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Geithner Putting the Fourteenth Amendment Into Play

Conclusion:  While Secretary Geithner's strategy of using the Fourteenth Amendment in defending an extension of the debt ceiling appears to have legal precedent, the potential for a Supreme Court showdown between Democrats and Republicans may make the strategy not worth the gamble.

 

Secretary of the Treasury Timothy Geithner has heightened the debate over the debt ceiling extension in recent weeks by implying that the President could simply push through an extension of the debt ceiling based on an interpretation of the Fourteenth Amendment of the United States Constitution.   While rumors of this defense have been circulating for the last 8 weeks or so, the idea was more officially circulated at a May 25th Politico Playbook breakfast at which Mike Allen was hosting Geithner.

 

At that breakfast, Allen asked Geithner about a potential default and the debt ceiling debate and Geithner responded with the following:

 

“I think there are some people who are pretending not to understand it, who think there's leverage for them in threatening a default.  I don't understand it as a negotiating position. I mean really think about it, you're going to say that-- can I read you the Fourteenth Amendment?"

 

Even as President Obama as late as last week has avoided opining or interpreting the Fourteenth Amendment, Geithner, who presumably is speaking as a representative of the administration, has made it very clear that he believes that Fourteenth Amendment gives a President the legal right to extend the debt ceiling.

 

As noted, in the same breakfast Geithner then read the following excerpt, Section 4, from the Fourteenth Amendment:

 

“The validity of the public debt of the United States, authorized by law, including debts incurred for payment of pensions and bounties for services in suppressing insurrection or rebellion, shall not be questioned. But neither the United States nor any State shall assume or pay any debt or obligation incurred in aid of insurrection or rebellion against the United States, or any claim for the loss or emancipation of any slave; but all such debts, obligations and claims shall be held illegal and void.”

 

In fact, the U.S. Supreme Court has actually ruled on the Fourteenth Amendment in Perry v United States (1935).  This case was part of a series of cases brought before the United States Supreme Court that were known as the Gold Clause Cases.  The gist of these cases was to question whether the U.S. Congress could change the form by, or terms under which, U.S. debts could be repaid.

 

The ruling by the Supreme Court in Perry v United States specifically referenced Section 4 in the following excerpt:

 

“Section 4 of the Fourteenth Amendment, declaring that "The validity of the public debt of the United States, authorized by law, . . . shall not be questioned," is confirmatory of a fundamental principle, applying as well to bonds issued after, as to those issued before, the adoption of the Amendment, and the expression "validity of the public debt" embraces whatever concerns the integrity of the public obligations.”

 

So, in effect, it would appear that there is some precedent for Geither’s statements as it seems that the United States Supreme Court has previously ruled that voiding a U.S. government debt is beyond the power of Congress.  Since we are far from legal scholars, we have attached below a link to the ruling:

 

http://supreme.justia.com/us/294/330/case.html

 

As is outlined in the following chart, the credit default swap markets on U.S. government debt are signaling that a default on U.S. government is highly unlikely and the odds of such haven’t increased much over the last six months, which perhaps also gives credence to Geither’s view.  Currently, CDS on 10-year U.S. treasuries are trading at 58bps, which is well off its highs for the year.  By way of comparison, German 10-year CDS are trading at 59bps, Greek CDS are trading at 1,550bps, and Spanish CDS are trading at 268bps.

 

Geithner Putting the Fourteenth Amendment Into Play - 2

 

Even if we accept that President Obama has the legal authority to make a unilateral decision on extending the debt ceiling as Geithner has been suggesting and legal precedent appears to support, the question is really whether it is the most practical or best political path to take. Regarding the latter point, it would seem that while President Obama would get a clear win by trumping the Republican Congress with the Fourteenth Amendment, the downside risk to this strategy is a potentially increased credit risk associated with U.S. sovereign debt and a potential Supreme Court showdown between Republicans and Democrats.

 

So, would the President and the Democratic rank and file actually pursue the Fourteenth Amendment option? While he doesn’t necessarily speak for all Democrats, Senator Schumer said on a call to reporters on July 1st when asked about the Fourteenth Amendment responded, “It is certainly worth exploring.”

