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Are the credit markets getting unstable?
I (and a few Wall Street spread traders) were blown away with the
announcement by the Fed that they were shelving the Maiden Lane asset
sales. This deal has been on the table for a long time. The reason given
was “market conditions”. It turns out that the Fed was right. The credit market stinks. The question is, “What does that mean”?
This chart tells the story of why the Fed pulled the plug. This tracks
securities that are comparable to those that the Fed had up for sale:
Note that this basket of assets has been on a downward tear all year long. The only price bounce came yesterday. That was “smart”
guys getting short the index knowing that the Fed was going to be a
seller of like paper. After the Fed announcement there was a rush to the
exits by the shorts. That blip means very little. The big picture shows
a sharply deteriorating trend.
Is this a phenomenon that just hit the Maiden Lane swill? No.
This chart looks at AA collateral. The time frame is extended for
perspective. It is clear that the last four months has been mostly to
the downside for this asset class.
S&P commented on this as well. They look at “Repricings” as a
measure of the health of the market. This tracks the amount of deals
that can be refinanced to achieve a savings. S&P had this to say
about the results:
Investors, empowered by the eroding technical situation, just said no to a lot more requests. The data speak for themselves:
So where is the pressure on spreads coming from? Is it because of excess supply? No, not the case. Consider Munis:
THOMSON REUTERS DEBT CAPITAL MARKETS REVIEW had this to say today:
Second quarter global debt activity totaled US$1.3 trillion, a 21% decrease from the first quarter of this year.
The 2nd
quarter saw the first consecutive quarterly decline since the second
quarter of 2010, with just over US$100 billion in high yield new issues.
High yield activity in June 2011 totaled US$15.5 billion, a decrease of 69% from May 2011.
The Wall Street Journal had this to say recently:
Bonds backed by subprime home loans and commercial real-estate debt plunged 20% to 25% in a span of a few weeks, erasing a whole year's worth of price gains.
"Risk tolerance has changed on Wall Street"
Just a final word on global spreads. There are at least a ½ dozen major
countries that are shut out of the debt market today. Greece, of course,
is on top of that growing list.
Okay. When you put this together you have to conclude that there is a problem in credit land. My thoughts:
*This precisely what QE2 was supposed to address. Bernanke and
all of his cohorts have said a dozen times that “spread compression” was
a principal objective of the LSAP program. The theory was that if
spreads declined it would encourage borrowing.
Let’s be real clear. The fact that the Fed junked the Maiden Lane sale on June, 30 is the smoking gun evidence that the policy of QE was a miserable failure.
*IMHO debt creation is a necessary condition for economic growth. AAA
sovereigns and very high-grade corporate names still have an open market
for debt capital. But the window is closing for everyone else. Where does that take us?
*The short-term US calendar looks terrible. Sometime in about a
month Treasury is coming to market with very big wad of paper. They will
have to fund the deficit and all of the catch-up borrowing they have
missed over six weeks. The second half of the year MUST bring us a very substantial new issuance of Munis. The fall will be where the rubber meets the road. (That also may be the time where Meredith Whitney gets back her mojo.)
*There ain’t going to be no QE/POMO/flip-em to the Fed stuff. At least not for the next six months. That’s more of that ‘rubber meeting the road’ stuff to look forward to.
*I’m happy to see that some of the “white spats” boys got their
fingers burned by shorting the ABX in front of the Fed. Some of them
must have had a miserable afternoon and evening. That’s nothing. Think
of this type of front running that goes on in EVERY Treasury auction.
The “rake” that the street takes is much smaller than on the Maiden Lane
deal. But there are so many more zeros involved. The street takes a
bite out of $3 trillion a year. Yes, sometimes they get hit for their
efforts. But the business of funding the government is a cash cow for those who play in this space.
*On the other hand, this business of widening spreads and declining assets is the very worst thing that could happen to a banker. What’s that say about the financials?
*I’m looking at a tale of two tapes. Stocks are saying the future is
bright. Credit spreads are saying the exact opposite. One thing for
sure. One side is wrong. The only question is, “Which one?”
*In the past week the ten-year interest rate increased by 12%. That is a monster change. This equates to 2,000 Dow points or 240 on the S&P.
Yes, it was not so long ago that the Bond had a 3.20 handle. And yes, the Euro story drove the big change in yields. So no big deal.
I disagree. This is a very significant ramp in volatility. I might even call it unstable. I wonder what the second half will give us given the price action in bonds.
