Fiat Laws

This note was originally published at 8am on May 09, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“Man is free if he needs to obey no person but solely the laws.”

-Immanuel Kant


Kant was an 18th century German philosopher who over-weighted the value of real-life experience versus academic theory. Hayek used Kant’s aforementioned quote in “The Road To Serfdom” to support his point that unchecked government planning and the Rule of Law run counter to each other’s objectives.


“By giving the government unlimited powers, the most arbitrary rule can be made legal; and in this way a democracy may set up the most complete despotism imaginable.” (F.A. Hayek, “The Road To Serfdom”, 1944, page 119).


Since professional politicians gave Hank Paulson the TARP “bazooka” and started begging The Bernank for both “shock & awe” rate cuts to zero (2008), then The Quantitative Guessing (2009-2010), we’ve been waking up every morning trying to manage risk around Fiat Laws.


This morning’s speculation as to what the European Union is going to do with Greece’s $110,000,000,000 lifeline of bailout Euros is no different than the perpetual risk management exercise of Gaming Policy that we engage with here in the US. It’s a sad state of the “free” market union.


The good news is that we can measure the Global Macro risks embedded in the next Big Government Intervention mathematically. If the intermediate-term TREND of US Dollar Debauchery is going to change, the currency market is going to signal that to us in real-time.


Last week’s short squeeze in the US Dollar did exactly what we thought it would do if and when it stopped crashing – it started making everything else start to crash. The Bernank calls this “The Price Stability.”


With the US Dollar closing up +2.6% week-over-week (only it’s 5th up week in the last 19 weeks), here’s what The Correlation Risk looked like:

  1. Euro = DOWN -3.4%
  2. CRB Commodities Index = DOWN -8.9%
  3. WTI Crude Oil = DOWN -14.7%
  4. Gold = DOWN -4.2%
  5. Copper = DOWN -4.8%
  6. Volatility (VIX) = UP +24.7%

No, that’s not a typo on the marked-to-market pricing of The Price Volatility associated with The Bernank pandering to the political winds and keeping “hope” for a 3rd round of rule making (QE3) alive.


Now, for myself, The Price Volatility is cool because I’m trying to prove that Big Government Intervention in our markets does nothing but A) shorten economic cycles and B) amplify market volatility.


For our profession and the economy that we live in, it’s not so cool. Last week’s US jobless claims (474,000 – breaking out to the upside) reflect this. So does the weekly Bloomberg consumer confidence survey coming in at minus -46.1. Volatility crushes confidence.


While there is a lot of partisan fanfare about a “bull market in stocks”, I don’t think I have ever seen so much storytelling go alongside a +6.6% YTD return for the SP500 since I started in this business 13 years ago.


Globally, as of Friday’s closing prices, the big “bull market” in equities isn’t especially bullish looking either. Take a look at the Top 3 Global Equity market performers for 2011 YTD:

  1. Venezuela = +17.6%
  2. Hungary = +11.2%
  3. Romania = +10.0%

Go Chavez and the Keynesian Kingdom?


Notwithstanding The Price Volatility that it’s taken us to get to another lower-long-term high in US Equities (down -14.4% versus it’s October 2007 peak), isn’t it interesting that there are only 3 stock markets in the world with double digit returns for the YTD?


Markets aren’t “free” – at least not like they used to be. And being reminded of that last week is why I took up the Cash position in the Hedgeye Asset Allocation Model on the Bin Laden news. Here are my current asset allocations and positions:

  1. Cash = 43% (versus 34% last Monday)
  2. International Currencies = 24% (Chinese Yuan and British Pounds – CYB and FXB)
  3. Commodities = 12% (Gold and Oil – GLD and OIL)
  4. Fixed Income = 9% ( US Treasury Flattener – FLAT)
  5. International Equities = 6% (China – CAF)
  6. US Equities = 6% (Technology – XLK)

As a reminder, the way I think about asset allocation is the way I think about my own net worth. I’m not saying that’s a perfect methodology for everyone else – I’m just saying it’s the only one I can hold myself accountable to. So after a +98.2% two-year rally in US stocks (where we got bullish in 2009), it shouldn’t be a surprise to see me wait and watch for my spots to get invested again.