 

Indeed.

 

Daryl G. Jones

Director of Research


European Risk Monitor: Greek Pause as Troika and Credit Rating Agencies Wrestle

Positions in Europe: Long Germany (EWG); Short Spain (EWP)

 

With the Greek Confidence vote won, austerity approved, confirmation over the weekend that the country will receive its next €12 Billion tranche on July 15th (from its original €110 billion bailout package), and talk that Greece’s second bailout package (est. €70-120 Billion) will be announced in mid-September,  the intense spotlight on Greece may dim in the coming days and weeks. Yet, the debate will now turn to recent proposals from France and Germany that its banks would voluntarily “restructure” Greek debt holdings by extending repayment on shorter term paper (5 years or less) to 30 year maturities. However, the specific terms, including the interest rate commanded, remains uncertain and as they say, the devil is in the details.

 

Importantly, under such a plan, great friction will develop with the main ratings agencies, which technically rate any form of restructuring (or re-profiling) as default.  We, however, expect some sort of back-door dealings between Troika (EU, ECB, IMF, and institutional banks) and the ratings agencies to modify debt repayments schedules without the mark of “default”, or else some other proposal may be drafted altogether.

 

Our European Risk Monitor signals that risk has mitigated week-over-week following the insurance from PM Papandreou’s confidence vote and confirmation that Greece will receive its next bailout tranche from the EU/IMF. This is represented in the charts below of sovereign CDS spreads and peripheral government 10YR bond yields.

 

European Risk Monitor: Greek Pause as Troika and Credit Rating Agencies Wrestle - m1

 

European Risk Monitor: Greek Pause as Troika and Credit Rating Agencies Wrestle - m2

 

A similar trend is seen in our European Financials CDS Monitor, in which bank swaps across Europe were wider for only 11 of the 39 referenced banks week-over-week, while 28 were tighter.

 

European Risk Monitor: Greek Pause as Troika and Credit Rating Agencies Wrestle - m3

 

While uncertainty surrounds potential restructuring of Greek debt held by public and private institutions, we expect the common currency to hold support with implicit guarantees from Big Brother Troika to prevent default of any member nation, and into the ECB’s interest rate announcement this Thursday (7/7). Trichet has indicated in recent weeks that the Bank is “strongly vigilant” and ready to act against rising inflation that remains above its target of 2% (Eurozone CPI currently stands at 2.7% in May Y/Y). We expect the ECB to raise rates 25bps on Thursday to 1.50%, and remain at that level for the remainder of the year.

 

In the EUR-USD cross, $1.43 remains a critical short-term support trading level we’re managing risk around. Our TRADE resistance stands at $1.45.

 

An important catalyst to keep on your sheets is the announcement of the second round of European Bank Stress Tests, expected on July 13th. Rumors swirl that up to 15 of 91 banks could fail the tests, but the number could be a token figure to convey that the tests were "stringent" enough.

 

Services PMI figures out today showed contracting to slowing figures month-over-month (see table below). Much like Manufacturing PMI figures out last week (for more see our post on 7/1 titled “European Manufacturing Cools in June”), both surveys  point to slowing growth expectations ahead as inflation remains elevated and sovereign debt contagion presses. Italian Services is a notable underperformer in the June survey, with a reading under 50 representing contraction.

 

European Risk Monitor: Greek Pause as Troika and Credit Rating Agencies Wrestle - m4

 

Matthew Hedrick

Analyst


TALES OF THE TAPE: WEN, MCD, CMG, PNRA, JACK, CBOU, PEET, AFCE, KONA, EAT, DRI

Notable news items and price action from the restaurant space as well as our fundamental view on select names.

 

MACRO

 

Wheat and corn prices rose in Chicago on speculation that last week’s losses, which brought the lowest prices of 2011, may have fueled demand from importers.  On Friday last, the Department of Agriculture said that exporters in the U.S. sold 1.14 million metric tons of corn. 

