Presented with little comment - equities and bonds are diverging aggressively now as 10Y accelerates towards its all-time low yields (1.67 on 9/23). As we noted earlier, foreigners are dumping Treasuries at a record pace and yet it grinds tighter and stocks rally on USD weakness. Our 'thesis' from yesterday that a reactive Fed QE is being priced in seems the most 'sensible' but year-end flows for now are tough to call.
Rather than making some predictions, here is a list of words and phrases that were popular in 2011 that just annoy us. It would be nice if they become less popular in 2012, but we predict they will remain in use.
UPDATE: Spanish bonds are leaking wider after the defiict projection looks set to be significantly worse than previously expected.
Something strange is happening in European risk markets this week. While that sentence is entirely 'normal' for what has become a diverging/converging flip-flopping correlation microstructure but the clear trend this week has been European Sovereign derisking and European Stock rerisking. The Bloomberg 500 index (that tracks a broad swathe of European stocks) is up 0.75% from Christmas Eve (and 1.6% from yesterday's lows) while 10Y sovereign spreads are wider by 10 to 30bps in the same period. France stands out as one of the worst performers - more than 25bps wider this week alone. Only Spain is notably improved on the week (-17bps) but all 10Y sovereigns are well off their best levels as stocks make new highs. Whether this is a front-run on asset rotation into the new year or expectations of the same risk-on ramp-job we saw on the first trading of this year is unclear - we do remind those front-runners that mutual fund cash levels are significantly lower this year than last. It is clear that yet another 'sensible' correlation (such as BTPs to equities) has broken but when volumes return and the reality of the huge supply calendar we face in the next month alone sinks in, perhaps equity ebullience will pull to bond bereavement. If stocks are reacting to a quasi-QE from the ECB, why wouldn't sovereigns who are the direct beneficiaries in that surreal LTRO-driven-carry trade?
The only thing of note today (there are no economic announcements at all, just the Fed disclosing the latest Op Twist schedule at 2 pm) is that while the bond market closes at 2pm, stocks will be left unsupervised for two hours of sheer idiocy between then and their normal closing time of 4pm by which point there will be nobody left trading, just some GETCO algo lifting every offer then dumping it all having made money over VWAP and suckered in the momos, as happens every single day on no volume levitation.
With year end fund flows making absolutely no sense for the most part, thank you global central planning, as the euro plunges and the market refuses to follow, with risk assets rising on speculation the ECB (and/or Fed) are about to restart printing yet gold collapsing (on one or two hedge funds liquidating, yet econ PhDs already rewriting their theses on why the "gold bubble has popped"), and finally with Treasurys soaring to near all time highs (10 Year under 1.9% yesterday even as stocks surged on data from the National Advertisers of Realtors, aka NAR, of all fraudulent and corrupt entities), here is the latest observation to make the confusion complete. As the Fed's critical H.4.1 weekly update shows (which is leaps and bounds more accurate than the Treasury's TIC international fund flow data), in the week ended December 28, foreign investors sold the second highest amount of US bonds in history, or $23 billion, bringing total UST custodial holdings to $2.67 trillion, a level first crossed to the upside back in April. This number peaked at $2.75 trillion in mid-August, and as the chart below shows the foreign holdings of US paper have been virtually flat in all of 2011, something which is in stark contrast with what the price of the 10 Year would indicate vis-a-vis investor demand. And going back further, the last week is merely the latest in a series of Custodial account outflows. In fact, in the last month (trailing 4 weeks), foreigners have sold a record $69 billion in US paper, a monthly outflow that was approached only once - in the aftermath of the US downgrade (when erroneously it is said that a surge in demand for US paper pushed rates lower - obviously as the chart shows nothing could be further from the truth).
In the last daily update of 2011, the ECB announced that European banks saw their usage of the central bank's deposit facility rise yet again following a modest drop the day before to fund some Italian bond purchases, and increased to just shy of the all tie record of €452 billion, at €446 billion, a €9 billion increase overnight. And while this is obviously not a seasonal pattern based on historical observations, nor is it banks holding their cash for 2012 auction use, as the carry opportunities are already there with the BTP back over 7% (although LCH still has to get the memo), we look forward to the first update of 2012 to see just how much more this non-seasonal expansion will rise by. One thing is certain: when the next, February 29, LTRO is conducted, European banks will park about €700 billion with the ECB in the biggest circle jerk ever conceived in modern monetary history.
It seems that it is not just the Europeans that are USD cash starved heading into year-end as the Swiss and Japanese gorged themselves on two-week maturity FX swap lines during the last week. The total outstanding under the Federal Reserve's USDollar Liquidity Swap Operations jumped from $62.599bn to $99.823bn - or more than 59% during the week ending 12/28. Admittedly, the size of the additional Swiss draw-down, $320mm more compared to $75mm the previous week, is a drop in the bucket compared to the ECB's additional $33bn this week. However, the more-than-$9bn additional draw-down by the Bank of Japan perhaps helps explain why USD-JPY cross-currency basis swaps eased so much this week (as the desperate need for USD through this counterparty-risk-exposed form of funding reduced by around 12bps or more than 25%). Perhaps it is time to take a closer look at some of the Japanese banks as while the stigma of borrowing from these lines is talked down, clearly there are funding/liquidity needs that are rising dramatically.