To those who live in this nutty country, a happy 4th. To those who don’t, have a nice weekend. Rest up. I sense that fast markets are ahead.
H/T JH
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I agree that the ramp in volatility is a bad sign for the markets. I also agree that credit has become very illiquid, particularly on the down days and that stocks ignore this at their own peril. European sovereign debt has underperformed other credit markets since the bailouts. It strikes me that if the market receiving the benefit doesn't have a massive rally, the rally in other risk assets is probably misplaced.
I'm not as convinced that treasury yields are moving higher. I think it is too early for U.S. treasuries to be treated like 'credit' and will still benefit from a flight to safety.
You can't sell a stack of shit to anybody these days. Might explain why Timmah wants to bail on the 'policy' team just now.
Astute observations as always.
Yes. We always knew these asset sales would be difficult, if not impossible. It is plain to see that the Fed is painted into a corner here, ironically, by their own hand. Yes. Interest rates are about to get very interesting too - Geithner is bailing. Thank you for the insightful analysis Bruce.
More "doom & gloom" forecasts about something that will never happen. "Experts" have been predicting a bond market collapse for decades. Guess what? It will never happen. The Fed won't allow it. They control everything. These markets are 100% rigged. Don't fight the Fed. In the end, they always win.
There are some real bargains for you in the 5 year, then.
the people who are certain something will "never" happen are the ones that always get hurt the worst when "never" transforms into "inevitable".
Those who are certain something WILL happen go broke waiting for the unpredictable.
Not a sailor, eh? Never lost the rigging? I have twice; once on a year old boat still in warranty. Port shroud popped. Sounded like a pistol shot. What are you willing to wager?
Thank you Sir. Try to enjoy the bleakest July 4th in my lifetime.
I will.
Good analysis and I also like your choice of graffiti. Why don't you ever source the graffiti? It looks like it is signed by P5 so I googled him and found this, which I think is rather impressive:
http://www.youtube.com/watch?v=fcfd77wrbxc
There ain’t going to be no QE/POMO/flip-em to the Fed stuff. At least not for the next six months.
Can you elaborate on that?
Is this your "no QE3" call in different disguise, or I am reacting a bit too Pavlov'ian here?
Otherwise great post.
Well done Bruce. Always enjoy your posts.
Excellent article, Bruce. Much appreciated.
Enjoy the fireworks. On the fourth, that is.
Bruce,
You stated "In the past week the ten-year interest rate increased by 12%. That is a monster change. This equates to 2,000 Dow points or 240 on the S&P".
You didn't say whether this was up or down (or does 240 on the S&P mean 240 ON, i.e. upwards?).
In my early days of learning about the markets, I'd thought (and still do) that rising rates generally had a downward effect on Bonds AND equities.
http://www.investopedia.com/articles/06/interestaffectsmarket.asp#axzz1Q...
And here we are, with the Dow back UP at near 12.600 and the S&P at 1340. I'm confused.
DavidC
Like I said somewhere, "Something has to give".
If you looked at just the last week where stocks shot up and bonds down you might think it is in conflict. As you say, higher interest rates are not such a good thing.
I saw it as bonds being overbought. Panic about Europe and a slowing economy got us the 2.85%. But that is not a fair rate. So we got back to 3.20 in a hurry.
I'm less concerned with the level of interest rates than I am of the very rapid changes that are taking place.
Instability breeds instability.
David, bond futures went from almost 127 last Friday to about 122 today. http://finviz.com/futures_charts.ashx?t=BONDS&p=d1 This is a huge move. Each point (i.e. 125 to 124) is worth $1000 on a 100,000 futures contract, or $10,000 per million. Essentially the cash long bond lost $50,000 per $1,000,000 this week (basis shift aside, it was ugly enough I didn't look). And bonds and stocks completely decoupled this week and traded inversely to each other. This is a sign that the major wallet fags are moving some serious jack due to the way they perceive things are shaping up. Looks like Bill Gross finally has some drinking buddies this weekend.
zhandax,
Thanks for your reply. I am aware that there has been a lot of pressure in the middle part of the yield curve (7s to 10s) but didn't know the figures you quoted on the long(?) bond, 127 to 122.
You say that bonds and equities decoupled this week. Does this mean that my previous premise is correct? And, if so, why the massive move UP in equities?
