Auction Which Sends US Debt To Over $15 Trillion Has Very Weak Reception; Drags Treasury Complex LowerSubmitted by Tyler Durden on 10/27/2011 - 13:18
Today's epic risk rally has been punctuated by something probably not all that surprising: a very weak $29 billion 7 Year auction, which has since dragged the entire bond curve even lower. The bond priced at a high yield of 1.791%, a notable 3 bps tail to the When Issued which was trading at 1.76 at 1 pm. But the internals are again where the action is: the Bid To Cover of 2.59 was the lowest in the series since the 2.26 back in May 2009! Additionally it appears that foreigners, either China or Europe, had very little desire to load up on this paper, with just 33.9% in Indirect Take Down, and a corresponding 86.9% hit ratio on the Indirects. So while Indirects came at the lowest since June, so the Primary Dealers took down the most since that month, at over half of the entire auction, or 54.15%. Directs also stepped up, bidding up 11.95% of the whole, compared to 8.95% last twelve auction average. And as the chart below shows, the disappointing auction has dragged the entire treasury complex lower in price. As a reminder, this bond auction brings total US debt to over $15 trillion, a number which would have resulted in a 100%+ debt/GDP using the Q2 GDP. As it sands, following today's update, the market has about $160 billion in capacity before that threshold is breached again.
It has been long in coming but finally the credit market is noticeably refocusing its attention to the two countries that are supposed to carry the burden of bailing out the world on their shoulders: Germany, and, that perpetual placeholder for global rescues, China. As noted yesterday, while following today's anticipated ISDA decision to effectively make price discovery in CDS null and void, and in the process also put the whole premise of sovereign debt insurance into doubt, CDS still provides a very useful metric courtesy of the DTCC, namely open interest, or said otherwise, gross and net notional outstanding in the CDS. And while we will reserve the observation that not only did ISDA kill sovereign CDS, but in the process it also ended bilateral netting effectively pushing up net CDS to the level of gross, we will highlight that as of the last week, net notional in both German and China CDS has hit a record, of $19.6 billion and $9.3 billion, respectively. This is occuring as notionals in the two most active countries to date, France and Italy, have been declining. In essence, what the CDS market is telling us is that while the easy money in French and Italian default risk has been made, it is now finally the turn of China and Germany to defend their credit risk and sovereign spreads. We expect that if China is indeed confirmed to be the backstopper of Europe through funding the EFSF in whole or in part, that while its CDS may or may not surge, net notionals will continue to increase as it means that ever more are laying insurance, as hobbled as it may be, on the country which recently was forced to bail out its own banking system, let alone Europe. Keep a close eye on China, which while the bulk of the market is taking for granted as the global rescuer of last resort with hard money, the smart money is already positioning itself for the next big disappointment.
Jed Rakoff is well known to frequent readers of Zero Hedge: he is the judge who nearly brought down the SEC settlement with Bank of America over the whole bonus non-disclosure issue two years ago, and where Bank of America effectively acted under the duress of Hank Paulson and Ben Bernanke. Granted at the end of the day he sided with the status quo., but this may be his chance to redeem himself. Just out from Bloomberg:
- CITIGROUP'S $285 MILLION SEC SETTLEMENT QUESTIONED BY JUDGE
- CITIGROUP JUDGE ASKS PARTIES TO JUSTIFY FAIRNESS OF SETTLEMENT
- SEC CLAIMED CITIGROUP MISLED INVESTORS IN $1 BILLION CDO
When we witness the clash between the Austerity and Stimulus camps, on the surface there is the appearance that a true debate is taking place between diametrically opposed economists. For example, Austerity folks correctly note that our economy has been badly weighted towards consumption for some decades. They want to clear out the excesses, let the malinvestments fail, and elect an overall path of acute economic pain in order to reset the system. Stimulus advocates find such plans completely unnecessary, if not downright masochistic. Armed with a more humanistic approach, Keynesians want the government to run large deficits to help the private sector deleverage, which of course could take years....A rather serious problem in the ability of Developed Economies to coherently allocate resources started showing up well before the 2008 crisis. This status quo, made in part by policy mistakes, credit creation, and the energy limit, still remains today. Crucially, neither stimulus nor austerity will dislodge this status quo. Unless, of course, by austerity we mean to intentionally collapse the system, or if by stimulus we mean to engender a runaway inflation that will eventually yield the same result.
