FURTHER DAMAGE TO THE SECOND HALF RECOVERY THEORY

At the centre of second half recovery theories was also the rebound seen in a number of Chinese indicators including iron ore data.

Now Chinese iron ore prices have fallen again recently and there has been a pickup in iron ore port stocks. More alarming however is the sharp rise in total ships (Panamax and Capesize) sitting at anchor off Chinese ports waiting to offload iron ore stocks. The number has risen to 75 from 55 at the beginning of February and 21 at the beginning of the year.

In addition daily rates for capesize vessels have plunged in recent days to $24000 from a recent high of $43000. Australian and Brazilian iron ore freight rates into China have fallen by 15-20% since last week.

MORE ON THE YEN

Todays MOF portf0lio flow data showed JPY 1,231bln ($12bln) foreign bond outflow. This follows last week's JPY 1,363bln ($14bln), and is the LARGEST 2 week outflow for many years.

Also Japanese investors bot Y215bn of foreign stocks, while foreigners sold Y75bn of JGBs and sold Y450bn of Nikkei.

This reinforces my view from my Yen turnaround post on Monday. Japanese repatriation in March has already taken place and in fact homeland flows are now going massively in the other direction.

The squeeze in USD/JPY and the crosses has been on all week, next to crack maybe Japanese margin traders who are still long JPY vs USD, EUR and GBP.

Japan's export engine still stalled.

Exports in January saw a 46% YoY drop and another 10% MoM fall. Cumulative decline since Sep is 36%. Sure imports are down sharply too - off 33% since September, but this is more price than volume so there is still the negative impact on real GDP.

Every region is getting hammered. Asia -47% YoY, US -53%, Europe -46%. Every product also hammered. Transport equip -54% YoY, electric machinery -47%, general machinery -41%.

Is it any wonder industrial output is crashing - those figures for January will be out on Friday.

Interesting article.

http://www.wired.com/techbiz/it/magazine/17-03/wp_quant?currentPage=1

I have been long Yen for a significant period of time. Today I have taken the position off. Why?

My pimary reasons for having it on were:

1. Massive repatriation to plug balance sheet holes at home and the better tax treatment on repatriated funds after 1 April.
2. Japan's relative "safe haven" status of the Yen.
3. Technicals strongly suggested a new long term high (below 79 vs the USD)

Lets deal with these one by one.

1. I think that this has largely taken place. The need for funds especially at banks has been so great that this has already happened. So that leaves the more structural offshore assets. When I recently met with Mr Saji (Chief Economist at Mitsubishi UFJ Bank) we discussed this issue. According to him there is some Yen 17 trillion sitting offshore but that most of it is invested in fixed assets and it is only the assemblers like Canon and Panasonic that have cash. His checks have persuaded him that this is not going to be a factor and that as long as the domestic investment picture in Japan remains bleak there is no incentive for these funds to move home. I am inclined to agree with him.

2."Safe haven"? Japan is probably in a Depression already, the first of many nations to go there. Its export engine has ground to a halt. It has swung from current a/c surplus to deficit in a big way. The government has the lowest approval rating in history and there is no viable leadership elsewhere. the bankruptcy this week of SFCG may open the floodgates to much more systemic type bankruptcies. Japanese banks credit cost assumptions are way off the mark in my opinion. They all need capital injections urgently. Mizuho has had to pay a 14% yield on its recent issue!The financial system in Japan is once again in crisis. The global crisis has simply masked this to some extent.

3. The technical call is very much a long term one. The high was made in April 1995 and all the action since is probably a huge "supercycle degree" 4th wave, which could easily still be in progress for several more years. So we may still see a new high but not for a long time.

This change of heart has massive implications for my big picture view on things. I do not view the US dollar as a "safe haven" currency and I do not believe that its recent rise is really more than speculative/relative and a result of the deleveraging process. So if there is now NO safe haven currency. GOLD'S recent rise is complementary to that view. I started to go long GOLD two weeks ago for the first time in a long while. More on GOLD later.

