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Guest Post: Hedge Funds And Cash Bonds - Synthetic And Organic Spread Compression

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Sat, 03/06/2010 - 11:39 | 256056 Ned Zeppelin
Ned Zeppelin's picture

Greece will be bailed out precisely because it is small enough to do so. The next one and the one after that are the real issue. Pressures building as synthetic walls will not hold.

Sat, 03/06/2010 - 12:13 | 256088 RhoRhoRhoBoat
RhoRhoRhoBoat's picture

I'm a credit/rates guy, so take my word when I say JM's articles are THE WORST!

The format is the same in each one -- s/he tries to wax eloquent on something rate related, with no understanding of even the basic mechanics, and uses 1 piece of peripheral data to support the "thesis".  In this article, JM goes so far as to come up with their own macro assumptions for each of these countries.  Pardon, but the author seems terribly unqualified to be generating macro assumptions from scratch.  Pure garbage.  PLEASE stop printing these.

 

 

 

 

Sat, 03/06/2010 - 12:33 | 256105 Anonymous
Anonymous's picture

Evidence please? I would like to read the eloquent the counter to JM's articles.

Sat, 03/06/2010 - 12:51 | 256125 yy
yy's picture

If you have something to say why don't you enlighten us?

You can make a thesis all your own or counter JM line by line.

Either way Zerohedge may well give you the space should you become constructive....

Sat, 03/06/2010 - 13:17 | 256164 jm
jm's picture

You have a valid critism about the debt service estimates.  I used the Moody's methodology from a AAA sovereign credit report that published late last month.

I used the methodology I got from an analyst assigned to the report, but since there are copyright laws and such related to reproductino of the numbers, I replaced their inputs with in-house numbers to come up with debt service figures.  The Moody's inputs, especially GDP were unrealistic.  If you are the Moody's analyst and are pissed, I'm sorry but it was for the best.

Greek 5yr bonds:  get on your bloomberg and check it Monday.

 

Sat, 03/06/2010 - 14:47 | 256238 Fritz
Fritz's picture

Hey Rho - its the internet dude - why should anyone "take your word" for anything?

I would enjoy reading your detailed thoughts/differences on the topic. ZH is great place for sharing ideas but just trashing the piece adds no value.

Sat, 03/06/2010 - 12:25 | 256096 Missing_Link
Missing_Link's picture

...

Sat, 03/06/2010 - 12:33 | 256106 Anonymous
Anonymous's picture

Evidence please? I would like to read the eloquent the counter to JM's articles.

Sat, 03/06/2010 - 12:57 | 256134 Crab Cake
Crab Cake's picture

Have you ever played Monopoly? 

There are generally one of two outcomes, and sometimes both occur. 

1. A player wins outright. 

2. Through cheating, handouts, rules changes, one sided deals, and good will participants are able to stay in the game.  The game exists in perpetuity outside the bounds of the game rules until participants become bored, and the game ends.

The current game of global Monopoly is coming to its conclusion, and this is a situation in which both of the above has occurred. 

The rules were thrown out a long time ago, and we're making up things as we go along.  Things no longer make sense, but we keep playing because its in everyone's interest that the party/game continue.

The current game will end, soon.  The next?  Anyone's guess.  Usually a new game cycle begins with Risk/Axis&Allies/Supremacy.... and then shifts into a game of monopoly. 

The end of a Monopoly game is almost always followed by a war game.  Power gamers hate to lose so they always approach the power vacuum of a new game with gusto, asserting their dominance in the usual and most predictable ways.

Who knows?  Maybe Pacal Votan was right?  Maybe we'll evolve before we wipe ourselves out?  We'll see, we've got a front row seat for the ending of one game and the beginning of another. 

"If Humanity Wishes To Save Itself From Biospheric Destruction It Must Return To Living in Natural Time."

