Archive - Nov 21, 2011

Belgium is the latest entrant to the fully inverted 5s10s club. Yet what is scary is that even Austria and France have just 14 bps to go before they also invert. And most worryingly, Germany is just 4 bps behind. Keep a close eye on the 5s10s. If it inverts for everyone in Europe, including the UK and German, it is game over.

Suddenly, everyone is discussing how the IIF “deal” made sovereign CDS worthless and that is why we are seeing a renewed sell-off in sovereign debt.  That is just plain wrong.  What the Greek “deal” did was make it perfectly clear, that banks that survive on the benevolence of the ECB directly and the IMF/EFSF bailing out their positions indirectly, will do what the governments tell them to do.  The separation of banking and state has been violated.  That is the problem, and that means banks need to reduce positions because they are scared of what their masters will demand of them, and they cannot survive a haircut on Italian or Spanish bond holdings.

Not only is Washington not able to present a model of its own efficacy in solving debt problems, but quietly, the Fed joined other central banks a few weeks ago to extend short-term dollar loans to European banks virtually cut off from dollar credit -- and not by those Occupy Wall Streeters.

• Moody's said that rising French bond yields increase the fiscal challenges facing France
• Members of the congressional deficit reduction committee voiced little hope of a breakthrough ahead of Wednesday’s deadline to agree a deal to reduce the US deficit
• EU's Rehn said that the sovereign crisis is hitting core Eurozone countries, and there should be no illusion
• ECB's Nowotny said an interest rate cut is possible, adding that the ECB will consider worsening economy at the next meeting
• Bundesbank slashed its 2012 German growth forecast to 0.5%-1% from its previous forecast of 1.8%, sees German economy entering 'difficult waters' in the coming months
• According to sources, EU governments rejected mutual guarantees for bank term funding, adding that the German opposition was key to the decision against mutual guarantees

• China Fears Lasting Worldwide Recession (FT)
• Grand deficit-cutting effort ends with whimper (Reuters)
• Global Economic Outlook Grim, China Tells U.S. Trade (Reuters)
• U.S. Billionaires Avoid Reporting Gains to IRS (Bloomberg)
• Deutsche Bank Could Transfer Contagion (Simon Johnson)
• Some BOJ Members Warned of Lehman Crisis-Type Shock (Reuters)
• Spain's Rajoy Triumphs With Big Election Majority (Reuters)
• Commission Proposes ‘Eurobonds’ (FT)
• Greek PM Heads for Brussels to Try to Secure Cash (Reuters)

We believe that the issue of primary dealer status – the role of the primary dealers, the significance of foreign firms and their importance in the primary dealer process, versus domestic US firms – needs to be examined. It needs to be aired publically.

Financial contagion in Europe is pushing already fragile global economies towards recessions, and the risk of slipping into global recession are rising significantly. Indeed, as we have warned for many months, there is a real risk of a global Depression given the scale of the debt levels in most western countries and the massive imbalances globally. A senior Chinese official, Chinese Vice Premier Wang, said yesterday that a ‘chronic’ long term global recession is certain to happen and China must focus on domestic problems. While all the focus has been on Europe in recent weeks, markets may again focus on the not inconsequential matter of the appalling US fiscal position which could see further market volatility and the dollar come under pressure again. Washington's latest fractious effort to come to grips with its mounting debt looks set to end in failure today as negotiators look set to announce they have failed to reach a deal. The Congressional ‘supercommittee ‘charged with cutting the US government's crushing $15 trillion debt looks set to admit failure which should support gold. SPDR Gold Trust, the world's largest gold-backed exchange-traded fund, reported a rise of 3.631 tons from a day earlier to 1,293.088 tons in its holdings, the highest in more than three months. The ETF witnessed an inflow of 24.422 tons last week, the biggest one-week rise in holdings since mid-August. Commerzbank say they expect to see gold trading at $1,800/oz by the end of the year. Barclays says it is sticking with a fairly bullish call for gold and says it sees the price at $1,875/oz in Q4, according to Reuters. Deutsche Bank say they expect periods of risk aversion to remain through 2012 and their strongest conviction trade remains long precious metals and specifically gold, according to Reuters.

These days the biggest single catalyst to a big gap down is the arrival of 3 am Eastern at which point Europe opens and specifically that one all important instrument, Italian BTPs, start trading. Sure enough, European risk aversion is back, hot on the heels of not only the completely expected Stuporcommittee agreement to disagree and put the US rating at risk, but following a Figaro report that it is now Moody's (as a reminder it was S&P which almost blew up the OAT market one week ago with that "technical glitch") that is contemplating a French downgrade. From Reuters: "Ratings agency Moody's believes the recent rise in interest rates on French government debt and weaker economic growth prospects could be negative for France's credit rating, newspaper Le Figaro on Monday reported the agency as saying. "Presistently high financing costs combined with a deteriorating economic outlook could increase the difficulties that the government faces, with negative implications for credit," the newspaper quoted Moody's as saying. Reuters sought but was unable to obtain confirmation of the reported remarks from the the ratings agency. On Oct. 17, Moody's said it could place France on negative outlook in the next three months if the costs for helping to bail out banks and other euro zone members overstretched its budget." The result: a resumption of the bloodbath. France CDS rise to 11 bps to match record 233. Italy CDS rise 15 bps to 543. Belgium CDS rise 12 bps to 337. The three-month cross-currency basis swap  was 131 basis point below the euro interbank offered rate at 8:45 a.m. in London, the most expensive since December 2008, according to data compiled by Bloomberg. The rate was 130 on Nov. 18. As for cash spreads: they are not at all time records... But they will be shortly, especially since the ECB is largely missing from the market today: telegraphing that it won't monetize? Or is there a hit job on yet another European leader? Which Goldman leader will replace Sarko?

The week ahead is light on data. The highlight of the week will be the publication of the PMIs in the Eurozone and the IFO in Germany. We expect business sentiment to deteriorate but only modestly. There is also the release of the first of several monthly China PMIs. Durable Goods and the FOMC minutes in the US will also be interesting to watch. Data in the US has been reasonably stable and have continued to surprise mostly on the positive side, albeit less so recently as expectations have adapted. Sub-trend growth will lead the Fed to consider its easing options again, but possibly not until sometime next year.  An important US event this week will be the deadline for the fiscal Super Committee, which will likely fail to deliver a plan to cut the budget deficit by $1.2tn over the next 10 years. Though markets do not expect a plan before the deadline, it is likely that the focus on structural US imbalances intensifies during the week. This could well become an even more risk-averse environment, leaving few options to go short the USD. As our weekly FX idea, we therefore like short $/JPY, aiming for a move back to the pre-intervention lows.