Japan's TOPIX Index which is cap weighted closes at a 25 year low today.
Nikkei 225 which is price weighted is still a tad above November lows.

Besides the fact that the country is in a Depression the number and size of capital raisings is starting to become a theme that is sending equities lower.

Nomura Securities started the ball rolling, then T&D Insurance and now Toshiba today. Other likely candidates include Nissan, Mazda, Pioneer, Taisei, Haseko, Tokyo Tatemono and Toku Land to name a few.

This is developing into a theme and I think the theme will go global with a WALL OF DILUTION FACING EQUITY MARKETS.

FURTHER CRACKS IN THE ECONOMIC REBOUND SCENARIO

I cannot emphasize enough how certain sell side strategists (no names mentioned) have influenced their community and most likely the long only community also, that the small bounce in Manf ISM heralded a second half recovery and that the forward looking stock market should therefore bottom.

I think it is no accident that the Dow closed at a new closing low (Dow Theory sell signal to boot) just as the second crack appeared in that theory with last nights release of the Philly Fed Manf Index. It plunged to -41.3 vs -24.3 previous and -25 consensus to a new low for the cycle.

In the details of the report, most major subcomponents pointed to an accelerating pace of decline, including new orders (-30.3 vs. -22.3), shipments (-32.4 vs. -16.7), unfilled orders (-32.1 vs. -31.1), delivery time (-29.2 vs. -26.5) and employment (-45.8 vs. -39.0). One noteworthy improvement was the 6-month outlook, which rose to 15.9 from 7.4 previously—interesting given the broad-based weakness in current conditions. Denial? The prices paid component pointed to a slower pace of decline (-13.7 vs. -27.0), although the deterioration in pricing power among producers accelerated as prices received fell even lower (-27.8 vs. -26.2). The fact that both the NY and Philly manufacturing indices were significantly worse than expected (and significantly worse than in January) implies downside risks to the February ISM number.

The LEI or Leading Economic indicator posted another increase for the same reason it advanced the prior month-strong positive contributions from two financial indicators, the real money supply (worth0.54 points) and the yield curve (another 0.23). The uptick is therefore just a direct result of the FED actions. The FED smokescreen got blown away by the Philly!

Look for 'give up' type selling from long only's and a "white flag" from certain strategists. Maybe no yacht this year after all.

HOPES OF ECONOMIC REBOUND TAKE A KNOCK

After the small rebound in the last reported US ISM manufacturing number a wave of hope spread through markets that we were going to see a second half economic recovery.

Today's Empire Manufacturing survey REVERSED it's small rebound falling to new lows for both the headline Empire Index (-34.7 Feb vs -23.75 consensus) and the New Orders sub index.

The Employment sub index also fell to near a record low and the Ave Workweek index (-31 Feb vs -23.9 Jan) fell to a record low.

Price pressures declined for a 3rd straight month but this month selling prices fall outpaced input prices fall!

The Empire Survey. which is the state of New York's, has recently been leading the National ISM index.

Yesterday the Korean Won broke 1400 as the BOK has seemingly given up defending that level.

Why?

Yesterday's 10yr Govt bond auction was met with poor demand. The govt was able to raise KRW584 bill @5.2% versus the target 800 bill. In Jan it got only 462 bill out of 800 bill target also.

Rates are going to have to go higher. Not surprising to see Korean bond spreads moving higher today.

Bust!

iTraxx Japan straddling 500bps today...

There are 50 companies in iTraxx Japan. A trade at 500bps implies a default probability of 21.7% or 11 out of 50, so if less than 11 companies in the list go bankrupt you profit from the trade.

Put into context European iTraxx closed at 156/7 on Friday.