The volatility of today is nothing more than a fight between the active perceptions of participants trying to maximize self-interest within the classical, traditional concept of a free economy, and the opposing forces of overlordship of the landed economic elite, trying to get the uninitiated to simply follow orders. The elite really believes that if everyone would gladly pile on even more debt and spend with reckless abandon, the Great Moderation would once again be within reach. Consumers should only stop thinking for and of themselves since common sense is dangerous to the controlled economic system. To get more debt “flowing” requires active price manipulation to make the world seem like it will be better in the near future so that people will start acting like it... That is both the opportunity and danger of a system reaching its logical end. Put another way, there is a growing realization that while free markets are messy and somewhat unstable, central planning is not really a cure for those symptoms. In fact, it has created more harm ($13 trillion in debt is only US households) than good, more illusion than solid results. Volatility means that the free market is at least attempting to impose itself at the expense of central planning’s soft financial repression and control. By no means is such a beneficial outcome assured; rather the other half of all this volatility (the risk-on days) is the status quo desperately trying to hang on through any and all means (even those less than legal, like bailing out Europe through cheapened dollar swaps).
If one had to summarize 2011 in one sentence, it probably would be: "a year in which the market ended unchanged, in which the world got within seconds of global coordinated bankruptcy, and in which central planning finally took over everything." Simple. On the other hand, conveying a comparably concise message full of hope and despair at the same time, using charts would actually be slightly more problematic. But not for the Economist, which has managed to do just that, however not in one but nine discrete charts. Here is what they did.
As headline-makers from every mainstream media outlet attempt to fit today's spectacle to their cognitive biases, we note the massive surge in volume at the close in ES (the e-mini S&P futures contract). Financials closed at the highs of the day and stocks managed to retrace almost all of yesterday's drop (with seemingly everyone waiting for the ETF-moment at the end to transact?). We noted the disconnect earlier (and potential QE chatter) and while the break between TSYs and the synced USD-down-ES-up was incredible, the 5.5% rally in Silver off its earlier lows was none too shabby as Gold also managed to get back to $1550 (as the Gold/Silver ratio reverted to its 55x 'stable' ratio of the last two weeks). Investment Grade credit outperformed high yield and stocks today (not exactly a bullish risk-hungry indication) managing to close tighter than Tuesday's close even as HYG (our trusty high yield bond ETF) shrugged off a little more of its NAV premium and underperformed all afternoon as the equity ebullience struck.
At this point the weekly ICI fund flow update, showing the barrage of redemption requests no matter what the market does, is a moot point, but we will do it anyway: in the week ended December 21, when the market was doing its usual Santa rally antigravitational acrobatics and rising on the now denied hope that the European LTRO would be the Hail Mary pass of 2011, investors in domestic equity mutual funds pulled another $2.7 billion, leaving funds with even less dry powder, with even less ability to lever up, and with an even lower margin of error to any sharp pull backs in stocks. To date, and with just one week left in, investors have withdrawn a whopping $135 billion from equity mutual funds, which we are 100% certain is an all time record for any year in which the S&P closed even nominally positive for the year, proving that nobody believes this farce known as a market any longer. But we all know that... In further detail, investors withdrew funds for 34 of 35 consecutive weeks, have withdrawn $19 billion in the past month alone, and their flows show no indication of any sort of market correlation any longer, indicating that no matter how high the "powers that be" push stocks, retail no longer cares, and will not chase "performance" especially when said performance is 100% fraud and manipulation.
Our earlier discussion of the relationship between ECB and Fed balance sheets as the driver of risk correlations this year seems particularly timely as we are seeing quite notable divergences among US asset classes and FX flows today. EUR is now up relative to the USD on the day (DXY is down and tracking stocks higher), Treasury yields are falling fast and the curve flattening (2s10s30s dropping rapidly) and Silver is rallying hard off its lows (Gold perhaps being held back for now by collateral/cash/redemption calls for now). Oil is back green for the week also. Is the market starting to comprehend that the non-QE of the ECB's LTRO and SMP is in fact QE and implies the currency wars just went to 11 - forcing the Fed's hand?
While the language, so far, of the new fiscal compact for the European Union remains wishy-washy at best and outright useless from an enforceability perspective at worst, we thought it instructive to take a look at just where we stand within the existing 'old' fiscal compact. The Wall Street Journal's interactive charts has an excellent example of the disappointing state of the union and the likelihood that anything new will change anything at all. Presented with little comment -12 of the 17 member nations currently have annual budget deficits that exceed the existing (and new) fiscal compact's 3% of GDP rule (including FrAAAnce) and the data is not all in yet obnviously!
European markets are thin this week, thinner even that in the US from what we see in credit runs and equity volumes, but today saw a notable divergence between credit (sovereign, financial, and corporate) and equity markets continue. The broad BE500 equity index (of European stocks) rose majestically in the European afternoon (after US day session began), ending the day nicely positive, while spreads were wider in every category. Financials were the worst performers in European credit as they didn't see any bid into the close even as investment grade and crossover credit rallied modestly. There are a lot of divergences (and breakdowns in correlation) occurring in and across asset-classes as we see EURUSD weaken - unch now on the day (weak auctions, macro data, or market recognition of ECB QE that is not QE occurring), Gold down (because the dollar is up? liquidation/collateral/cash needs?), Stocks up (QE that is not QE again?), Corp and financial credit wider (nothing is solved and QE does not help a spread-based not currency-based numeraire), Sovereigns wider (nothing is solved and even ECB buying is not working now). Its always tricky to read too much into Christmas week trading - low volumes, high marginal impact, and year-end rotations and window-dressing (cash management), but the trend in risk assets overall seems to be lower not higher, no matter how you squint at it (even though last year's opening-day rampfest is fresh in most people's memories).