Thanks again,
DavidC
David, if you get back to basics, equities and bonds are competing asset classes. In the old days, you had your choice of stocks or bonds. Absent fed-generated 'instant liquidity' you chose between them and their prices reflected supply and demand. Overall, increases in interest rates would tend to depress the prices of both asset classes but the reaction time differed. For bonds, it is more immediate. Why would I pay as much for your year-old 3% bond as I would for a new 4% bond? For stocks, there was the assumption that rising interest rates will slow economic activity, causing lower revenues and profits. Also, a dividend stream as a cash flow is worth less with higher alternative 'risk free' investments.
A large divergence in the price action between the asset classes could potentially signal a paradigm shift. Case in point is 1987. You know the equity side of the equation; stocks screamed. Did you know that between February and October of 1987 bond prices dropped about 35%? There was a large currency component to that move as well (dollar dropping against the yen). 5% in one week is consistent with that magnitude move. One week does not a trend make, but it is a big waving red flag that something is going on that needs further investigation.
Maybe they held back because a big wad of it is fraudulent paper.
"*IMHO debt creation is a necessary condition for economic growth."
Actually, that is an absolute fact when a sovereign uses debt as money (like USofA).
Have a great holiday weekend Bruce!
If growth is measured in nominal terms instead of real terms then I would also agree. Otherwise, debt creation is another euphemism for printing.
Bruce must have missed the last 3 days of spread tightening in both junk and IG credit. The run I got late today regarding finance credits show spreads coming in anywhere between 5 and 10 bps - today. This is on top of the same or greater tightening y'day.
So contrary to double-down's commentary above, Bruce gets it completely and utterly wrong.
The Fed announcement caused the big back-up. I was clear on this. No? Step back and look at the year to date even with the Fed blip.
I also spoke of volatility in the markets. Read the title. I asked if capital markets were getting unstable. Ie. more vol.
I did not suggest which way the charts would move next. Only that price changes are going to be more dramatic. Markets will get "thinner'.
So just what was I wrong about?
you forgot this part in your analysis:
http://www.youtube.com/watch?v=wj-7yP3fG9g&feature=player_detailpage
Good report Bruce.... I knew you had it in you!
Were we not expecting interest rates to go higher with the end of QE2? Then everyone would realise we cannot pay the interest on the debt at the higher rates. After much screaming and pointing fingers everyone would "Beg the Fed" to launch Queasy Easy ad nauseum?
Oh yeah and equities shrivel like the testicles of Polar Bear clubmembers swimming in Lake Vostok, Antarctica.
I don't believe in Stocks anymore.
I do believe that Credit is the oil that keeps the engine running.
And People need to make a wage sufficient to be well (Not obese) and be in a position to fulfill whatever oppertunities they may have.
Student Loans and Unsecured credit are at very high amounts and if that stops, we are done.
Does the student loan ponzi need to grow? It would be better if fewer kids were indebted with $100K in their early 20's. We don't need any more graduate degrees in ethnic and gender studies. We don't need anymore psych and polysci majors.
Finally, oh, you forgot Events Management and Interior Design.
The current crop of MBAs and Law degrees give new life to the term "educated idiot" as well. All this rhetoric about the need for education, particularly in math and science, and those folks get swept up creating programs for banking as well.
All that time and money spent on nothing of substance.
you seem unimpressed. here's another shot she sent me for ya'
http://www.youtube.com/watch?v=tjG1xeiwjb8&feature=player_detailpage
Ten year bond broke through both 50dma 200dma. The chart does not look pretty.
http://finance.yahoo.com/echarts?s=^TNX+Interactive#symbol=^tnx;range=6m;compare=;indicator=sma%2850,200,360%29+volume;charttype=area;crosshair=on;ohlcvalues=0;logscale=off;source=;
Martin?
Martin Armstrong: http://www.martinarmstrong.org/economic_projections.htm
See Martin's last piece. Who's gonna buy bonds when yields are rising [potentially for a long time]? Stocks are owning a piece of something real....not a promise to pay more fiat.
treasury buyers will be back and these yields will come down
yep ... risk off is good for T-bills!
stocks are very very richly priced. if one excludes the uniquely tulipy late '90's, current prices look like '29, '87, '07, maybe a little late '72. rising yields will crush them.
In normal times I would agree, but once rising rates take hold the risk of default rises. I'm not always a big follower of Armstrong but I encourage everyone to read his latest "The next 4.3 Years"...also, stocks in REAL terms are 7% cheaper than 1999. If we take it as a given that inflation will lay waste to the dollar, then stocks will rise in nominal terms until such time as the bond market doesn't look like Russian Roulette with 5 rounds in 6 cylinders. If we measure the SPX in Gold, it sells for 24% of its 1999 price. So, stocks are CHEAP and should be the only place where paper value can flow other than into the usual hard assets.
