Archive - Oct 2011 - Story

Two months ago we said core European default risk is about to surge on risk transfer fears. This morning German CDS just hit a record. Yesterday, and on Friday, we said Belgium CDS is about to be monkeyhammered. Sure enough, Belgium is the worst performed of all European sovereigns, +18 on the day and soaring and threatens to go offerless as we type on imminent Dexia nationalization fears. And there's your alpha for the day.

Risk averse trade was observed in early European trade following the news over the weekend that Greece were to miss budget deficit targets set by the Troika with the Asian markets closing sharply lower into the beginning of the European session and consequently fixed income markets being heavily supported. Focus remained on the banking sector following reports that consultations are underway regarding the nationalisation of Belgian bank Dexia with further comments from ECB’s Noyer on the dependence of French banks on USD funding. At the Equity open Dexia opened down 12% with the French banks underperforming heavily, however as the session progressed risk sentiment did begin to creep back into the markets with the Euro-area manufacturing PMI’s generally being higher than expected. This was allied with the ECB’s Securities Market Programmed rumoured to be buying in the Spanish and Italian curves with significant tightening observed in both countries 10-year government bond yield spread over Bunds. Looking forward in the North American session focus will be on the Eurogroup meeting due to start at 1600BST where discussions on EFSF leveraging will be on the agenda. In terms of data there will be the ISM manufacturing report for September and the start of Operation Twist, alongside the latest Outright Treasury Coupon Purchases.

Nomura Bob is back with another hotly anticipated if, unfortunately, grammatically flawless, market strategy piece. Short and sweet, Bob as usual cuts right to the point. "My secular view remains bearish. In or within a year from now I expect global equities to be 25% to 30% lower. My S&P500 target for the low in 2012 remains 800/900, and I think an 'undershoot' into the 700s is entirely possible. In this bearish outcome I would expect 10-year bund yields at 1% to 1.25%, 10 year UST yields at 1.25% to 1.5%, and 10-year gilts below 2%. The USD should do well, credit and commodities should not....On a secular basis, investors should remain cautious, and focus on strong balance sheets and strong/robust business models. I expect the next year to be about capital and job preservation. Any counter-trend rally should be tradable but short lived - it should be viewed opportunistically."

ISM manufacturing index, construction outlays and vehicle sales/GM channel stuffing.

Tired of all the trite meaningless propaganda from Economic PhDs who crawl out of the woodwork every time there is a downtick in gold, proclaiming in big bold letters that the Gold "bubble" has burst, only to crawl right back in when gold soars $100/oz in the days following their latest terminally wrong proclamation? Or, alterantively, wondering what will happen to gold from this point on? Then the following report from Nomura is for you. As Saeed Amen analyzes: "In this article we explain why the price of gold has fallen in recent weeks. Notably, price action during Asian hours has become very bearish, which had not been the case in previous unwinds earlier in the year. In addition, it is likely that losses in risky assets such as equities helped precipitate unwinding of very heavily extended long gold positions. However, the key reasons for being bullish gold remain; namely, a very low interest rate environment and the potential for long-term demand from Asia. Also, the potential for gold’s status as a safe-haven hedge to tail risks arising from various uncertainties due to the European debt crisis is likely to be enhanced, especially now that short-term speculative positioning is relatively light. Also on a short-term basis, we have begun to see some reversal in gold  back upwards during Asian hours, after the unwind." Overall, informative but nothing new to regular readers: gold liquidations on market plunge (confirming ironically that gold is now among the most liquid types of investments in the market) as had been predicted months ago, and the same long-term fundamentals for the metal once the current stock downturn shakes out all the weak hands.

• German conservative MP says "Greece is bankrupt" (Reuters)
• Eurogroup to discuss EFSF leveraging, Greek reforms (Reuters)
• Europe Aims to Dodge ‘Scapegoat’ Label (BBG)
• UK Treasury Fears Effects of a Euro Break-up (FT)
• Dollar Beating All Assets in September Undermines S&P Downgrade (BBG)
• Japan Tankan Sentiment Below Pre-Quake Level on Global Slump (BBG)
• Osborne Reaches for Middle Ground (FT)
• Hong Kong Banks Face Higher Credit Risks in Midterm, KPMG Says (BBG)
• Greece to Miss Deficit Targets Despite Austerity (Reuters)
• US Congress Presses China on Currency (FT)

Just when you thought the latest round of liquidity improvement rumors out of the ECB (such as the resumption of a 12 month refinancing operation from last week) would buy the European financial system some time (not like many did, but for the sake of sentence construction bear with us), here comes reality confirming that it took about 4 days before liquidity got hopelessly snarled up again. As of Friday, the ECB Deposit Facility usage soared to a fresh 2011 high of €200 billion, beating the previous high of €198 billion set on September 12. Once again banks are scared of keeping excess cash with each other (as confirmed by the nearly 50th consecutive increased in LIBOR) and instead have dumped a 2011 high amount with the ECB. And the flip side, or looking at the ECB's Marginal Lending Facility, which does just as it says, shows that €1.4 billion in cash was loaned out from the ECB to "needy" banks - the highest since the €3.4 billion lent out September 14.

