Archive - Jun 27, 2012

Earlier we noted that while the rhetoric on a European debacle is particularly negative, it appears positioning for it is actually considerably less bearish in FX markets. From a credit perspective, based on Citi's investor survey, it appears we have a similar picture of breathless anticipation and front-running of some central-planning solution to save the day. As they note, almost all respondents expected spreads, even in USD credit, to widen notably in the event of Spanish and Italian bond yields continuing to crack higher; and yet there was relatively little change in investors' overall net long position - and in USD credit it actually increased. One piece of reality is in European banks where real-money remains notably underweighted, and while leveraged money (hedgies) remains overweight, they have reduced their exposure somewhat recently. Leveraged accounts have reduced their short positions recently in peripheral Europe while real-money accounts are still avoiding it like the plague. The point being that fast money is certainly not going to be the ammo for a short-squeeze in European credit (or FX) that everyone appears to believe it to be.

There was nothing pretty about today's 5 Year auction, which confirmed the trend of weak bond auctions started with yesterday's 2 Year issuance. Pricing at 0.752%, superficially it was only the second lowest yield ever for a 5 Year bond. However, with the When Issued trading at 0.734%, the tail was surprisingly wide for US paper which had not seen a such a big miss from market implied prices in many months. Add the Bid To Cover of 2.61, which was the lowest since June 2011, and things start to get really ugly. Finally observe the take down which saw Indirects account for only 35.1% or the least since February 2011, forcing Directs to load up with even more paper they don't want or need courtesy of the Twist extension through year end (meaning Dealers are stuck buying up all the Fed's unwanted paper in the short-end), forcing them to take down 54.1% of the auction, or the most since February 2011 also, and one can see why Rick Santelli gave the auction a barely passing grade of D. And with these two auctions, and tomorrow's 7 Year issuance, net US debt will be a solid $50 billion greater next week when all the bonds price, and rapidly on its was to $16 trillion, which should be breached in just under 6 weeks time.

Because once you pop, you can't stop.

Cliff Asness, head of the quant hedge fund AQR, has been known to be a vocal opponent of various failed governmental policies in the past few years. Today, he has shared his "dictionary" (of "humorous" persuasion as he himself notes, with definitions "written sarcastically as a faux left-winger, some just conservative/libertarian interpretations of what the left really means.") of the key terms dominant in Progressive America right now. In a world in which other people's money has pretty much run out, and ahead of a rather historic Supreme Court ruling tomorrow, we believe some of these are quite relevant.

"Thinking sucks."--Beavis

McAfee and Guardian Analytics have uncovered a highly sophisticated, global financial services fraud campaign that has reached the American banking system.

It's another one of those hope-fueled days in Europe as European stock indices across evey nation close comfortably in the green as the EU Summit begins. Germany has taken all the substantive things off the table and Cyprus and Portugal threw in the towel but nevertheless, stocks are 1-2.5% higher (with Italy and Spain outperforming). We assume this is reflexive pricing of 'the crisis is now so scary that the ECB will have to do something' but it seems the FX and Sovereign bond market missed that pre-emptive hope-driven view as Portugal yields/spreads spiked, Spain pushed back up to 6.93% and saw further flattening in its yield curve (as short-dated LTRO-enthused bonds underperform dramatically) as 2s10s is almost back to six-month pre-LTRO levels. Italian spreads pulled off their worst levels to close mixed but remains over 40bps wider on the week. EURUSD closed down over 35 pips at 1.2450 and stocks were in a world of their own also relative to credit markets today.

Europe faces three systemic risks: Sovereign (GRExit vs. GERxit), Liquidity (unsustainable refinance rates and foreign capital outflows), and Banking (insolvency and under-capitalization). All of these can fundamentally be traced back to an era of excessive over-indebtedness, which as Pictet notes, leads to required deflationary policy responses that are incompatible with developed market government targets (of re-election, Keynesian pro-growth fiscal policy, and satisfying financial market's expectations). While LTRO did indeed address liquidity risk in the very short-term, it is now painfully clear (just look at European bank stock prices) that financials are driven by sovereign risk (not so much liquidity risk) at the margin. The following three charts provide a roadmap to Nirvana or Samsara (hell). With the Summit underway, Pictet's path to catastrophe roadmap (tactical and strategic) is critical to comprehend.