We made a call in April of 2010 called “May Showers” that saw The Price Volatility index (VIX) shoot up to 45 by June. Looking ahead at the US political calendar of deficit and debt ceiling debates this June, I’m not especially hurried to be levering myself up alongside my least favorite Fiat Fools either. I’d rather obey my own risk management laws.


My immediate-term support and resistance line for Gold are $1485 and $1521, respectively. Immediate-term support and resistance for oil are $98.63 and $109.11, and my immediate-term support and resistance lines for the SP500 are now 1333 and 1351, respectively.


Best of luck out there this week,



Keith R. McCullough
Chief Executive Officer


Fiat Laws - Chart of the Day


Fiat Laws - Virtual Portfolio




TODAY’S S&P 500 SET-UP - May 12, 2011


In our Q2 Global Macro Theme slide deck, we call this stage of asset prices (relative to USD) “Deflating The Inflation” – send an email to if you need those slides  and scenario analysis (we also have the conference call replay on the Hedgeye Portal).


Obviously with last week’s hyper correlation risk (USD +2.6% week = Oil down -14.7%, CRB -8.9% on the week, etc), yesterday’s unwind was proactively predictable.  USD UP = CRB index down -2.9% on the day – and oil hammered (we made a call to sell Oil on Tuesday).


The Hedgeye models are registering immediate-term TRADE (3 weeks or less) downside in WTI Crude Oil this morning of $93.33/barrel. That’s eye opening – and the other side of the biggest net long position in hedge fund history should be. The only “commodity” we are long here is gold.  The Immediate-term TRADE ranges to watch on the way up to USD immediate-term TRADE overbought line = 75.79:


The reason why the Hedgeye models have USD and Euro “neutral” in the immediate-term is that the big moves in both are now in the rear view mirror! USD is bullish TRADE, bearish TREND whereas Euro is bearish TRADE (resist = 1.44), bullish TREND (support = 1.40). As we look at today’s set up for the S&P 500, the range is 18 points or -0.83% downside to 1331 and 0.52% upside to 1349.









  • ADVANCE/DECLINE LINE: -1431 (-3326)  
  • VOLUME: NYSE 975.04 (+16.76%)
  • VIX:  16.95 +6.54% YTD PERFORMANCE: -4.51%
  • SPX PUT/CALL RATIO: 2.20 from 1.54 (+43.06%)



  • TED SPREAD: 24.70
  • 3-MONTH T-BILL YIELD: 0.03%
  • 10-Year: 3.19 from 3.23
  • YIELD CURVE: 2.62 from 2.60 



  • 8:30 a.m.: Fed’s Plosser speaks in Aventura, Florida
  • 8:30 a.m.: Initial jobless claims, est. 430k, prior 474k
  • 8:30 a.m.: Net export sales (commods)
  • 8:30 a.m.: Producer price index, est 0.6% M/m, prior 0.7%
  • 8:30 a.m.: Retail sales, est. 0.6%, prior 0.4%
  • 9:30 a.m.: Senate Banking committee votes on Fed nominee Diamond; Fed Chairman Ben Bernanke then testifies in oversight hearing on Dodd-Frank law
  • 9:45 a.m.: Bloomberg consumer comfort, est. (-45.9), prior (-46.2)
  • 10 a.m.: Business inventories, est. 0.9%, prior 0.5%
  • 10:30 a.m.: EIA natural gas storage, est. 71, prior 72
  • 1 p.m.: U.S. to sell $16b 30-yr bonds
  • 8 p.m.: Bernanke gives brief remarks at award ceremony in Wash.


  • AT&T to cut lots of jobs if its purchase of T-Mobile USA is approved - NY Post
  • China raises reserve requirement ratios for banks by 50 bp to 21%; The reserve requirement ratio increase is effective 18-May
  • EPS season ending ugly with the CSCO quarter - Soon it will be MACRO time
  • Reserve-rich Asian countries still see US Treasuries as the safest bet - Reuters