Presented without comment - except to say the 11% rise in Silver since Friday (and 16.7% rise since last Thursday's lows) is the highest 4-day move since 7/18/11 and is over 2 standard deviations on a long-run mean.
The European sovereign debt markets are dominated by the haves and the have-nots today as risk transfer is the key phrase of the day. Away from the technicals of the CDS markets and the liquidity of the CDS indices, the critical yields on sovereign bonds are not exactly exuberant in most cases. Obviously GGBs are improving but still not dramatically and while we would expect the PIIGS to all be benefiting greatly, we note that from the exuberant opening levels, BTPs (for instance) have leaked lower in price (higher in yield) all day long. As 10Y BTPs inch back up towards 6% and EFSF bonds slide lower in price, it seems, as Peter Tchir points out below, that "it's like throwing a surprise birthday party and not inviting the person whose birthday it is".
We have previously presented the correlation of US consumer confidence and spending in the form of retail sales, leading us to wonder how it is possible that "The More Depressed And Broke US Consumers Are, The More Worthless Trinkets They Buy." Following today's GDP data it is not difficult to see where this post is headed. As we noted earlier, the biggest contributor to the 2.5% annualized GDP spike (the biggest sequential surge since Q4 2009), was Personal Consumption, i.e. consumer spending. This is for the quarter ended September 30, when the market plunged to 2011 lows. It is also the quarter when consumer confidence collapsed completely. And that is what we are showing. Courtesy of John Lohman, we present the correlation between US consumer confidence and the main driver of US GDP growth. Of course, if one assumes that consumer confidence is the true (and leading) data series here, it means US GDP would have declined at a roughly 3% annualized rate. Credible? Realistic? China-inspired? We leave it up to our readers.
In the original, July 21st proposal, the IIF assumed a 3.8% discount rate on the 30 year zero, and a 9% discount rate on the Greek flows. According to my little spreadsheet, that created an NPV of 78.9% - pretty much what they said. So that is how they calculated a 21% haircut. So what would the absolute most egregious way to say they are taking a bigger discount? If they ran the NPV with a rate of 4.25% for the zero (French 30 year zeros were trading at 4.1% yield yesterday according to Bloomberg) and they ran the Greek flows at a "less normalized" 20%, then guess what, the same bonds as July 21 would have an NPV of 50%.
And So They Line Up At The Concessions Trough: "Irish Spy Opportunity" In Greek Debt Blue Light SpecialSubmitted by Tyler Durden on 10/27/2011 - 10:37
When sharing our kneejerk reaction to yesterday's latest European resolution, we pointed out the obvious: "Portugal, Ireland, Spain and Italy will promptly commence sabotaging their economies (just like Greece) simply to get the same debt Blue Light special as Greece." Sure enough, 6 hours later Bloomberg is out with the appropriately titled: "Irish Spy Reward Opportunity in Greece’s Debt Hole." Bloomberg notes that Ireland has not even waited for the ink to be dry before sending out feelers on just what the possible "rewards" may be: "Greece’s failure to cut spending and boost revenue by enough to meet targets set by the European Union and International Monetary Fund prompted bondholders to accept a 50 percent loss on its debt. While Ireland won’t seek debt discounts, the government might pursue other relief given to Greece, including cheaper interest payments on aid and longer to repay it, according to a person familiar with the matter who declined to be identified as no final decision has been taken." There is one very important addition here: "While Ireland won't seek debt discounts" yet. And seek it will: after all, all Ireland needs is for its economy to mysteriously resume its deterioration. Purposefully. Impossible you say? Well, maybe. Or maybe the tricky Irish statistical bureau can just pull a page from their Greek colleagues on just how this is done. And Ireland is just the beginning. Very soon, and by that we mean 24-48 hours, every country in Europe that is undergoing "austerity" (which in Italy's case means increase the retirement age by 2 years over the next 15 years, or 49 days per year), will see its striking (and rioting) fringe elements demand just the same that Greece got, and probably far more. Which then goes right back to the question: yes, French exposure to Greek banks is limited. But what about Irish, Portugues, Spanish and finally Italian exposure? Will that be something to be a little more worried about?
