................................................................................................................................................................. 75
OPERATIONAL READINESS .............................................................................................................................................................................................. 75

CONCERNS WITH BANKS & US CREDIT MARKETS.............................................................................................................................. 77

BANK OF AMERICA ............................................................................................................................................................................................................. 77

WHISTLEBLOWER TELLS ALL AT THE RATING AGENCIES................................................................................................................ 79

REAL ESTATE "DOUBLE DIP" UPDATE ................................................................................................................................................... 80
BIG PICTURE ........................................................................................................................................................................................................................ 80
RESIDENTIAL REAL ESTATE- "STILL HOME SICK" ...................................................................................................................................................... 83
CURRENT SITUATIONAL ANALYSIS ......................................................................................................................................................................... 83
HOME OWNERSHIP TRENDS ..................................................................................................................................................................................... 85
$6.5 TRILLION IN MIDDLE CLASS NET WORTH EVAPORATES .......................................................................................................................... 87
GARY SHILLING LAYS OUT THE HOUSING FACTS .............................................................................................................................................. 88
DISTRESSED MORTGAGES ..................................................................................................................................................................................... 102
NATIONAL STATISTICS.............................................................................................................................................................................................. 103
SHILLER WARNING .................................................................................................................................................................................................... 107
COMMERCIAL REAL ESTATE.......................................................................................................................................................................................... 108
COMMERCIAL REAL ESTATE DECLINES 3.7% IN APRIL - NEW POST BUBBLE LOW ................................................................................ 108

2011 US ECONOMIC IMPEDIMENTS....................................................................................................................................................... 112

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MONTHLY PROCESS OF ABSTRACTION

The Global Macro Tipping Points (GMTP) Service is an integral part of our monthly Process of Abstraction research
methodology. The process starts monthly with the Tipping Points and completes with a final Synthesis. The
sequence is optimized to align with the established Macro Economic Data releases.

Section

Release
Date

II.

3rd Saturday
of the Month

III.

I.

1st Day of the

Month

Day Following
Monthly Labor
Report
(~ 1st Saturday)

Service

Coverage

Tipping Points

Tipping Points

Abstraction

Global Macro

Abstraction

US Economy

Technical Analysis

Technical Analysis

Market Analytics

Fundamental Analysis

Market Analytics

Risk Analysis

Synthesis

Commentary

Synthesis

Commentary

Thesis

Conclusions

Global Macro Tipping Points

(GMTP)

Market Analytics & Technical

Analysis (MTA)

Monthly Market Commentary

(MMC)

September 2011 Edition

4

Focus

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TIPPING POINTS
WE ARE HERE

September 2011 Edition

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SHIFTING TIPPING POINTS - Changes to Watch

Sovereign EU Debt and the EU Banking Crisis have once again returned to the number one and two spots in our
Tipping Points ranking. This was reflected in last month's report.
The rankings have not changed during the last 30 days
CURRENT

Q4 '10

CHANGE

Sovereign Debt

INCREASES

EU Banking Crisis

Geo-Political Event

37

+34

Social Unrest

36

+32

Risk Reversal

Rising Inflation &

Interest Pressures
Food Price Pressures

14

+8

15

+8

Oil Price Pressures

30

+22

North & South Korea

35

12

-23

Bond Bubble

17

-14

Financial Crisis Program

Expiration

34

24

-10

MAJOR DECREASES

We need to continue to carefully watch:

1) The increasing & broadening potential for Global Contagion as a result of:
- Japan:

Yen Carry Trade Unwind & an FX fallout,

- North Africa:

An escalation of the Libyan Civil War and UN Military involvement,

- Middle East:

Mounting pressures on oil prices due to worsening social unrest,

- EU PIIGS:

Sovereign Debt Crisis, EU Banking problems and Spain potentially being next,

- CEE:

Central & Eastern Europe is not presently getting the attention it deserves. it is
the 'sub-price' of Europe
and has yet to be addressed.
2) How and if Global Central Banks actually do unwind
their crisis triage programs or are they permanent?
Specifically, what will the US Federal Reserve signal in
late April and May regarding the expiration of
Quantitative Easing (QE) II. It was originally planned
to expire in June 2011.
3) What G20 Government public policy initiatives will
be concerning:
- Weakening economic conditions
- Chronic unemployment levels.
These events will allow us to determine if our roadmap is still
valid or if we are going to see an acceleration in weakening
global financial conditions.

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Social Unrest
Our 2011 Thesis analysis outlined that we needed to be watching for a major shift towards Conflict and Tension
in 2011. This prediction has arrived with an unexpected jolt in Q1 2011, even to us!
Social Unrest and Geo-Political Tensions seem to have broken out globally in a wide spread fashion. It is our
opinion that the drivers behind these tensions are rising food, energy and cost of living prices, that coupled with
extreme levels of unemployment is heralding an era of unprecedented levels of global unrest.

September 2011 Edition

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SOVEREIGN DEBT - PIIGS

Insolvency and Inability to stimulate

Q2

Q4

2011

2010

Diff.

37

+34

36

+32

14

+8

15

+8

economies
EU BANKING CRISIS

Bank Ratios of 50:1 and toxic debt on and off

the balance sheet

GEO-POLITICAL EVENT

A sovereign country overthrow, rebellion or

insurrection

SOCIAL UNREST

Public rallies, protests and rioting against the

government.