  • Commodities Drop for Second Day as Higher Rates May Curb Economic Growth
  • Crude Oil Declines After IEA Cuts 2011 Global Demand Forecast on Prices
  • Copper Slides to a Five-Month Low as Tightening Cuts Into Demand in China
  • Gold, Silver Decline as Dollar Gain Reduces Alternative Investment Demand
  • Cocoa Falls as Ivory Coast Exports Add to Supply; Arabica Coffee Declines
  • Investors Shifting to Cash From Commodities as Outlook Dims in Global Poll
  • China’s Sugar Imports May Be 28% More Than Forecast by U.S., Olam Says
  • Corn, Wheat Extend Decline as Crude Oil Trims Gains, Dollar Strengthens
  • West African Oil’s Two-Year High Threatens Growth in India: Energy Markets
  • Shanghai Exchange May Widen Silver Trading Band Tomorrow After Price Drop
  • Food Prices May Extend Advance, Adding to Inflationary Pressure, FAO Says
  • Japan Orders Slaughter of All Cattle Around Fukushima Nuclear-Power Planth








  • EuroZone Mar Industrial production +5.3% vs consensus +6.2% and prior revised +7.7% from +7.3%; EuroZone mar Industrial Production (0.2%) m/m vs consensus +0.3% and prior revised +0.6% from +0.4%
  • UK March Manufacturing output +2.7% y/y vs consensus +2.8% and prior +4.9%; UK March Manufacturing output +0.2% m/m vs consensus +0.3% and prior +0.0%
  • UK Mar Industrial output y/y +0.7% y/y vs consensus +1.1% and prior +2.4%; UK Mar Industrial output m/m +0.3% y/y vs consensus +0.8% and prior (1.2%)
  • France Apr CPI +2.2% y/y vs consensus +2.2% and prior +2.2%; France Apr CPI +0.4% m/m vs consensus +0.4% and prior +0.9%
  • Markets are weal across the board; Oil markets are leading the way down.





  • Asian market were weak across the board
  • Japan April M3 +2.1% y/y. March trade surplus (77.9%) y/y. March current account surplus (34.3%) y/y to ¥1.679T vs consensus ¥1.731T.
  • Australia April employment (22,100) m/m vs consensus +17,000; April unemployment 4.9%, matching expectations..








Howard Penney

Managing Director


Huge quarter but upside from consensus was all due to high hold.



"The first quarter 2011 revenue are good as a result of the execution of our overseas marketing plans. The enhanced product offerings and service excellence that our customers demand, will allow us to build significant brand equity over time as the foremost destination resort in Asia."




  • Genting Singapore IR 1Q11 detail (S$MM's):
    • Casino revenue: 804.4MM
    • Non-gaming non-gaming: 109.154MM
    • Adjusted EBITDA: 537.9MM (59% EBITDA margin)
  • Group revenue was S$922.6MM and Adjusted EBITDA was S$529.4MM
  • "Singapore IR experienced good win percentage and gaming volume in the first quarter of 2011 with steady growth in Universal Studio Singapore (“USS”) and the hotels."
  • USS daily average visitation: 7,400 and average daily spend per visitor was: S$88 per visitor
  • Hotel occupancy: 79% and ADR: S$280
  • D&A: S$76.6MM
  • "Higher finance costs of S$39.7 million was mainly due to charges related to the refinanced syndicated loan facility"
  • "Higher taxation of S$77.4 million in the first quarter of 2011 mainly from the higher deferred tax expenses due to temporary difference in property, plant & equipment."
  • Capex in the period was S$0.46BN
  • "Our Casino VIP rolling market segment continues to be a major contributor to the total gaming revenue with growth compared to the previous quarter at 19%. The Casino VIP rolling revenue is now 62% of the total gross gaming revenue."
  • "We are delighted that we have been able to attract record volumes of overseas visitors to our resort, and Universal Studios Singapore continues to be a major draw for the young and not so young from around the region."
  • "Hotel occupancy has been good and our bundled products have been extremely popular. Quarter 2 bookings continue to be encouraging and we look forward to a strong summer holiday season."
  • "We are encountering some unforeseen difficulties which may delay the completion of the second phase. However, we are addressing this issue and have allocated resources to catch up with the schedule."