And some thought we were only kidding that NIRP is soon going to be Europe's new best friend. Also, if the former employer of Mario Draghi is now saying a rate cut is imminent, it means that the fiscal pathway to resolution is dead and that Friday's summit will be an even bigger disappointment than everyone now expects.

Only a wilful and ideological Keynesian could ignore the salient detail: as soon as the USA left the gold exchange standard,  total factor productivity began to dramatically stagnate.   Coincidence? I don’t think so — a fundamental change in the nature of the money supply coincided almost exactly with a fundamental change to the shape of the nation’s economy. Is  the simultaneous outgrowth in income inequality a coincidence too? Keynesians may respond that correlation does not necessarily imply causation, and though we do not know the exact causation, there are a couple of strong possibilities that may have strangled productivity. It’s not just total factor productivity that has been lower than in the years when America was on the gold exchange standard — as a Bank of England report recently found, GDP growth has averaged lower in the pure fiat money era (2.8% vs 1.8%), and financial crises have been more frequent in the non-gold-standard years.

There are now reports that the Reserve Bank of India (RBI) is likely to clamp down on gold bullion coin sales by banks as the rising bullion imports are adding pressure to the current account deficit and weakening the rupee.  

Western central banks and mints will not be clamping down on gold bullion coin sales in the near future as demand for gold and silver bullion coins fell in Q1 2012.

Everyone and their dog is by now well aware of the stress in Europe - and implicitly the chance for a major tail-risk event occurring. Yet, as Citi's Steven Englander notes, the amount of tail risk that is actually priced in is astonishingly small. Whether it is risk-reversals (which are skewing increasingly towards EUR strength relative to the USD) or Digital options (which are essentially the market's oddsmaker for a big - 15% or more - move in the currency), it appears investors are gravitating to a view that the sovereign crisis will play out in debt markets more than in currency markets. We agree with Englander when he notes "this looks to be an extremely hopeful view of how events will play out". Given the German unwillingness (and quite possibly inability) to underwrite the rest of the euro zone, the risk of contagion and EUR weakness may be much bigger than what is now priced in.

One just can't come up with better wording if one tried.

• EUROGROUP WELCOMES SPANISH REQUEST FOR FINANCIAL ASSISTANCE
• EUROGROUP SAYS CYPRIOT RESCUE IS `WARRANTED AT THIS STAGE'
• EUROGROUP SAYS SPAIN BANK NEEDS ESTIMATE AT EU51B TO EU62B
• EUROGROUP SEEKS `AMBITIOUS MEASURES' FROM CYPRUS ON BANKS

And a little change in the original plans:

• EUROGROUP SAYS SPAIN TO REQUEST TECHNICAL ASSISTANCE FROM IMF

"On 26 October 2006, an external trader made a request for a lower three month US dollar LIBOR submission. The external trader stated in an email to Trader G at Barclays “If it comes in unchanged I’m a dead man”. Trader G responded that he would “have a chat”. Barclays’ submission on that day for three month US dollar LIBOR was half a basis point lower than the day before, rather than being unchanged. The external trader thanked Trader G for Barclays’ LIBOR submission later that day: “Dude. I owe you big time! Come over one day after work and I’m opening a bottle of Bollinger"

Last night's release of DTCC CDS data came and went with little furor. Despite the protestations of various mainstream media reporters last week that they had been 'told' that JPM had unwound 65-75% of their IG9 disaster last week, their is nothing in the actual reported data from the CDS repository to suggest any 'epic' unwind or change in actual risk transfer occurred. We hate to say we told you so but the spike in activity was very likely associated with the CDS roll as all those Weinstein-wannabes unwound their index-arb positions (sold back their index protection and bought back their single-name protection) as opposed to face the illiquidity cliff of holding through the roll. The last few weeks have seen index net notionals drop for IG9 - which fits with the index-arbitrage unwind - but little to no change in the tranched risk (which is the more appropriate to track JPM's exposure) suggesting that JPM remains the 'diligent shareholder-friendly' holder of its tail-risk hedge just as Dimon said they would.