This morning I met with Mr Saji, Chief Economist at Mitsubishi UFJ Bank. He has been the number one rated economist in Japan for over a decade and was made famous by his persistently bearish view of the Japanes economy through it's "lost decade". He is pretty bearish about prospects for the world economy and in particular Japan.

Japan is structurally dependent on exports for economic growth. Despite the past 5 years of economic expansion Japan still could not convert to a domestic demand driven growth structure. During the past 5 years export growth contributed to 143% to Japan's nominal GDP growth rate, far higher than Korea at 78% or China at 43%. While its main competitors currencies are falling the YEN is rising. This is the 'perfect storm'.

I completely agree and it reinforces my technically driven 4000 target for the Nikkei 225 index.

When looking at potential hot spots to ignite further global stress he highlighted Russia. Based on a $35 oil price he believes Russia is already in Current a/c deficit. If oil falls further the focus on Russia financing it external debt will intensify. Recall, I wrote last week:

"Russia’s total official reserves are now US$386 billion, down from US$597 billion in July 2008 - implying an average of close to US$10 billion worth of losses in reserves per week during this period, making this the largest run on a currency in history. The pace of reserve haemorrhaging has accelerated in recent weeks. Continued pressures on the RUB will help push the 'risk' currencies lower."

This is what is driving Asia lower.


Feb. 11 (Bloomberg) -- Woori Bank, South Korea’s second- biggest, won’t exercise an option to redeem $400 million of subordinated bonds as it would be more expensive to refinance the debt than to pay penalty interest.
The Seoul-based bank won’t call the notes due to "current adverse market conditions," it said today in an e-mailed statement, without elaborating. Credit-default swaps on Woori’s subordinated debt jumped 100 basis points to 830 after rising 25 basis points before the announcement, BNP Paribas SA prices show.
"Their decision just destroyed the trust and confidence investors have," said Arthur Lau, a fund manager in Hong Kong with JF Asset Management Ltd., which oversees $128 billion.
"South Korean banks will be struck off from the international capital market for quite some time because of this."
Deutsche Bank AG in December took bondholders by surprise when it passed up a chance to redeem 1 billion euros ($1.3
billion) of notes, paying a penalty rate instead of refinancing the debt at a higher cost. Spain’s Banco Sabadell SA followed suit for its 300 million euro lower-Tier 2 notes on Feb. 4, roiling investors who expect borrowers to repay callable debt at the first opportunity and who value the securities on that basis.
Woori "is considering various liability management alternatives," it said in today’s statement. Bank spokesman Kim Ki Rin said he couldn’t comment further, and Kim Jong Geun, executive vice president in charge of the treasury department, couldn’t be reached for comment.
Domino Effect
Woori’s decision "may trigger a domino effect on Asian banks’ subordinated debt," said Brayan Lai, a credit analyst with Calyon in Hong Kong. "The problem is, it doesn’t make sense economically for Woori to call the bonds in the current market conditions, even after taking into account the step-up cost they would need to pay not to exercise the call."
The bank will need to pay coupon that’s 406.5 basis points more than five-year U.S. government debt after March 13 for the lower Tier-2 notes, data compiled by Bloomberg show. Five-year U.S. Treasuries today yielded 1.79 percent.
The price of its $400 million notes maturing in 2014 plunged to a record low of 79.5 cents on the dollar to give a
12.73 percent yield, compared with 89.5 cents before the announcement, Royal Bank of Scotland Group Plc data show.
Rival Shinhan Bank’s $200 million of 4.5 percent subordinated notes fell to a record 80 cents on the dollar, yielding 9.8 percent compared with 7.9 percent yesterday, RBS prices show.
Credit-default swaps, contracts conceived to protect bondholders against default, pay the buyer face value in exchange for the underlying securities or the cash equivalent should a company fail to adhere to its debt agreements.
A basis point, or 0.01 percentage point, is worth $1,000 on a swap protecting $10 million of debt.
================================


The Deutsche Bank and Banco Sabadell SA decisions got relatively little airplay but 3 strikes and you have a trend maybe the thought process at work.