  • Next week, Journey from Madagascar will open and USS will celebrate its grand opening
  • VIP net revenue market share has grown from 65% to 68%
  • They believe that the Mass market has entered a steady state, and therefore will not show big growth with aggressive marketing and comps to the local population which they won't do
  • 3.8% hold rate this quarter helped achieve their high margin this quarter
  • Gaming revenue was 88% of total rev
  • No update on junket approvals
  • MICE team did over 670 events, making the IR one of the 3 most active MICE players.
  • Maritime Museum is set to open in the quarter, which should be a big attraction


  • Rolling was 60% of their revenue, non-rolling was 40% - so they still have the majority market share in both segments
  • There will definitely be organic growth in Mass, but it has usually tracked GDP plus around the region
  • Long term stabilized margin target is still between 45-50%
  • Was there a sequential decline in the RC volumes?
    • RC volume declined sequentially and they expected that given that when people lose faster they roll less
  • Post Golden Week, they are still quite happy with business
  • Delays on PH2?
    • There are minimal capex implications
    • The delay is a few months due to design enhancements
    • The delay is specific to just a few components - but they wouldn't elaborate
  • Any thoughts on a clamp down post election?
    • They will not pursue any marketing campaigns targeted at the local market
  • Level of write-offs?
    • Ratio of the provision of bad debt vs. receivables has come down
  • Seasonality?
    • Still hard to say until another year or so
    • Will be opening parts of the West zone in the 2H11 which will positively impact the visitation to the resort
  • Taxes is their largest expense, followed by primarily fixed labor expenses (20% is variable / 80% fixed). They don't see any significant expense increase.
  • ETG's increased by about 150 machines. They are getting a little better than organic growth on the ETG side. The max is 2,500 and they are at 2,000 ETGs
  • The restriction on their gaming floor is the restriction on SQFT on the main gaming floor - they are always tweaking the mix to maximize revenues
  • 589 tables at 3/31/2011 (30% are VIP); 1,437 slots, 363 ETGs
  • Interest expense: The facility is already fully drawn down. Going forward the interest expense will be a little lower because this quarter includes a refinancing fee
  • Market share for RC volume was 59% vs 4Q share was 67%
  • How much of their gaming SQFT have they used so far?
    • 90%
    • Still in the planning stage for the rest
  • There was a reduction in construction payables this quarter
  • What's the residual capex for the West Zone?
    • 1Q capex wasn't for west zone - so there is still S$700-800MM to be spent of which S$100MM has been spent
  • VIP net revenue was 50% of net total gaming revenue and 62% at the gross level of total gaming revenue
  • The commission rate was slightly lower than last quarter - they are not buying the business or increasing commissions
  • VIP demographics - the market segmentation is still similar and don't see material shifting
  • Allocated minimal space to poker on their floor. They will continue to tweak their mix on on the floor to maximize win
  • First quarter they have collected a lot more of their receivables than last Q - less than 40% of receivables are past 30 days due
  • Mass market drop was pretty flat but they held pretty well
  • Would EBITDA have been S$400-410MM for the Q if hold was 2.8%?
    • No Comment

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Notable news items and price action from the past twenty-fours along with our fundamental view on select names.
  • In the QSR space the notable call-outs were WEN, TAST and SBUX all down more than 1% on accelerating volume
  • In the FSR space the notable outperformers were RRGB, CPKI and TXRH; all up on accelerating volume
  • Sonic plans to simplify its crowded food-and-drink lineup when it introduces new menu boards on May 26. But gaining breathing room comes at the cost of removing 18 slower-selling items.  In the short run SSS will suffer.
  • Chipotle Mexican Grill Inc's (CMG.N) legal costs are starting to rise as the result of a federal probe into its hiring practices - CFO
  • MIDD, THI and COSI report EPS today



Fear Mongering Meets Brinksmanship: A Comprehensive Guide to Navigating the Debt Ceiling Debate

Conclusion: We expect the current debt ceiling debate to heat up substantially in the coming weeks, resulting in a measured pickup in volatility across global financial markets, primarily as a result of increased  volatility in the US Dollar being driven by the whims of D.C. politicking. Further, we expect the debt limit to be increased prior to any sort of default on any of the federal government’s obligations. And within that legislation, we would expect to see the groundwork laid for potentially meaningful fiscal reform ahead of the FY12 budget debate – an event that is likely to prove dollar bullish when it’s all said and done.


Position: Short the US Dollar (UUP); Long Gold (GLD).


With the debt ceiling debacle looming over the horizon, we thought we’d use the opportunity to equip you with an in-depth guide for navigating the next 3-4 months of what is likely to be heightened volatility for global currency, bond, and equity markets. Even as QE2 expires in June, macro markets are likely to continue to gyrate on the whims and words of a few “inspired” politicians within our nation’s capitol.