 

 

QUICK SERVICE

  • WEN this morning announced that it has completed the sale of Arby’s Restaurant Group, Inc. on the terms previously announced, to Roark Capital Group, effective as of July 4, 2011.
  • MCD is looking to Twitter as one forum for advertising its products.  On Friday, it is estimated, the company spent $80,000 on purchasing two promoted trends: #ANewMcDFavorite and #LoveMcDsSmoothies.  The response from the twitterverse has been heavily negative and perhaps brings into question the wisdom of spending such sums of money on 24 hour promoted trends.  It will be interesting to see how the company’s sales of smoothies fare this summer, especially given the difficult comps the company is faced with.
  • MCD is set to accelerate expansion into South Africa after striking a developmental license transaction with Cyril Ramaphosa’s Shanduka Group Ltd.
  • CMG has gained confidence in its business’ viability in the UK and Europe following the opening of its Charing Cross store last year.  The Independent (London) reports that it has just signed up for its second site in Baker Street, as well as hiring the property agent Michael Peddar & Co to search for sites in London and the UK.
  • PNRA, JACK, CBOU, PEET, and AFCE all gained on accelerating volume on Friday.


FULL SERVICE

  • KONA, EAT, and DRI gained substantially on accelerating volume on Friday following DRI’s earnings call.
  • RT - Ruby Tuesday appoints Steven Becker and Matthew Drapkin to the board.

TALES OF THE TAPE: WEN, MCD, CMG, PNRA, JACK, CBOU, PEET, AFCE, KONA, EAT, DRI - stocks 75

 

Howard Penney

Managing Director

 

Rory Green

Analyst


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Retail Fuel

 

Conclusion: Sales look decent headed into Thurs. But we think that anecdotes We will fuel the fire for the Street on 2H margin weakness – especially as it relates to earnings season beginning for the vendors in 2 weeks. This has been our call (4.5 Below – 450bos of margin weakness beginning in 2H) and we’re sticking with it. Short JCP, HBI, GIL, COH, CRI, JNY. Long NKE, LIZ, FL.

 

 

Before looking forward, let’s set the context as to where we stand today, and what we’ve been fed over the past year at a Macro level.  

 

As important as things like weather and calendar shifts are, let’s start off with a couple of bigger picture points about the Macro climate ‘then versus now.’

  1. Gross Personal Income was running at about 2.5% compared to about 4.5% today. That’s a function of slightly lower unemployment and marginally higher nominal wage. (positive point)
  2. The two main levers that account for the delta between Gross Income and Personal Consumption pretty much wash each other out.
    1. The consolidated personal tax rate has risen above 10% vs 9.1% this time last year. (negative point)
    2. The personal savings rate, which had been running at 6.1%, has since trended back to 5%.
  3. When we look at what we call ‘essential spending’ (food, energy, healthcare), we’ve seen growth go from 2.6% last year up in nearly a straight line to around 4.3% today.
  4. All that’s left goes into the ‘discretionary spend’ bucket which is far more volatile.  This stood at a healthy 7.5% a year-ago – a level that remains today (at least for now).
  5. Based on our read out of POS data (NPD, SportscanINFO), sales for the month of June were pretty much middle of the road. Apparel decelerated over the course of the month, albeit still positive. Footwear unit growth accelerated, though it the direct result of slightly lower price points. Overall there are nit picks here and there, but the trend overall is unremarkable.

What’s Next?

  1. We think that sales day will be another domino to tip as it relates to giving additional datapoints to the Street about margin weakness – especially as it relates to earnings season beginning for the vendors in 2 weeks. This has been our call (4.5 Below – 450bos of margin weakness beginning in 2H) and we’re sticking with it.
  2. The consumer’s top line – believe it or not – strengthened materially beginning in July of last year. Personal income growth accelerated over 3% -- -and hasn’t looked back. Now we go against that in 2H. Perhaps it stays at that level. But our point is that the yy delta helped out so many in retail – and that’s no longer there.
  3. Could we get a few bps of tax relief to buoy spending? Maybe. But not over 100bp. It’s simply not there – even with the political calendar heating up.
  4. Is the consumer going to draw the personal savings rate back down to 2-3% to free up a few points of spending? It’s possible – especially given US consumer spending habits. This is the biggest area where we could be wrong with our call in 2H. But that will make the setup for 1H12 very grim – i.e. low taxes, trough savings rate, with interest rates nowhere to go but up. That’s the ultimate defensive position for the consumer.
  5. Check out the weekly average earnings chart below. There was a whole lot of nothing until May 2010, until growth accelerated meaningfully – peaking in October, and remained at healthy levels throughout year-end. We’ve got to comp against this.

