Archive - Dec 2011

EU leaders just decided to impose stricter budgetary requirements from EU members. Only in La La Land could this be viewed as progress. The EU already had budgetary requirements… which the PIIGS countries all ignored. So how will these NEW budgetary requirements change anything? And who or what is going to enforce them?

Last week's biggest political shock was David Cameron telling Europe to shove its authoritarian ambitions and breaking away from the Group of 27, in effect killing any chance of a favorable summit outcome. Watch him live now as he explains why he did what he did.

For boys...

There were only two questions that mattered, going into the EU summit.

1. Would leaders at the summit come up with any actions of their own to help end the immediate crisis?
2. Falling short of this, would any of their actions give enough confidence to the European Central Bank to allow it step up its role and be a lender of last resort to all troubled eurozone countries, but especially to wobbly Italy? In other words, could the conservative ECB now give itself the greenlight to print euros and buy up bonds from the world’s third largest issuer?

The answer to the first question is very clear: NO. The answer to the second question is, unfortunately, another question. “Who the heck knows?” Time to consider plan B.

Following the release of its November fund statistics, Pimco's Total Return Fund has once again reaffirmed it is betting on imminent QE by the Fed in the form of MBS monetization, a trend it started two months ago as we pointed out. And with a record $60 billion short cash position, or 25% of the entire fund $242 billion AUM, they better be right this time (he did the same thing in Jan-Feb... that did not work out too well). It is amazing to consider that back in April, Gross was long $90 billion in cash: a $150 billion swing! The TRF's 43% holdings of MBS is an increase of 5% compared to October, the most since December 2010, but still just half of the 86% held in February 2009 in expectation sof MBS monetizations by the Fed as part of QE 1. Just as notable is the near record effective fund duration, which at 7.46 was the second highest ever, just a modest drop from the 7.58 in October. What is most curious is that Gross, for the first time as far as our records go, is completely out of the 0-3 year maturity range. Which makes sense: after all the Fed has telegraphed there will be no money made in that band of rates until mid-2013, a deadline which will likely soon be extended.

Maybe, but not in the way everyone seems to think.  Haven't we already decoupled? Sure, but maybe we will just finally catch up to the rest of the world.  The US stock market has outperformed the world this year.  It seems just as easy that we decouple by other markets outperforming - especially since most people talk about the opposite occurring. We have decoupled, so I would be worried about re-coupling, or that we decouple in a bad way.  The "decoupling" theory seems very priced in global stock markets so be careful using this as a reason to get too bullish.

We warned on Friday that the strength in equities was divergent from any of the higher beta risk-on trades and today has seen this divergence grow even larger as European credit markets are selling off considerably even as stocks maintain some semblance of extending-and-pretending. Subordinated financial credit has now retraced over 62% of the rally from 11/25 to 12/7 and XOver (the European high yield credit index) has retraced 50% of that rally. The broad European equity index tracked by Bloomberg has lost significantly less, seemingly ignorant of the stress (EUR-USD basis swap widest in two weeks) as we see even Main (the European investment grade credit index) now starting to drop notably. If, as we have experience cycle after cycle, credit anticipates and equity confirms, then it seems to make sense (especially given the concerted weakness in metals which suggests some kind of margined selling or cash-need desperation) to at worst hedge long equity beta.

If Reg. T is a "problem" then we have a big problem.

Art Cashin recalls how it all started 81 years ago. Naturally, it "ended" with World War 2. Will history rhyme, or will "this time be different"?

Mayhem Monday is the new Merger Monday, with the latest a la carte addition courtesy of Intel, which just cut Q4 guidance.

In what will likely be the fastest margin cut-to-hike about face, we note that since CC&G (and then subsequently LCH) cut margin rates on Italian debt last week, 10Y BTPs are now trading over 100bps higher in yield and 110bps wider in spread (and CDS +120bps). Both long-and short-term, it seems a margin hike is just around the corner, as we warned last week on the CC&G announcement, and with the ECB now a little less aggressively rerisking their already debt-laden balance sheet, it seems once again managers used the SMP-indiced better prices to cover stuck longs.

With concerns about liquidity and solvency in the European banking system, there is lending and possibly even selling of gold by banks to raise much needed cash. This may be creating short term weakness in gold bit is bullish for gold in the long term. The FT reported last week that “gold dealers” said that banks – “primarily based in France and Italy – had been actively lending gold in the market in exchange for dollars.” The key question is who is lending and is their lending simply liquidity driven - to raise dollars or euros? John Dizard, who frequently comments on gold in the Financial Times wrote on Saturday that, “Gold market people say European commercial banks are being driven to lend gold for dollars at negative interest rates just to raise some extra cash for a few weeks. There’s not a lot of transparency about where the banks are getting the gold they are lending out, but it could be lent to them by either their national central banks, or by gold exchange traded funds.”

And just in case a brutal reminder that nothing is solved in Europe is not enough, here comes Iran:

IRAN MP SAYS MILITARY TO PRACTISE CLOSING STRAIT OF HORMUZ TO SHIPPING; IRANIAN MILITARY DECLINES TO COMMENT - RTRS

For anyone wondering why CDS pricing shifts to a points upfront methodology from running spread once said spread passes 1000 or so bps, look no further than the Greek 5 year today, where the 5 Year CDS is shown with a mid-price of 10,115 bps, being offered at 10,418. Now if there was a one to one equivalency on the CDS and bond curve, this would imply a bond price in cash terms that is negative. And since this would be quite impossible to be achieved, even for Greece, this is a perfect example of why spread in CDS terms becomes promptly irrelevant due to the shapeshift in the default curve past the 16% or so discount from par threshold. And while in practice this means that CDS could in theory go up without an upside limit, for all intents and purposes this is irrelevant as the DV01 in the 100% range approaches zero.

• Bundesbank Cools ECB Bond-Buying Talk (Bloomberg)
• Central banks fire the second barrel of QE (FT)
• Sarkozy Gets New Rival for the Presidency (WSJ)
• Wolfgang Münchau: Snags, diversions – and the crisis goes on (FT)
• Italy Sells EU7 Billion in Bills as Costs Decline (Bloomberg)
• McConnell, Graham Predict Congress Will Pass Extension of Payroll-Tax Cut (Bloomberg)
• Clegg Says Coalition Breakup Would be ‘Disaster’ as Cameron Faces Dissent (Bloomberg)
• Bank of England said to have overestimated QE boost (FT)