Fear Mongering Meets Brinksmanship: A Comprehensive Guide to Navigating the Debt Ceiling Debate - 1


In short, while we accept the consensus belief that the debt ceiling will eventually be extended prior to any sort of default on the US government’s obligations, we do believe the events and rhetoric leading up to the passage of any deal will be anything but “smooth sailing”. As such, we are in the process of taking down our gross and net exposure within the Hedgeye Asset Allocation Model and Virtual Portfolio due to our expectation of heighted volatility in the months ahead. Below we explain the drivers of said volatility via an in-depth analysis of the current political situation and previous debt ceiling impasses.


Current Situation


Hitting the Ceiling: Congress created the statutory federal debt limit in the Second Liberty Bond Act of 1917 as a result of negotiations which resulted in securing financing for WWI and creating an additional check on the fiscal power of the executive branch/ruling party. While federal debt is appropriately divided between debt held by the public and intra-governmental debt, nearly all of it is subject to the limit. The powers that be at the time of creation appropriately intended the debt ceiling to be a reoccurring opportunity to reassess the direction of the US’s fiscal policy. It is, however, not without limitations, as the current consequences of not increasing the debt ceiling almost always outweigh the current consequences of extending it, making it quite toothless from a policy making point of view.


Creating Headroom: As indicated in Treasury Secretary Geithner’s most recent letter to Congress on May 2nd, we are scheduled to hit the current $14.294T debt limit on this upcoming Monday, May 16th. As such, Geithner & Co. must take “extraordinary measures” to ensure the US government has enough cash on hand to navigate the timing of cash flows in order to fulfill its existing obligations.


The first trick in his bag of is to declare a “debt issuance suspension period”. This allows him to suspend (until further notice) the issuance of State and Local Government Securities, prematurely redeem existing Treasury securities held by the Civil Service Retirement and Disability Fund, suspend the issuance to that fund as investments, and suspend the daily reinvestment of Treasury securities held by the Government Securities Investment Fund of the Federal Employees Retirement System Thrift Savings Plan. In addition, he may be forced to suspend the daily reinvestment of Treasury securities held as investments by the Exchange Stabilization Fund. For the sake of brevity, we’re not going to explore in this report the exact technical mechanisms by which these measures contribute to freeing up headroom under the debt ceiling, as the net result of each step is overwhelmingly benign as it relates to the economy and financial markets. For all those interested in digging into these processes a bit more, we are happy to follow up with you.


All told, in conjunction with “higher than expected tax receipts”, the aforementioned measures are expected to extend the Treasury’s borrowing authority until “roughly” August 2nd under current projections for financing needs ($738B through the September 30th end of FY11 as of April 27th). The Treasury has asked for a $2 trillion hike in the debt limit to accommodate financing through FY12 under current budget projections.


After the ceiling is hit on or around that date, the US government will begin to default on its obligations absent an increase in the debt ceiling or some form of temporary legislation exempting new issuance from being counted towards the statuary debt limit. What is being made clear by Geithner’s letters to Congress is that he considers any failure to pay any of the US government’s obligations (not just interest payments and principal redemptions on Treasury securities) as a detriment to the full faith and credit backing America’s hand shake. While we don’t often agree with the man, we do find common ground on this principle and we believe the vast majority of Americans would agree. Below is a list of federal government liabilities that would be directly impacted should the debt ceiling not get raised in time: 

  • US military salaries and retirement benefits;
  • Social Security and Medicare benefits;
  • Veteran’s benefits;
  • Federal civil service salaries and retirement benefits;
  • Individual and corporate tax refunds;
  • Unemployment benefits to States;
  • Defense vendor payments;
  • Student loan payments;
  • Medicaid payments to States; and
  • General operational expenses for federal government facilities. 

Net-net, the sheer breadth of this list alone gives us conviction that Congress will ultimately enact a permanent increase in the debt ceiling or at least kick the can down the road by temporarily upping the limit to accommodate borrowing needs through the either the remainder of FY11 or CY11. Of course, as with all of life’s many destinations, it’s the journey there that matters most. Given that, we offer the next section as a guide for the road ahead.