MIND THE LAG!!!

 

We all know that ‘the cotton trade is dead.’ That’s been the consensus for 7 months now. But we still think that the ‘earnings trade’ is very much alive. Remember that cotton, oil and other raw materials generally have a 9-12 month lead time. That means that what is selling today was procured last summer/early fall of last year. That’s precisely when costs started their precipitous ascent. We’ll have to deal with this for the next year at a minimum. Likely longer. We still don’t think we’re looking at a recovery until 2013 in this space.

 

Retail Fuel - SSS CIS 6 11

 

Retail Fuel - SSS Earnings 6 11

 

Retail Fuel - SSS Unemployment 6 11

 

Retail Fuel - SSS FW App June 6 11

 

Retail Fuel - SSS Cotton 6 11

 

Retail Fuel - SSS Gas 6 11

 

Retail Fuel - SSS Otexa 6 11

 

Retail Fuel - SSS 6 11 YY Chart

 

 


WEEKLY FINANCIALS RISK MONITOR: RISK RETREATS FOR NOW POST-GREECE

All our indicators looked better following Friday's rally. Big picture risks we remain focused on include the ongoing slowdown in the JOC Industrial Commodity Index signaling ongoing slowdown in the global economy and the relentless drive higher in EU sovereign swaps.  In the short-term, however, the EU/Greece bandaid has put concerns on hold. 


Financial Risk Monitor Summary (Across 3 Durations):

  • Short-term (WoW): Positive / 8 of 11 improved / 0 out of 11 worsened / 3 of 11 unchanged
  • Intermediate-term (MoM): Negative / 1 of 11 improved / 4 of 11 worsened / 6 of 11 unchanged
  • Long-term (150 DMA): Negative / 2 of 11 improved / 6 of 11 worsened / 3 of 11 unchanged

 

WEEKLY FINANCIALS RISK MONITOR: RISK RETREATS FOR NOW POST-GREECE  - summary

 

1. US Financials CDS Monitor – Swaps tightened for all domestic financials last week, with the moneycenters and brokers leading the charge.

Tightened the least vs last week: UNM, AGO, GNW

Tightened the most vs last week: C, WFC, GS

Widened the most vs last month: PMI, MTG, ALL

Tightened the most vs last month: JPM, GS, PRU

 

WEEKLY FINANCIALS RISK MONITOR: RISK RETREATS FOR NOW POST-GREECE  - us cds

 

2. European Financials CDS Monitor – Banks swaps in Europe were mixed last week.  11 of the 38 swaps were wider and 28 tightened.   

 

WEEKLY FINANCIALS RISK MONITOR: RISK RETREATS FOR NOW POST-GREECE  - euro cds

 

3. European Sovereign CDS – European sovereign swaps corrected amid good news from Greece.

WEEKLY FINANCIALS RISK MONITOR: RISK RETREATS FOR NOW POST-GREECE  - sov cds

 

4. High Yield (YTM) Monitor – High Yield rates edged dropped sharply on Friday of last week, ending at 7.38 versus 7.57 the prior week.

 

WEEKLY FINANCIALS RISK MONITOR: RISK RETREATS FOR NOW POST-GREECE  - high yield

 

5. Leveraged Loan Index Monitor – The Leveraged Loan Index climbed slightly last week, ending the week 7 points higher than the previous week at 1605.   

