Archive - Dec 28, 2011

Throughout this entire crisis (going back to 2007), the governments and central banks have made efforts to “fix” certain things. If LIBOR gets too high, then they take action, that at least temporarily improves LIBOR. Those who look at the “improved” data and think the problem has been fixed have been proven wrong, as the market exposes other holes and eventually even the government and central bank money can’t keep the prices artificial for too long without forever increasing the amount of public money at risk. There may be no better example of that phenomena than the Euro Basis Swaps. To some degree, this rate measures the difficulty that European companies (banks) have when trying to get dollars. The First “globally coordinated” action in September brought the rate back from-110 to -80. That faded until it hit an almost scary -160. The Second “globally coordinated” swap line action got us all the way back to -110 (about the same level that had sparked the first action). We retraced some of those gains, saw fresh gains on the back of LTRO, but again have stabilized at rates that are worse than what the policy makers have targeted. Where would these rates be without intervention? Should we be happy about the improvement, or should we be concerned that in spite of all the intervention, this is the best they could do?

As we said yesterday when Sears decided to very unprudently (if very conveniently) post an update of its revolver in its horrendous preannouncement, the company is about to experience some MF Global style "death shorting" having invited every short from miles around to sniff at just how (un)stable its liquidity is. Judging by the action in the pre-market session, where the stock is another 4% lower, we may have been correct. And just to make the lives of key shareholders Eddie Lampert and Bruce Berkowitz even worse, here is Goldman cutting its price target from $43 to $30, while still maintaining a Sell. Alas, this name is going far lower.

Our friends at Themis Trading, who continue the good, if seemingly futile fight, for a fair and untiered market, refresh on their late 2010 market structure forecast, only to find that with a 1 out of 10 "success" track record, they have the same predictive hit rate as Byron Wien and Joe LaVorgna. Which, incidentally, is not a good thing: it simply means the US stock market is now more broken and corrupt than ever, a development that is not lost on US investors, who later today we will find have redeemed a near record amount of cash from US equity mutual funds in 2011, and have pulled cash for 34 out of 35 weeks in a row, leaving mutual funds with virtually zero cash buffer, massive leverage and dreading that day when the Santa rally coupled with low volume levitation is no longer sufficient to mask the massive capital hole in the heart of the S&P 500.

With many expecting 2012 to be a replica of 2011, at least for US stocks which the non-permabull consensus sees closing the year largely unchanged for the second year in a row, one open question is whether this will also be applicable to Europe. As a reminder, the EURUSD opened this year near the 52 week lows, only to rise by several thousand pips as concerns about European contagion were brushed away on hopes Europe's politicians had it "under control." They didn't, and the EURUSD returned to its year's lows recently. But is the same pattern in store for early 2012, where as we already noted, the bulk of gross debt issuance is due to take place, especially in January? Below are UBS' 5 other key reasons why the European resurgence (however brief) that was experienced early this year will not be recreated in the new year that is now just around the corner.

• BRIC Decade Ends With Record Fund Outflows as Growth Slows (Bloomberg)
• U.S. says China not currency manipulator; chides Japan (Reuters)
• Japan Deflation Returns as Production Slides (Bloomberg)
• Record use made of ECB deposit facility (FT)
• Irish May Pay Greek Price for T-Bill Market Return: Euro Credit (Bloomberg)
• Italian 10-Year Bonds Rise, Stocks Advance After Debt Auction (Bloomberg)
• Obama to nominate economist, banker, as Fed governors (Reuters)
• Japan relaxes weapons export ban (FT)

Despite European banks hoarding cash at the ECB at record levels as observed previously, Italy succeeded in selling ultra short maturity debt earlier today at interest rates that confirm Europe has managed to stabilize near-term expectations. Specifically, as Reuters reports, Italy sold 1.7 billion euros of 24-month zero-coupon bonds on Wednesday at an average 4.85 percent rate, sharply down from an auction yield of 7.8 percent a month ago.  The Bid to Cover was 2.24 compared to 1.59 previously. Nonetheless, this amount was less than the maximum 2.5 billion euros targeted at the auction. Italy also sold 9 billion euros of six-month bills at an average yield of 3.25 percent on Wednesday, half of what it paid a month ago to sell six-month paper at a bid to cover of 1.69 compared to 1.47 previously. Lastly, the fact that Italy can place debt in under 2 years when the LTRO itself has a 3 year maturity means that the real issuance test will come tomorrow when Italy is on deck to sell 3 Year bonds. As for 10 year BTP, which were trading at over 7% as recently as overnight, that is a different story completely.

If there is anything that the European banks' negative response to the LTRO's invitation to use "free money" and relever even as Europe faces a perfect storm of deleveraging in 2012 (a topic beaten to death by us here previously) is that the problem at the root of the European financial crisis is not a liquidity one - it is, and has always been one of solvency, or, said otherwise, a problem when bank assets do not generate enough cash flow to satisfy cash outflows from bank liabilities, period, the end. Everything else is irrelevant. And while the market is fascinated in complete noise such as at what price will Italian bonds price in minutes, what the real focus should be on is the state of the primary driver that led Europe into (and eventually will take it out of) the credit bubble- housing. Today, Bloomberg provides a quick update of the Spanish housing situation which can be summarized as follows: horrible and getting much worse, because as October data shows, lending has imploded, down nearly by half just from a year earlier, while the average price is down over 7%.

While sovereign spreads are leaking modestly tighter this morning as European credit markets emerge from the holiday hibernation, the ECB Deposit Facility surged 10% further to a LTRO-busting EUR452bn. While we assume there is some year-end 'management' involved here (and some will argue that putting the LTRO-carry-trade to work takes time), the sheer velocity and scale of the ramp in deposits suggests this is not a game-theoretically optimal use of this new-found cash (neg-carry-trade) but instead a clear message that banks will delever and remain risk averse no matter what the central banks 'suggest' is appropriate. Didn't we learn this lesson already in Japan (for two decades of debt minimization as opposed to profit maximization) and the US (Fed reserves skyrocketed as dealer bond inventories drop precipitously?). Also, those saying that banks are just waiting for the new year to start putting LTRO cash to use, there is no reason to wait - Italian BTPs are already at 7% - all banks are doing by delaying is giving up on days of free carry trade, thus this argument is pure rubbish. We are also seeing EUR-USD basis swaps starting to decompress (worsen) once again. In summary: since LTRO day, EUR187 billion of the 210 billion free money has been redeposited at the ECB.

Hi, Ben!