Political Stakes: Since 1960, Congress has passed legislation which increased (permanently or temporarily) or revised the definition of the debt ceiling 78 times – 49 times under Republican presidents and 29 times under Democratic presidents. So while it may seem like reaching the debt ceiling is a big deal at face value, in reality, increasing the debt limit is quite a common occurrence.


Judging by the political posturing and partisan rhetoric being thrown around Capitol Hill currently, however, we expect this round of Piling Debt Upon Debt to be anything but commonplace – especially with characters like Boehner and Reid leading the charge. The next few months will be full of enough headline-worthy news quotes, political posturing, brinksmanship, and enough fear mongering to rattle global financial markets. As we outlined at the beginning of the year, the 112th Congress is among the greatest risks to global financial stability. This summer we expect them to prove us right in spades.


As such, we’ve compiled recent quotes from politicians on either side of the aisle in an effort to outline the strategies and goals of each party in the upcoming negotiations. While paraphrasing would indeed save time and space, we find their messages better delivered by actually “YouTubing” these bureaucrats at face value.  Also, if we’ve learned anything from the near government shut down we’ve recently experienced several weeks back (over just $38.5B in “reported” budget cuts), it’s that neither side is afraid to send us to the edge of chaos in order to advance their political agenda.



  • 5/9: Charles Schumer, Chairman of the Senate Rules Committee, NY: “Mr. Boehner needs to have an adult moment here and now… This next speech by the Speaker will be a litmus test on whether House Republicans plan to finally approach the debt ceiling as adults. So far many of them have not been responsible about this issue at all.”
  • 5/9: Roger Altman, Chairman of Evercore Partners, former Treasury Secretary under Clinton, and consultant of Sen. Schumer: “Markets could crash if it begins to look like Congress will allow a default.”
  • 5/10: Kent Conrad, Senate Budget Committee Chairman, ND: Unveiled a budget proposal which called for a 50-50 split between spending cuts and tax increases. The plan was immediately rejected by Republicans.
  • 5/10: Jay Carey, White House Press Secretary: “It is folly to hold hostage the vote to raise the debt ceiling to prevent the United States of America from defaulting on its obligations to any other piece of legislation… Maximalist positions do not produce compromise.” 
  • 5/10: Chris Van Hollen, MD: “We have identified some areas of common ground [in today’s bipartisan meeting]. The major areas of disagreement have not yet been engaged.” 


  • 1/7: Mike Huckabee, former Governor of AR: “One of the things that gives a little bit of juice for the Republicans is that Senator Barack Obama in 2006 stood on the Senate floor with an impassioned speech, saying that we should not raise the debt limit, that it was the lack of leadership, and that George Bush was just completely derelict in duty by asking Congress to raise the debt limit… Mr. President, we certainly don’t think you’ve made this radical change in just a few years, so we’re going to take you up on it.”
  • 5/5: John Boehner, Speaker of the House, OH: “Instead of talking about billions [of budget cuts], I think it’s time to start talking about trillions. They should be actual cuts and program reforms, not broad deficit or debt targets that punt the tough questions into the future... Nothing is off the table except raising taxes.”
  • 5/5: Mitch McConnell, KY: “We face a crisis that makes the panic of 2008 look like a slow day on Wall Street.” Still, McConnell suggested to the Senate floor that he would only vote for an increase in the debt limit in exchange for “deep and permanent” cuts in federal spending.
  • 5/5: Steve King, IA: “I’d put the cutting off of all funds to ObamaCare on that debt ceiling bill and say, there’s going be no raising of the debt ceiling here by the House of Representatives unless we shut off all funding that is going to implement or enforce ObamaCare.”
  • 5/5: Paul Ryan, WI: “[Spending] caps in and of themselves, alone I don’t think our conference would accept that. The GOP wants a down payment of spending cuts… Knowing that we are very far apart between the president, the Senate and where we are, we are not under any illusion that we’re going to get some grand- slam agreement… getting a single or double instead of a home run is the goal of the talks… Tax increases are off the table and triggers for automatic tax increases are a cop-out for those who cannot cut spending.”
  • 5/9: John Boehner, Speaker of the House, OH: “To increase the debt limit without simultaneously addressing the drivers of our debt – in defiance with the will of our people – would be monumentally arrogant and massively irresponsible. It would send a signal to investors and entrepreneurs everywhere that America still is not serious about dealing with our spending addiction... It’s true that allowing America to default would be irresponsible, but it would be more irresponsible to raise the debt ceiling without simultaneously taking dramatic steps to reduce spending and reform the budget in the process.”
  • 5/9: Michael Steel, Spokesman for Boehner: “The American people flatly reject Senator Schumer’s call for a blank check for the Democrats who run Washington to keep their spending spree going. There’s no way an increase in the debt limit will pass without real spending cuts and reforms.”
  • 5/11: Eric Cantor, House Majority Leader, VA: “The substance of [Tuesday’s] discussions was trying to focus in on areas where we can cut spending and cut it big.” He affirmed house support for Boehner’s recent demands for trillions of dollars in budget cuts, saying “Anything less is not serious”