- Pacal Votan 7th century Mayan prophet king

Sat, 03/06/2010 - 14:56 | 256247 RhoRhoRhoBoat
RhoRhoRhoBoat's picture

Awesome response, love the analogy

Sat, 03/06/2010 - 16:14 | 256308 jm
jm's picture

You are the most piss-ant trader I've ever seen.  I'd really love to read your surely rudimentary criticisms of this article.

I thought last week you were grading papers.  You seemed the academic type.  Whatever the occupation, you're just a piss-ant.

  

Sat, 03/06/2010 - 12:58 | 256137 Anonymous
Anonymous's picture

Well, as an anaology harkening back to the 1930's, soveirgn countries throw "rent parties" and each ponies up some dough to buy these bonds to keep them in there home to buy time.

I get the interest rate arguement, yet, after what I've seen in the last decade, I see no reason whatsoever they can't come up with a law that says interest rates for sovereign debt will never go above 5%.

Of course it will be in the interest of for the time being and stability.

They say never fight the Fed, when it is really, the fed, the banks, and the government are all powerfull, all the time, always into perpatuity.

It's obvious Bens plan is keep home prices up, let the banks have cheap money, recapitalize them, make money in proprietary trading to cover the idiocy, keep the shadow inventory manageable with repeal of accounting laws until they can be gone, and the ones with jobs slowly spend a bit more here and there, so that you run out a time line of a. first inventory restocking boost, helped by stimulus and pomo pumping markets. b. zirp, eventually allows large capital investments that have been put off to finally be done en masse after you have confidence of 18 months of a rising stock market c. some financial reform passes in q4 with a two year unwinding window, which gives them more time, and more ways to design and develope new loopholes d. job growth in q1 2011 sets in, confidence grows anew e. another round of rent parties around the world in 2011, hey, we can afford it now, and grand debate on maybe not repealing bush tax cuts, pumps the market f. 2012, election year bull market g. 2013, see what you got going on

risks, runaway commodity prices, oil and metals and food, but no wages so they can say, oh, nah no inflation here, pass on by, which will most likely happen

the plan, ahhh, yes, extend and pretend, in hopes folks forget, and forget they will, they always do, always

Sat, 03/06/2010 - 15:59 | 256298 jm
jm's picture

I appreciate the insight and respect it.  You said something out of the box about decreeing a legal cap on yields.  Just another way of distorting credit risk.  No one would buy the bonds.

Sun, 03/07/2010 - 05:34 | 256746 merehuman
merehuman's picture

30 million unemployed with empty wallets can not forget.

Sat, 03/06/2010 - 13:01 | 256143 Lionhead
Lionhead's picture

I disagree with comment 256088. While JM may/may not have the "mechanics" of spread compression correct, the thesis of the article is correct for the yield curve is being controlled.

"The yield curve is the spinal chord & all spreads from it constitute the nervous system. Spread compression just means that the key policy control lever is the distortion of credit risk."

Yes, I completely agree with that. Remember the Greenspan conundrum when asked why rates were so low? Greenspan's reply was his shoulder shrug, I dunno. Now, if anyone can prove/posit otherwise, state your rebuttal, as I'd love to hear your thesis.

Sat, 03/06/2010 - 13:35 | 256179 jm
jm's picture

I admit I'm not qualified to address DV01 strategies and such.

If that is your line, I am interested in how these mechanics either diminsh or augment my points.

Sat, 03/06/2010 - 17:07 | 256335 Lionhead
Lionhead's picture

jm, thank you for replying to my comment. It seems many posters do not take the time to do so. As for the "mechanics," I have no specific comments for or against, hence my challenge for those that think they disagree to prove or posit their position(s). My agreement with you is based from what I observe in the bond market over a long time frame. Would a rational investor line up, oversubscribing at a low single digit interest rate, to buy Greek bonds when their citizens are rioting in the streets & the country has distorted its risk perceptions & finances with rate swaps? Oversubscription & low risk perception means the bond buyers know something the rest of the market does not or is it another case of TPTB must support Greece no matter the cost or outcome even if it means the bonds default someday. More than likely the original buyers may sell those bonds to transfer that risk to another party.