Real result/interpretation of these actions:

1. The bonds get hit and holders mark them down, more pain alround.
2. The market is still overpricing corporate debt. (The perceived yield on a bank or corporate's existing bonds is still not the rate it could finance at in the market.) These banks actions are tantamount to them saying that they do not agree with the way the market is pricing their debt!!!!!!!!!!!!!!!!!!!!!
3. In turn it makes the equity look more expensive.

Checking now to see what percentage of debt have these "step up to perpetuity" maturity clauses. I know I am an equity guy but perpetuity?? what were buyers thinking?? Stay tuned.

China demonstrating that it's buying of US assets is no sure thing!

China should seek guarantees that its $682 billion holdings of U.S. government debt won’t be eroded by "reckless policies," said Yu Yongding, a former adviser to the central bank.

Premier Wen Jiabao said last month his government’s strategy for investing would focus on safeguarding the value of China’s $1.95 trillion foreign reserves.

China may voice its concerns over U.S. government finances and the potential for a weaker dollar when Secretary of State Hillary Clinton visits China on Feb. 20, according to He Zhicheng, an economist at Agricultural Bank of China, the nation’s third-largest lender by assets.

"In talks with Clinton, China will ask for a guarantee that the U.S. will support the dollar’s exchange rate and make sure China’s dollar-denominated assets are safe," said He in Beijing. "That would be one of the prerequisites for more purchases."


related links:

http://www.bloomberg.com/apps/news?pid=20601009&sid=aG_eSDsmh7rw&refer=bond

MS report out today.

CHINA: FREE FALL IN UPSTREAM PRICES TO BRING ABOUT CPI DEFLATION - February 10, 2009

Deflation is under way: In our view, the latest data confirm that the free fall in upstream prices is bringing about rapid disinflation at the consumer level. We believe it will not be long before we see consumer inflation dipping into negative territory, and we forecast 0.8% CPI deflation this year.

*RUSSIAN BANKS, BUSINESSES SEEK TO RESCHEDULE LOANS, NIKKEI

*This seemingly shocking headlines come from an article on the front page of the Nikkei Shimbun this mornin g (in Japanese only)- It quotes from an interview with the Chairman of the Russian Regional Bank Assoc saying that Russia started negotiations with foreign banks (mainly European) to extend its debt terms. Debt involved totals up to $400B. Russia has already reached agreement with some banks. HSBC, DB are cited as looking to start negotiations. Effect on Japanese banks are unknown.

EUR under pressure.

Deutsche economist in Japan calling DEPRESSION.
Heading for uncharted territory
Unfortunately, we have become further convinced that the ongoing downturn will likely drive the Japanese economy to the most severe depression in the post WWII era, in terms of both depth and duration. It is neither a downturn nor recession anymore, but a severe depression. The DBCLI-ECONOMY, our leading index of the business cycle, has fallen by 24% since the peak and its pace is accelerating, which suggests that economic activity throughout 2009 will continue to deteriorate at a rapid pace. So far the deterioration has been mainly concentrated in manufacturing activity, such as industrial production and exports, but we believe this will spread to non-manufacturing sectors as well, in the forms of deterioration in the labor market and postponing capital investment. We tentatively suspect that he levels of real GDP and real final demand (=GDP minus inventories) will stop falling in 2Q and 3Q 2010 respectively (ie, the QoQ growth is expected to turn flat in those quarters), and that economic recovery at an annualized 1% or higher will be delayed into 2011. Our real GDP growth now stands at -2.3% in FY 2008 (ending March 2009), -6.0% in FY 2009, and -0.9% in FY 2010 (or, -0.4% in calendar 2008, -6.6% in 2009, and -2.0% in 2010).
The following factors are likely to contribute to the severity of the depression, although some of them are already familiar to many people.
1) Severe overseas recession,
2) Capital stock adjustments,
3) Backward-looking monetary policy stance in Japan,
4) JPY appreciation,
5) Downward revision of medium-term expected economic growth,
6) Downward rigidity of wages (higher employment adjustment forces)
7) Negative financial accelerators (through substantial falls in corporate cash flow and tighter lending standards of financial institutions).
Third-round shocks still large enough
Among those, #1 was a pure first-round shock to the Japanese economy. However, Japan's dependence on exports as a source of economic growth, the high income elasticity of exports, and the lack of substantial monetary accommodation relative to other central banks combined together to form a large second-round shock described in items #2 to #4 above. We regrettably forecast this chain is strong enough to result in the third-round shock shown as items #5 to #7 throughout 2009. We should not ignore the tendency that misfortune never comes alone, ie, bad events tend to follow each other in a self-fulfilling way in recessions (the opposite is true in economic recoveries).