Tea Party

  • 4/10: Sarah Palin, former VP nominee and Governor of AK: “There needs to be an understanding in the GOP leadership that we cannot provide another tool for the liberals to just incur more debt, and that’s what raising the debt ceiling is going to allow again.”
  • 5/9: Michele Bachmann, MN: Recently stated that any vote to raise the debt ceiling must be attached to a bill fully de-funding ObamaCare. She also criticized Boehner for “squandering” an opportunity to cut spending in the latest continuing resolution.
  • 5/9: William Temple, Head of this fall’s Tea Party National Convention: “We’re telling Boehner and all of the House Republicans they came into office with Tea Party help. We now expect them to keep their promises and hold the ceiling on the national debt.” He added that the party would support a small increase if it were to be accompanied by a major policy win such as the repeal of ObamaCare. 

All in all, the gaping divide between the two ideologies on what it would take to collectively lift the debt ceiling by early August is omnipresent in their recent commentary. While it’s clear that some fiscal reform will be included in any legislation towards increasing the debt ceiling (US dollar bullish), it’s almost equally as clear that: a) it will fall short of current Republican demands (US dollar bearish) because the Democrats are, on the margin, willing to stand their ground and engage in this game of political brinksmanship (evidenced by GOP leaders backing away from their recent support of Paul Ryan’s Medicare reform plan); and b) as political brinksmanship inches us closer to the deadline, we are likely to see a measured increase in fear-mongering quotes that are likely to be the source of much consternation for global financial markets.


As such, we anticipate a broad-based pickup in volatility, given the heighted Correlation Risk we’ve seen across all asset classes to date. This tug-of-war on the US dollar is an acute risk that needs to be managed around, particularly from a timing perspective. In short, the playbook is as follows: Republican compromise = dollar DOWN; Democrat compromise = Dollar UP. Gaming Policy is about to get a little more challenging in the coming months.


Historic Impasses


Below we briefly touch upon prior debt limit impasses and how key financial markets fared in the months leading up to and just beyond the eventual increases.  Keep in mind that the charts below are not at all an attempt to forecast what might happen in the coming months; like history itself, no two debt ceiling periods are alike. Rather, the illustrations below are merely points of reference for pondering how the markets will react this time around.


1985: In September of 1985, the Treasury Department became unable to issue new securities as a result of the statutory limit on federal debt being reached. As such, it was forced to take “extraordinary measures” consisting of and similar to the maneuvers listed in the section above. The debt limit was temporarily increased on November 14, 1985 and permanently increased on December 12,1985 from $1.82T to $2.08T. In addition, the accompanying legislation granted the Treasury Department authority to declare a “debt issuance suspension period” in future debt limit impasses.


Fear Mongering Meets Brinksmanship: A Comprehensive Guide to Navigating the Debt Ceiling Debate - 2


1995-96: On November 15, 1995, the Treasury Department declared the first ever “debt issuance suspension period” and used “extraordinary measures” to finagle its way through the beginning of the next year. It subsequently notified Congress that it did not have enough cash on hand to pay the March 1996 Social Security benefits, at which point Congress responded by temporarily increasing the debt limit in an amount commensurate to the upcoming benefit distribution ($29B).  Just one day before the March 15th deadline, Congress acted to extend the temporary increase by two weeks until March 30th. And just one day before that deadline, Congress passed legislation permanently increasing the debt limit to $5.5T from $4.9T.