RISK REVERSAL

Historic level of financial market participation

and dependency (i.e. pension entitlements)

RISING INFLATION PRESSURES &

Reversal in Interest rate and impact on

INTEREST RATES

government financing budgets

FOOD PRICE PRESSURES

Production shortages, distribution breakdowns with growing Asian demand

OIL PRICE PRESSURES

Shortages, Peak Oil & Asian Growth demand.

30

+22

CHINA BUBBLE

Real Estate & speculative bubbles

22

+13

RESIDENTIAL REAL ESTATE

Shadow Inventory, Strategic Defaults,

10

-4

PHASE II

Looming Option ARMS python, LTV levels.

US BANKING CRISIS II

Deferred accounted write-downs for Real

11

10

-1

Estate, Commercial Real Estate & HELOCS

CHRONIC UNEMPLOYMENT

Historic Unemployment rates in G7

12

-3

COMMERCIAL REAL ESTATE

Market Values are down 45 - 55% with little

13

-6

14

18

+4

15

-11

16

31

+15

write downs as of yet being taken by banks,

insurance or financial holders.
JAPAN DEBT DEFLATION SPIRAL

Ability for Japan to continue to fund national

debt with shifting demographic patterns.

US STATE & LOCAL GOVERNMENT

Unprecedented budget shortfalls & funding

problems

NATURAL PHYSICAL DISASTER

Presently: Japan's Earthquake, Tsunami and

Nuclear Accident. -- The Economic Fallout

BOND BUBBLE

Historically high Bond Prices

17

-14

PUBLIC POLICY MISCUES

Impact of Obamacare, Dodd-Frank Bill and

18

13

-5

19

27

+8

others in reaction to present environment.

SHRINKING REVENUE GROWTH

Slowing Corporate Top-Line revenue growth

RATE

rates

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CENTRAL & EASTERN EUROPE

The Sub Price of Europe Level of borrowing

20

-12

in non sovereign currency (EU loans)

PENSION ENTITLEMENT CRISIS

Unfunded Pension Liabilities - > $100T in US

21

11

-10

US DOLLAR WEAKNESS

Domestic Inflationary Pressures

22

28

+6

CREDIT CONTRACTION II

Bankruptcy & Mal-Investment Catalyst

23

18

-5

US FISCAL, TRADE AND ACCOUNT

Inability of the US to finance imbalances

24

21

-3

FINANCE & INSUR. BALANCE SHEET

Accounting for Commercial Real Estate

25

17

-8

WRITE-OFFS

market values, loan loss reserves

US STOCK MARKET VALUATIONS

Over-Valuation and unrealistic earnings

26

16

-10

27

23

-4

IMBALANCES

estimates.
GOVERNMENT BACKSTOP

Fannie, Freddie, Ginnie, FHA, FDIC, Pension

INSURANCE

Guarantee backstop funding.

GLOBAL OUTPUT GAP

Global Overcapacity & Underutilization

28

29

+1

US RESERVE CURRENCY

Emergence of alternative solutions such as

29

20

-9

SDRs. Inflationary repatriation impact

PUBLIC SENTIMENT & CONFIDENCE

Growing social unrest and public rage

30

26

-4

SLOWING RETAIL & CONSUMER

Impact of slowing consumer sales and

31

25

-6

SALES

increasing savings rate on 70% consumption

US Economy

CORPORATE BANKRUPTCIES

Reverse Gearing & margin pressures

32

24

-8

TERRORIST EVENT

Unknown black swan

33

35

+2

FINANCIAL CRISIS PROGRAMS

Withdrawal of Financial Crisis Triage

34

24

-10

EXPIRATION

Programs and interest rate normalization

NORTH & SOUTH KOREA

Geo-Political tensions - Escalating

35

12

-23

IRAN NUCLEAR THREAT

Israeli attack on Iran - Middle East escalation

36

33

-3

PANDEMIC /EPIDEMIC

Unknown black swan

37

32

-5

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TIPPING POINTS IN FOCUS: August 2011

I - SOVEREIGN DEBT
As quickly as one solution is proposed to
contain potential contagion due to the EU
Sovereign Debt Crisis, it is discarded for
another.
The problem is as much political as it is the
economics of how to structure a financial
work-out to the crisis.
The biggest hurdle is whether the members
states, and most significantly Germany, can
accept a stronger fiscal Union within the EU.
With it comes huge financial burdens on the
wealthier states and its citizens who
ultimately must pay!
A solution will be found that will liekyl be
nothing more than "kicking- the-can=downthe road".

II - EU BANKING CRISIS

The European Stress Tests were released

Friday July 15th, 2011.
Generally analysts derided the latest round of
industry stress tests as inadequate.
Analysts and investors said the criteria used
by the EBA were overly optimistic and failed
to capture the severity of the current
sovereign debt crisis sweeping across the
euro zone.
The EBA has already faced criticism for being
too soft, particularly because it did not make
any allowance for a sovereign debt default
as is now widely expected in Greece.
Simply said, the Stress Tests did not alleviate
the concern about EU banks ability to
withstand fallout from a sovereign debt
default - especially when only 15% discounts
were used for Greek bonds already trading at
more than a 50% discount.

September 2011 Edition

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