With actual economic data now largely irrelevant, and why should it be : "got a recession? There's an EFSF for that" it is hardly worth noting that the third notable economic data point of the day, the first being GDP which came in line on an inexplicable surge in consumer spending in Q3 despite an epic collapse in consumer confidence, and a drop in the market to 2011 lows; the second being the nth consecutive print in initial claims over 400, which was the pending home sales update from the NAR which printed at -4.6% on expectations of an increase of 0.4%, and down from last month's -1.2%. This is the third consecutive monthly slide in sales data, and merely adds to yesterday's near record drop in median home prices, once again simply confirming that the biggest source of US "wealth" housing still has a long way to drop. And while we ridicule him all the time, even the NAR's Larry Yun has figured out that operation twist and monetary policy in general is a failure: "The Federal Reserve evidently has been attempting to lower mortgage rates, yet more consumers are faced with taking out jumbo loans that carry higher interest rates." Speaking of Jumbo loans, PrimeX jumped earlier today on the European news, and has since been drifting lower. It will continue doing so once some semblance of rationality returns.
While this was surveyed before the earth-changing discussions last night, Bloomberg's Consumer Comfort Index hits its lowest level in over a month. We have pointed to the stable and low levels of consumer confidence/sentiment/comfort many times recently but today also sees expectations (a much more powerful indicator of potential spending) drop to its lowest since March 2009 and the current state of the economy at its lowest since Feb09 (which was the only print EVER lower than current). Of course the man-in-the-street will be overjoyed at the efforts of the EU and this will jump to meteoric levels next week - or perhaps it won't?
For those who have not been following, ISDA has released their updated Q&A on whether a 'voluntary' gun-to-my-head haircut of 50% is not a credit event. Nothing really new here but it clarifies much of what we have said with regard to their 'determinations' process and how they will defend their decision against a lot of very upset basis traders (who by the way were most supportive of both new issues and secondaries in the European sovereign market - well until now that is). And some persepctive: I don't believe that this "solution" has done that much and too many people are looking at sovereign CDS as a sign. I think as the news is digested, real details come out, Sovereign CDS will continue to gap tighter, bonds of Germany and France will continue to be weak, Italian and Spanish bonds will give up some of their gains, and CDS in MAIN and XOVER and IG will drift wider in response to moves in bonds rather than moves in sovereign CDS.
We know that the latest plan for Greece revolves around a 50% haircut for private bonds (not to be confused with bonds held by the ECB, which will somehow exist in some Schrodingerian universe in which they are neither defaulted nor haircut). So far so good. It also means that very soon, the bulk of publicly traded private sector debt, of which there is about €200 billion will get a 50% cut. In the parlance of our bond times, this essentially means trading "flat" going forward, as we now have the terms of a bond transaction, and no further interest will be accrued (however this is merely speculation: there is obviously no detail). Which is why we present the entire Greek bond curve, which show that while bond maturing around 1 year from now have since jumped to just shy of the 50 cent on the dollar haircut level, bonds further down the curve are just not buying it and continue to trade in the 30s! In other words, while Europe may have convinced the EURUSD shorts that everything is fixed, Greek bondholders are certainly not convinced. Those who believe that the ECB will go ahead and carry through on its promise of a 50% haircut and no further, should be buying up the entire curve which trades below 50. We also wish them good luck. Stocks and algo driven FX may be fooled but the bond market certainly isn't. If anything, judging by prevalent values, even assuming some modest accrued interest, the bond market is expecting a final haircut of about 62%.
What is going on in Greek CDS is extremely important to watch, and take advantage of. Somehow CDS always attracts analogies to home insurance. It is most often written about in terms of being able to buy insurance on your neighbor's house and then set it on fire. I never thought that was a particularly good analogy, but now we have Greece on fire, and the insurance is potentially being cancelled. I remain bearish and doubt that this rally has much staying power since the plan doesn't actually fix anything, and it isn't even yet clear if it actually works in the near term. The sentiment has also changed dramatically and there are far more bulls than just a few days ago so the market is potentially now overbought. But for some long positions that play the technicals to maximum advantage I would target selling CDS where dealers are most vulnerable and the realization of what has happened in Greek CDS isn't fully priced.