Fear Mongering Meets Brinksmanship: A Comprehensive Guide to Navigating the Debt Ceiling Debate - 3


2002-03: At several instances during this two year period, the Treasury Department had to declare “debt issuance suspension periods” (April 4, 2002-April 16, 2002; May 16, 2002-June 28, 2002; and February 20, 2003-May 27, 2003) and take “extraordinary measures” to smooth the timing of cash flows in order to meet the federal government’s obligations. The debt limit was permanently increased twice during this legislative impasse; first on June 28, 2002 to $6.4T from $5.95T and subsequently on  May 27, 2003 to $7.38T.


Fear Mongering Meets Brinksmanship: A Comprehensive Guide to Navigating the Debt Ceiling Debate - 4




While we expect the US dollar to find a bid at some point in the coming months due to the market eventually looking through this impasse to the increased likelihood of meaningful fiscal reform in the intermediate term, we do think the weeks leading up this occurrence will provide another opportunity for the global currency market to vote against the short-term political compromises we continue to see out of Washington D.C. If anything, this exercise will continue to expose to the world just how far away both sides are from agreeing on a credible solution to the #1 issue driving the US’s long-term fiscal and balance sheet deterioration – entitlement spending. Over the near term, we expect the tough choices to continue to get punted to future sessions; as such, we remain short the US dollar and long Gold in the Virtual Portfolio – for now. That will most likely change in the coming months.


Darius Dale



Fear Mongering Meets Brinksmanship: A Comprehensive Guide to Navigating the Debt Ceiling Debate - 5


Sources: US Department of the Treasury, CBO, Government Accountability Office, The, Fox News, Congressional Research Service, and National Association of State Budget Officers.

The Oil Market Has Gotten Ugly in a Hurry

Conclusion:  A myriad of bad news today has taken the price of oil out to the woodshed, though it still has not violated our key support lines.


Position:  Sold OIL yesterday.


While we didn’t have an expert network to advise us, we sold OIL in the Virtual Portfolio yesterday and it was obviously a fortuitous call given today’s action.   Front month oil futures for WTI are down almost 5% currently and trading was halted earlier due to the volatility in trading.  As Keith wrote yesterday when selling the position:


“I have no idea what centrally planned idea is coming down the pike next, so I'll sell here.”


Today, it seems, we know exactly what has come down the pike, which is that the CME, who owns the NYMEX, is increasing margin requirements by 25% at the close today.  Obviously, as we are seeing today, this is not good for the price of oil.  As investors, hedgers, and speculators are forced to either fund margin accounts, or reduce their positions, this obviously creates selling pressure.


To add to the adjustment of margin requirements, inventory levels released from the Department of Energy today were very bearish for the second week in a row. Specifically, crude inventories rose by 3.8 million barrels week-over-week, which is 2.2% above year ago levels. In addition, gasoline stocks were up 1.3 million barrels week-over-week.  This broad increase of inventory was underscored by clear demand destruction as consumption of motor dropped 1.3% last week, which is the lowest level since the week ended February 11th.   In the charts below, we show an increasing trend of oil inventory building in the United States.


The Oil Market Has Gotten Ugly in a Hurry - cushing


The Oil Market Has Gotten Ugly in a Hurry - oil


The Oil Market Has Gotten Ugly in a Hurry - gasoline


Additionally, while emerging market demand still seems solid, Chinese growth of oil imports did show more tepid year-over-year growth with the April import data.   Over the course of the past year, the average monthly year-over-year growth for Chinese oil imports is 10.7%.  In April, and admittedly this is only one month, imports were up only 1.7% year-over-year, which is a deceleration from the prior three months and certainly a cautious flag.


The other important factor to consider today is the relative strength of the U.S. dollar, especially versus the Euro.  Currently, the Euro is down roughly -1.5% in today’s trading versus the U.S. dollar and the U.S. dollar Index is up nearly a full percent.  The value of the U.S. dollar continues to be the key driver of the commodity complex, in particular oil.  In fact, as of last night’s close the correlation between the U.S. dollar and front month crude futures was -0.86 on a six-month basis.


In the chart below, we’ve highlighted our quantitative levels for oil.  The TREND line is $98.63, which is an important support level.  The next level is longer term TAIL line, which is $86.79.  Based on our quantitative models, a sustained violation of the TREND line, typically three days, would put the TAIL line in play, which is more than 12% downside from here.


Daryl G. Jones

Managing Director


The Oil Market Has Gotten Ugly in a Hurry - wti price

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