If there is one thing Zero Hedge readers should be well aware of, it is that the biggest Belgian bank (whose assets are 180% of Belgian GDP) Dexia is in trouble. Potentially very big trouble. Sure enough, even those embarrassingly late to the party "analysts" at Moody's have just figured it out: "Moody's Investors Service has today placed on review for downgrade the standalone bank financial strength ratings (BFSRs), the long-term deposit and senior debt ratings and the short-term ratings of Dexia Group's three main operating entities -- Dexia Bank Belgium (DBB), Dexia Credit Local (DCL) and Dexia Banque Internationale à Luxembourg (DBIL). The review for downgrade of Dexia's three main operating entities' BFSRs is driven by Moody's concerns about further deterioration in the liquidity position of the group in light of the worsening funding conditions in the wider market." Immediate result: stock plunges up to 15% overnight. We are still confident the outcome will be a full or partial nationalization, with all the ensuing bells and whistles for the various trading securities.

On the policy front, a series of critical EFSF votes went through last week without any hiccup, including the German, Finnish, and Slovenian decisions. Though the clearing of these hurdles provided some support to markets in the earlier part of the week, renewed Greek headlines pushed risky assets lower. In FX, a similar pattern persisted as in other asset classes, with most Dollar crosses matching the round trip during the week, including in EM. Only a few currencies marked notable new lows last week, in particular the Canadian Dollar. Positioning has continued to move in favour of defensive currencies, in particular the USD. The latest IMM report hints at very stretched short positioning in currencies like the EUR, AUD, and CAD. The upcoming week will provide more detail on both key subjects. Firstly, we will get the latest round of PMIs, though regional US surveys and preliminary readings in Europe suggest that macro data will continue to stabilise at relatively low levels, as mentioned earlier. The second important issue is the upcoming ECB meeting.

With the weekend full of on-again-off-again comments from various European, Asian, and US politicians and central bankers with regard the chances of various incarnations of the EFSF solving all of our ills (or not), Nomura's Fixed Income Research team has what we feel is one of the most definitive analyses of the various options. We have discussed the self-exciting strange attractor nature of the endgame that will be a leveraged EFSF many times recently. The Nomura team, however, does a great job of breaking down various scenarios, such as Structural Weaknesses of EFSF 2.0, Proposals for an EFSF 3.0 (and their variants), Leverage-based options, and EFSF 2.0 as TARP and how these will result in one of three final outcomes: fiscal union, monetization, or major restructurings risking the end of the euro, as everyone searches for a steady state solution to the 'problem' of the eurozone.

While the most elegant solutions have no official sanction, we think the necessary political resolve is yet to be forthcoming, and the technical issues are challenging if not insurmountable for many of the legal workarounds, resulting in the need for yet another round of parliamentary approvals. Consequently, we see a significant risk that the market, looking for large headlines and enhanced flexibility, will be disappointed at least in the short run.

Two weeks after Bernanke agreed to invest unlimited taxpayer funds in the form of global FX swap lines to prevent a worldwide dollar funding squeeze arising from the Europen financial collapse, the Chairman appears to be getting cold feet. BusinessWeek reports: "The Federal Reserve Bank of New York may ask foreign lenders for more detailed daily reports on liquidity as the U.S. steps up monitoring of risks from Europe’s sovereign debt crisis, according to two people with knowledge of the matter. Regulators held informal talks with some of the largest European lenders about producing a “fourth-generation daily liquidity” or 4G report, according to the people, who asked for anonymity because communications with central bankers are confidential. The reports may cover potential liabilities such as foreign-exchange swaps and credit-default swaps, said one person. The U.S. has already increased the number of examiners embedded in these banks, the person said." In other words, not only after Bernanke's pledge to fund as much money as is needed to prevent bank defaults around the world, is he actually going to have enough information to determine if there is any danger of this money not getting repaid. Well, better late than never. But at least we can permanently set aside any latent questions over whether European banks have liquidity problems. When even the Fed no longer believes you, you have far bigger problems than just liquidity (except for Dexia: liquidity there may well be the largest problem, but at least it won't be for long).

Presented without comment.

Back on Friday, when we closed out the Dexia long sub CDS trade, we said "We expect a partial or complete nationalization to be announced imminently, which in addition to all other side effects, would lead in a Bear Stearnsing of all accrued profit." Sure enough, here is the Sunday Times on the very topic... And while a nationalization of Dexia, which now appears a matter of hours if not days, will be bad for anyone still long the bank's CDS (it should trade down to pari with Belgium tomorrow, just as Bear CDS trades in line with JPM), it is pretty horrifying for SovX and Eurocore CDS in general, now that a bank which holds assets amounting to 180% of Belgium's GDP, is about to be nationalized by the very same country. Anyone who is still not long Belgium CDS, this is probably your last chance to get on that particular train. Of course, if one is waiting patiently in line at a Dexia ATM machine, one is forgiven.

Previously, we brought you parts one, two and three of the Canadian must see documentary "Meltdown." In this final episode "After the Fall", we hear about the sheikh who says the crash never happened; a Wall Street king charged with fraud; a congresswoman who wants to jail the bankers; and the world leaders who want a re-think of capitalism. As one world leader handles the crisis through denial, other leaders try to re-think capitalism. Even though the causes of the 2008 meltdown are now clear, there is no magic formula to stop it from happening again. The world has to start planning for the next crisis, even as we recognise that this one is not over yet.