Not to mention the corporates repatriating also.

http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aN2_Ux8H74Wg

"Funny money"

So far my sources in Japan are saying that the lobby for government issued banknotes is grandstanding to try to force the BOJ to be more aggressive (this happened before when political pressure had the BOJ keep increasing the reserve target even though they knew it would have no effect) and is NOT a real consideration.

In any case for the YEN the bigger deal is repatriation.

The process of repatriation is probably at most halfway through. Yen repatriation commenced in September 2008. Based on the investment trust fund (ITF) (these are similar to mutual funds) flows, repatriations began in earnest in September 2008, and remained intense throughout 4Q08. The movement of USD/JPY in 2008 was broadly consistent with these ITF flows. With the intensification of pressures on risk assets so far this year, these repatriation flows continued in January, forcing JPY crosses lower. Broadly speaking, in 4Q08, we saw monthly repatriations at a size of US$38 billion per month, about six times the size of monthly outflows during 2004-2007.

The outstanding external ITF stock of investments, as of November 2008 reached around US$233 billion, down from a peak of US$330 billion reached in October 2007, and was similar in size to that of July 2006. There is still substantial scope for further repatriation of ITF money.
This does not include pension funds and life insurance companies. If we look at the BOJ’s balance of payments (BoP) data - which are more comprehensive and three times the size of ITF flows, we see that monthly portfolio outflows have averaged US$11 billion during 1999-2007, and the repatriation has been negligible in recent months. This suggests that Japanese pension funds and life insurance companies are substantially behind in repatriating assets, compared to mutual funds.

In Japan the industrial production index plunged 9.6% MoM in December, its biggest single monthly decline since these statistics have been kept. As a result, output fell at a postwar record of 11.9% QoQ in Q4 2008. Even more shocking is that the Survey of Production Forecasts shows that a further decline of close to 20% is expected in Q1 2009. If this is realized, production will fall 30% in just six months, returning to the level of the early 1980s, before the yen strengthened dramatically. Production is falling off a cliff.

Depression in Japan?


According to the Japan Economic Dictionary (Nikkei Inc.), a depression, based upon the indexes of business conditions, occurs when both the leading and coincident CI turn sharply downward and decline in a straight line. The outlook for the coincident CI closely matches this description. From this viewpoint, it would not be far off the mark to say that the real economy is in a de facto depression.

Deutsche saying that they think the main force behind BDI's rally is meddling by miners who are trying to create the illusion of good demand ahead of commodity price negotiations with Chinese steel mills.

No surely not. PPT in the mining world. It's an epidemic.

Mizuho is Japan's 2nd largest bank by asset size.

The real estate situation in Japan is a disaster. So far Inoue Ind, Suruga, El Create, Urban, Japan General Estate, Morimoto, Dynacity and Human 21 have all gone under.

What did they have in common=Mizuho was one of their main lenders.

Other weak players include Tokyo Tatemono, Cosmos, Meiwa, Joint, Toei, New Japan, Earnest, Area and Atrium.