Your thesis fits into the issue as to why the yield curve matters & why TPTB must control it to distort the risk perceptions. The Treasury will never allow us to see who the indirect & direct buyers are in the Treasury auctions. Without knowing who those buyers are, we will never know whether it is yet another case of manipulation or a group of super sophisticated buyers who possess such knowledge that is unavailable to other mortals, in which case the TPTB "efficient market theory" is just useless rubbish. Please continue your research & posts.

Sat, 03/06/2010 - 20:10 | 256437 jm
jm's picture

There aren't many sov CDS curve traders on the planet and their side of this picture is important.  If you were one, I was going to pick your brain as long as you could stand it. 

The Portugese bond CDS curve has inverted, just as Greece's did. This is of course ominous.  There will be others coming. 

The common read on corporate name inversion is something like "near-term the prospects of default are high, but if they make it through the storm they'll be a stronger company for it".

Such a view really doesn't make much sense to me in sovereign names.  The default intensity should be the same across the curve.  There needs to be some other issue going on to invert the curve, like market maker issues. 

Sat, 03/06/2010 - 16:03 | 256300 Anonymous
Anonymous's picture

How will they control rates when the cds crutch is kicked out from under the market?

Sat, 03/06/2010 - 20:30 | 256468 jm
jm's picture

Sovereigns never controlled market rates and never will.

Once upon a time when protection could be bought for 10-20 basis points for 10 years, CDS were the belle of the government ball.  The supposed triumph of human risk management over market limitations. 

But CDS never made the risk go away.  They only did what they were supposed to do.  They transferred the risk to someone willing to receive payments in exchange for covering a default event. 

People want a higher payment to take on that risk now, so proetection is expensive.  This makes bond yields go up.  This in turn makes it harder for governments to finance borrowing.  And they want to borrow without restraint.

Governments are being horribly short-sighted.  They think that blaming CDS and curbing the trading of credit risk will make bond yields go down.  I believe yields will actually go even higher because bond holders can't sell off the credit risk.  They will have to bake this risk into the price over the duration.  Fewer people will be interested in buying the bonds.

More cynically, one could view this as a ploy to blame imminent fiscal problems on an old enemy: hedge funds.    

Sat, 03/06/2010 - 13:30 | 256172 Anonymous
Anonymous's picture

I always assume that when people come around to denounce someone's argument because they are 'unqualified', and then refuse to rebut that argument, that the argument in fact hits the nail square on the head. Remember GS response to Taibbi? Same thing. It's a weak and pathetic response.

Sat, 03/06/2010 - 14:43 | 256235 Oracle of Kypseli
Oracle of Kypseli's picture

Six of my high school classmates and I went on a long weekend retreat up in the mountains. With not much to do and plenty of time, we decided to play friendly poker game with about two hundred dollars total.

Soon enough two of us have broken the other four. In order to keep the game going, we started issuing little sheets of paper with our signatures and $10 denominations.

Two days later, the two of us who had won all the actual dollars, put them away and continued playing with these IOU's and the IOU's had grown to thousands of dollars. Mind you that the risk taking had exploded, as you knew that you can create more IOU's.

Now the weekend came to an end and trying to get paid on the IOU's was of course out of the question.

Is this telling or what? You learn fast in real examples in life.

M. Bernake. Are you listening? Yes you are and you know what's wrong.

The problem is the solution. There is none.

Dark ages are coming.

All of you reading zero hedge and other blogs, either know it or you are in the denial stage. The faster you jump to acceptance the easier will be to survive what is coming.  

 

 

 

  

Sat, 03/06/2010 - 16:32 | 256319 Seal
Seal's picture

Hey ZH! What's the BUY CALIFORNIA BONDS.COM ad doing at the top of the feed??????

Sun, 03/07/2010 - 20:49 | 257301 Anonymous
Anonymous's picture

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Sun, 03/07/2010 - 20:49 | 257302 Anonymous
Anonymous's picture

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