Archive - Nov 25, 2011 - Story

Given the recent market reaction to short- and mid-dated bond auctions in the European sovereign space, it seems the Spanish have blinked and decided to cancel the planned 3Y auction for next week. Reuters is reporting that instead of a single 3Y new issue, they are reopening 3 existing deals in the hope it will be easier to garner demand across several maturities and potentially more fungible for managers to add to existing positions than create new ones. Of course, it really doesn't matter too much as what we are concerned with is the secondary-trading 2015, 2016, and 2017 bonds will now be perfectly repriced at whatever is marginal demand for new risk positions - which we suspect will not be positive. The main reason for the shift to off-the-run, we suspect, is that the ECB is now allowed to 'buy' the bonds (not at re-issue but in the secondary pre-acution) as it is not allowed to buy primary issues. Once again - it smacks of desperation.

European sovereign credit curves are bear flattening (inverting wider) in almost all cases as short-dated yields breaks to new records in several names. At the same time, European credit is breaking to new lows in Corporates and financials with Subordinated financials underperforming. Somewhat strangely - though not exactly surprising given the market's behavior in the last few weeks - European equities are holding up as they ignore the reality priced into credit. It seems equities see the light at the end of the tunnel, but credit knows its an oncoming train. US markets are in sync with the broad risk-asset basket (CONTEXT) for now but correlations are tending to be much lower than on average so far.

Market participants continue to be surprised by gold’s continuing weakness and some are even questioning gold’s safe haven status. However, the fundamentals of broad based global physical demand remain very sound as evidenced by the central bank gold buying data today. Russia bought 19.5 metric tons of gold in October bringing their total gold reserves to 871.1 tons according to IMF data released today. Belarus increased holdings by 1 ton, Colombia by 1.2 tons, Kazakhstan by 3.2 tons and Mexico by 0.9 ton, the data show. Germany reduced reserves by 4.7 tons and Tajikistan cut reserves by 0.4 ton, the data show. Thus, Russia, Kazakhstan, Colombia, Belarus and Mexico added a combined 25.7 metric tons of gold to reserves in October, after gold prices corrected from record highs...Might Russia and China use gold in order to undermine U.S. political and economic dominance? There is certainly the possibility that they may use gold as a geopolitical weapon against the U.S. and as a way of furthering their growing global political and economic aspirations. Putin's endorsement in 2005 of the Russian Central Bank's plans to diversify the Russian reserves out of fiat currencies and debt instruments and into gold bullion was seen by some as as much a political act as an economic one.

It is time to face facts. I think there is a solution to the financial war in Europe. It isn't pleasant, particularly if you are a mediocre bank, but it may work. In the meantime, Europe needs to do something to calm the markets so they can spend a month preparing for orderly chaos in Europe. The EFSF should announce bonds sales to the Fed. The Fed should purchase 200 billion Eur of EFSF bonds today. They should commit to further purchases of 100 billion in Q1 and Q2 next year. The Fed has been dying to do some quantitative easing and has been looking for a liquidity crisis in need of some liquidity. It has also been looking (quietly) for ways to keep the dollar weaker.

Italy held an auction for EUR8 billion 6 month Bills today. Unlike Wednesday's German 10 Year Bund issuance, the auction was not a failure (at least not yet), and for good reason - the yield paid for the Bill was 6.504%, the highest since August 1997, and is nearly double the October 26 auction when it priced at a now nostalgic 3.535%. But... the maximum target of EUR 8 billion was met without anybody's central bank have to retain anything. The bid-to-cover was 1.47 compared to a bid-to-cover of 1.57 one month ago and average yield of the last six 6-month auctions of 2.443% and average bid-to-cover 1.636. All sarcasm aside, this is an unprecedented collapse and a total catastrophe as Italian Bills now yield more than Greek ones - the market has basically said Rome needs a debt haircut and pari passu treatment with Athens. In the aftermath of the auction everything has come unglued: 2s10s is inverted at unseen levels, the 5 Year has hit 7.847% , and Euro liquidity is gone...it's all gone.. as the 3 month basis swap hits -157.5 bps below Euribor, the lowest since October 2008.

• Trading volumes remained thin owing to early closes associated with Thanksgiving in the US
• Italy paid a record premium of 6.504% on the 6-month BOT and the bid/cover remained on the softer side, however the country managed to raise the full amount in the auction
• Market talk of the ECB buying Italian and Spanish government debt
• According to an article in the FT, the EFSF may not be able to raise enough funds to increase its capacity to more than EUR 1trl as planned
• ECB's Coene said that if the current trend continues, rate cut is probable