In a word. Yes. The true cost for creating capital without adding any real value to the organic economy. Hedge accordingly.
"Stocks are saying the future is bright. Credit spreads are saying the exact opposite. One thing for sure. One side is wrong. The only question is, 'Which one?'"
Exactly Bruce.
History says the bond market's got this one right...
Thanks Bruce,
Really good analysis as usual.
Happy 4th to you.
Higher rates on the way..across the 'credit spectrum'. The US ten yr needs a 4 in front of it maybe a 5. US has had Monetary madness for twenty yrs.. with QE being the grand finalle.
Nice work as always.
Bruce, your quote says it all, especially in light of near future US funding needs!
"Stocks are saying the future is bright. Credit spreads are saying the exact opposite."
Stocks are the 90lb weakling and Credit is the 240 lb ripped cage fighter. I wonder who will win?
No, Stocks are the slow, fat, dumb kid who watches too much TV, and Credit is the wise and patient uncle with a PhD in history.
I wonder who makes better decisions?.
the end of a seventy five year (more or less) credit cycle occurred in 2008. it doesn't get reversed by juicing the money supply in an environment of broken, lying balance sheets and unemployed workers.
LULU Nation rules!
Don't worry - maybe Jamie will fix it
http://finance.yahoo.com/blogs/daily-ticker/mark-zandi-jamie-dimon-fabul...
The bond crowd is smarter than the equity crowd.
Hello from sandy beach shores and with some fine pale ale in my belly (my Holiday had begun).
First, this is fantastic article by Mr. Krasting.
It efficiently and empirically supports the contention by many that there simply is very little demand (aka "we'll buy, but onl for pennies on the dollar") for the types of assets that the Federal Reserve, under Bernanke's brilliant and/or honest and/or good stewardship policies (/sarcasm), has accumulated - in massive amounts.
Hell, the ten year treasury, which is still AAA+ compared to the crap the Federal Reserve is now holding (and wanting to sell off, but...hmmmm...can't seem to catch a bid that wouldn't severely and maybe mortally wound their balance sheet and expose their massive achilles heel) is literally starting to get smoked - this after Bernanke has claimed keeping yields low (presumably on a wide spectrum of interest bearing instruments) as a primary goal of QE1 and QE2. The 10 year is not going to be an isolated case, so Bernanke wasted an incredible amount of powder, it would appear, if suppressing yields on a long term basis was truly one of primary objectives with QE (an 'if' for all of you to answer).
Now, doesn't this forecast a more serious problem, also? Not only are yields on treasuries making dramatic gaps up, but isn't Jim Rickard's case that the Fed will have significant continued purchasing power from both rolling over monies from asset sales and interest income starting to appear to be in some legitimate jeopardy?
If the Fed had to begrudgingly cancel the first of its planned sales of AUM, in a loud and embarrassing fashion, this should call into question the competence of every analyst who did not at least predict this or highlight this occurrence as at least a real possibility months ago.
Now what is the Fed to do if this continues? They'll be absolutely screwed, because much of this crap was rightfully passed over as it is essentially MBS and other shitty assets that are essentially hand grenades with timers attached, with a real value that will continue to shrink as more and more defaults on the underlying assets take place, further impairing the already deeply impaired value of these holdings.
As for the final point: I am looking at cash levels generated from any returns on any asset classes that have appreciated in the past two years, and asking whether that money will get rolled over (e.g. from the sale of equities to...?), and to where, and I am having a hard time believing that any redemptions in these asset classes will get rolled over into the types of assets held by Bernank in Maiden Lane(s), almost at any price/discount.
Bernanke is in a bad way.
Shorting US Treasuries is looking more and more like the epic play of the last 30 years (when going long US Treasuries in about 1980 was a killer trade) with each passing day.
Bernanke is toast absent some major, global calamity that makes the 100% risk-off trade possible, where foreign central banks literally flood the U.S. with demand for US Treasuries at any yield (even negative ones).
War will do that. War is our only way out. war for oil.
Equities are grossly overpriced here. I believe we are going to soon see the big 40% drop I have been waiting for since QE1 was announced (and started after it ended, only to be rescued by QE2).
The trend you are seeing in the ABX is a growing realization that housing is still shit. For all the machinations Bennie and Timmay pulled, they did nothing to address the mortgage mess. Bennie lowered mortgage rates but no one qualified to refinance.
The day of reckoning was delayed due to the moratoriums, etc, but that delay is over now.