 

WEEKLY FINANCIALS RISK MONITOR: RISK RETREATS FOR NOW POST-GREECE  - lev loan

 

6. TED Spread Monitor – The TED spread fell slightly, ending the week at 23.0 versus 24.1 the prior week.

 

WEEKLY FINANCIALS RISK MONITOR: RISK RETREATS FOR NOW POST-GREECE  - ted spread

 

7. Journal of Commerce Commodity Price Index – Last week, the JOC index rose less than one point to 8.6. 

 

WEEKLY FINANCIALS RISK MONITOR: RISK RETREATS FOR NOW POST-GREECE  - JOC

 

8. Greek Bond Yields Monitor – We chart the 10-year yield on Greek bonds.  Last week yields came in 44 bps, ending the week at 1634.

 

WEEKLY FINANCIALS RISK MONITOR: RISK RETREATS FOR NOW POST-GREECE  - greek bonds

 

9. Markit MCDX Index Monitor – The Markit MCDX is a measure of municipal credit default swaps.  We believe this index is a useful indicator of pressure in state and local governments.  Markit publishes index values daily on six 5-year tenor baskets including 50 reference entities each. Each basket includes a diversified pool of revenue and GO bonds from a broad array of states. We track the 14-V1.  Last week spreads dropped 13 bps to 109. 

 

WEEKLY FINANCIALS RISK MONITOR: RISK RETREATS FOR NOW POST-GREECE  - mcdx

 

10. Baltic Dry Index – The Baltic Dry Index measures international shipping rates of dry bulk cargo, mostly commodities used for industrial production.  Higher demand for such goods, as manifested in higher shipping rates, indicates economic expansion.  Last week the series remained close to flat versus the prior week.

 

WEEKLY FINANCIALS RISK MONITOR: RISK RETREATS FOR NOW POST-GREECE  - baltic dry

 

11. 2-10 Spread – We track the 2-10 spread as a proxy for bank margins.  Last week the 2-10 spread widened to 271 bps.   

 

WEEKLY FINANCIALS RISK MONITOR: RISK RETREATS FOR NOW POST-GREECE  - 2 10

 

12. XLF Macro Quantitative Setup – Our Macro team sees the setup in the XLF as follows:  1.0% upside to TRADE resistance, 3.4% downside to TRADE support.

 

WEEKLY FINANCIALS RISK MONITOR: RISK RETREATS FOR NOW POST-GREECE  - XLF

 

Margin Debt Back Off of Recent Highs

We publish NYSE Margin Debt every month when it’s released.  This chart shows the S&P 500, inflation adjusted back to 1997, along with the inflation-adjusted level of margin debt (expressed as standard deviations from the long-run mean).  As the chart demonstrates, higher levels of margin debt are associated with increased risk in the equity market.  Our analysis shows that more than 1.5 standard deviations above the average level is the point where things start to get dangerous.  In May, margin debt decreased $5.3B to $315B.  On a standard deviation basis, margin debt fell to 1.36 standard deviations above the long-run average.

 

One limitation of this series is that it is reported on a lag.  The chart shows data through May.

 

WEEKLY FINANCIALS RISK MONITOR: RISK RETREATS FOR NOW POST-GREECE  - margin debt

 

Joshua Steiner, CFA

 

Allison Kaptur


THE M3: IMPORTED LABOR

The Macau Metro Monitor, July 5, 2011

 


MACAU GOVERNMENT APPROVED MORE IMPORTED LABORS Macau Daily News

The government approved 8,560 imported workers in May, significantly higher than the numbers in the first four months.  Over 6,600 foreign workers were hired by the construction industry in the first five months, followed by maids at 6,500. The number of approved foreign workers for hotel and dinning industry also increased.

 

MACAU ENCOUNTERED PROBLEM HIRING IMPORTED LABOR FROM THE MAINLAND Macau Daily News

China passed the proposal of raising the personal income tax threshold from RMB 2,000 to RMB 3,500 in end of June, making it more difficult for Macau enterprises to recruit mainland employees. As a growing number of employees are not renewing their contracts, Macau enterprises are now turning to hiring Filipinos.


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