What do they have in common=Mizuho is their main bank.

Russia’s total official reserves are now US$386 billion, down from US$597 billion in July 2008 - implying an average of close to US$10 billion worth of losses in reserves per week during this period, making this the largest run on a currency in history. The pace of reserve haemorrhaging has accelerated in recent weeks. Continued pressures on the RUB will help push the regional currencies lower.

A classic PPT video:

http://www.cnbc.com/id/15840232?video=931599105

Yesterday I posted an analysis of this Japanese "funny money" issue. Some are saying that is what moved the Yen overnight. FT stirred it up with this article.

MPs step up clash with Bank of Japan By Michiyo Nakamoto in Tokyo
Published: February 5 2009 19:19 Last updated: February 5 2009 19:19
A plan to print some Y50,000bn ($546bn) worth of a new currency to fund pump-priming projects has been drawn up by influential politicians in Japan in a sign of desperation in the ruling Liberal Democratic Party over the country’s failing economy.
To be released on Friday, the proposals to issue government notes come amid rising frustration among politicians with the independent Bank of Japan. It has been reluctant to bow to pressure to run the yen printing presses faster to stimulate the economy.
The politicians include Yoshihide Suga, deputy chairman of the LDP’s election strategy council and a close aide to prime minister Taro Aso, and want the government to issue its own notes to fund projects.
The group wants Y30,000bn of the new money to fund programmes supporting new industries and infrastructure projects, including doubling the size of Tokyo’s Haneda airport. The remaining Y20,000bn would be earmarked for government purchases of stocks and real estate.
“We are facing hyper-deflation, so we need a policy to create hyper-inflation. We have to do something to undermine the central bank and government’s credibility or else we won’t be able to halt the yen’s rise. So, while we know this is drastic medicine, we will do it,” said Koutaro Tamura, an upper house Diet member who will chair the new group.
The plan for the government notes came as Atsushi Mizuno, a board member of the BoJ, warned that the central bank, needed to take “extraordinary” measures to counter Japan’s deepening recession.
Warning that the Japanese economy would remain in a “severe” state, Mr Mizuno said it was “important to be ready to act promptly and consider taking policy action that may be considered extraordinary under normal circumstances”.
Critics said the currency scheme could result in a surge in inflation that would damage the credibility of the BoJ, even though it would not be responsible for issuing the new currency. Others point out that it would be far easier to achieve the same effect by urging the central bank to buy more government bonds.
Richard Jerram, chief economist at Macquarie Securities in Japan, said the emergence of policy proposals that had previously been seen as unthinkable was a “move forward” that could push the monetary authorities into action even if the notes were never printed. “By threatening them with this plan, the real aim could be to twist the BoJ’s arm to take more action,” he said.
The proposals reflect the government’s difficulties, with Japan’s industrial output and exports down by record rates in December and unemployment up the most in over 40 years. With an election due by September at the latest, the BoJ forecasts at least two years of economic contraction and deflation. Voters are increasingly concerned by the government’s lack of decisive economic action.

The govt of course denying it:

http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aA3Wk2_uqs7Y

Some say this is just grandstanding to force the BOJ to print. I am checking with sources in Tokyo stay tuned.

===============================================================

On the other hand a broker is saying the reason for Yen's move was:


A large JPY Spread traded in the broker market this afternoon, with a US
bank behind it. They bought 4bill$ of 27Jan 91.25 USD Calls VS selling 8bill$
of 27Jan 77.00 usd puts. It seems the net Delta of this spread was to buy mutiple yards of USDJPY. At the same time there was also good demand from Cross-JPY into the 4pm Fix.
This flow has caught the market very short USD and Cross-JPY and lots of technical names looking at $JPYandthey have been buying on stops for prop/spec accounts the whole way.

Well so much for that, only panic was in the Kazakstan currency.

5th Feb is a key Astrological date for a possible market panic.