Ordinarily this space would be reserved for Friday humor, but unfortunately, this is nothing short of a tragedy, especially since as of today the US debt target is $16.394 trillion, a number which will be breached before the end of the year, and possibly before the presidential election in November. As a reminder, in 2011, the US economy grew by 1.7%. It almost, but not quite, offset the growth of US debt held by the public, which grew at a brisk 11.3% pace in the past year...
Bloomberg's Trish Regan (yes, she is no longer at CNBC), has just announced that the bank which earlier announced it is shutting down its catastrophic prop trading desk (at which point shreholders let out a sigh of relief), has proceeded with slashing banker pay by 30% for overall comp and some bonuses by as much as 70%. This follows earlier announcements by Bank of America and Morgan Stanley which earlier said they would limit cash bonuses to $150K for senior positions. At the end of the day, the biggest losers are secondary, non-financial New York jobs (supposedly there are some: rat exterminators; strippers; limo drivers; food spitters also known as waiters?) as each banker jobs indirectly supports up to 3 downstream jobs. In other words between layoffs and comp cutting, the immediate impact will likely be to leave New York City, which is the farthest point on the economic procyclical receiving end, with hundreds of thousands of layoffs. Which incidentally, to the bizarro crazy scientists at the BLS, means that initial claims are about to go negative (with the traditional upward revision in the following week).
While Silver had a better week than Gold (+5.4% vs 4.3%), Gold managed its biggest gain in three months as the Fed's QE-ness seemed to separate the precious metals from other asset classes. Oil underperformed relative to the USD's weakness (-2% on the week in DXY) managing only a 1.3% gain (and ending below $100). Silver and Gold have no managed four weeks in a row of gains as the latter has more than retraced half of the all-time high sell-off range. With 5 minutes to go, NYSE volume was -32% from yesterday, by the close of the cash markets it was only down 2.5% leaving the week -10% from last week (so 32% of the day's NYSE volume was done in the last 1.3% of the day). In credit, HYG underperformed stocks, HY credit stayed synced with stocks and IG outperformed (touching 100bps as we closed). Treasuries ended the day (and week) at their low yields with 5s to 10s all lower by around 14bps on the week and 30Y rallying to -4bps on the week by the close. FX markets were a little odd as EURUSD squeezed higher and higher all day (largely ignored until a late ramp) by stocks as JPY's strength kept EURJPY (carry driver) relatively flat. EURUSD ended at 1.3227 (up around 300pips on the week) at its highest in 7 weeks as CFTC net shorts rose once again to new record highs at 171k. Broadly speaking risk assets and ES (the e-mini S&P 500 futures contract) have been highly correlated all week. This afternoon saw CONTEXT pull ES higher (mainly on EURJPY strength, and Oil stability versus TSY/Curve compression) but after the cash market close, ES limped back down to its VWAP to end its worst-performing week of the year (+0.15%) though not down (which we are sure would scare investors away) as stocks handily underperformed credit on the week as high beta starts to unwind.
Update 2: the first local headlines are coming in now, from Spiegel: Griechenland soll Kontrolle über Haushalt abgeben (loosely Greece must give up domestic control)
Update: Formal Greek annexation order attached.
It was tried previously (several times) under "slightly different" circumstances, and failed. Yet when it comes to taking over a country without spilling even one drop of blood, and converting its citizens into debt slaves, Germany's Merkel may have just succeeded where so many of her predecessors failed. According to a Reuters exclusive, "Germany is pushing for Greece to relinquish control over its budget policy to European institutions as part of discussions over a second rescue package, a European source told Reuters on Friday." Reuters add: "There are internal discussions within the Euro group and proposals, one of which comes from Germany, on how to constructively treat country aid programs that are continuously off track, whether this can simply be ignored or whether we say that's enough," the source said.' So while the great distraction that is the Charles Dallara "negotiation" with Hedge Funds continues (as its outcome is irrelevant: a Greece default is assured at this point), the real development once again was behind the scenes where Germany was cleanly and clinically taking over Greece. Because while today it is the fiscal apparatus, tomorrow it is the legislative. As for the executive: who cares. At that point Goldman will merely appoint one of its retired partners as Greek president and Greece will become the first 21st century German, pardon, European colony. But at least it will have its precious euro. We can't wait until Greek citizens find out about this quiet coup.
"Reach for yield" is a phrase that never gets old, does it? Whether it's the "why hold Treasuries when a stock has a great dividend?" or "if this bond yields 3% then why not grab the 7% yield bond - it's a bond, right?" argument, we constantly struggle with the 100% focus on return (yield not capital appreciation) and almost complete lack of comprehension of risk - loss of capital (or why the yield/risk premium is high). Arguing over high-yield valuations is at once a focus on idiosyncrasies (covenants, cash-flow, etc.), and technicals (flow-based demand and supply), as well as systemic and macro cycles, which play an increasingly critical part. Up until very recently, high yield bonds (based on our framework) offered considerably more upside (if you had a bullish bias) than stocks and indeed they outperformed (with HYG - the high-yield bond ETF - apparently soaking up more and more of that demand and outperformance as its shares outstanding surged). With stocks and high-yield credit now 'close' to each other in value, we note Barclay's excellent note today on both the seasonals (December/January are always big months for high yield excess return) and the low-rate, low-yield implications (negative convexity challenges) the asset-class faces going forward. The high-beta (asymmetric) nature of high-yield credit to systemic macro shocks, combined with the seasonality-downdraft and callability-drag suggests if you need to reach for yield then there will better entry points later in the year (for the surviving credits).
Courtesy of reszatonline, who brings us the following allegory by way of Tim Coldwell, we are happy to distill (no pun intended) all of modern economics and finance in a narrative that is 500 words long, and involved booze and broke alcoholics: in other words everyone should be able to understand the underlying message. And while the immediate application of this allegory is to explain events in Europe, it succeeds in capturing all the moving pieces of modern finance.
In an effort to reach the angry mob, CNBC's Rick Santelli goes all Sesame Street on the numbers behind the US Debt Ceiling Rise. Focusing for two minutes on what this practically means for every man, woman, child, and politician, the shouting Chicagoan points out that when the US breaches this new limit then the world's entire population will be on the hook for $2,346 each (and $52,409 per US person).
Festive Friday fun:
- FITCH TAKES RATING ACTIONS ON SIX EUROZONE SOVEREIGNS
- ITALY LT IDR CUT TO A- FROM A+ BY FITCH
- SPAIN ST IDR DOWNGRADED TO F1 FROM F1+ BY FITCH
- IRELAND L-T IDR AFFIRMED BY FITCH; OUTLOOK NEGATIVE
- BELGIUM LT IDR CUT TO AA FROM AA+ BY FITCH
- SLOVENIA LT IDR CUT TO A FROM AA- BY FITCH
- CYPRUS LT IDR CUT TO BBB- FROM BBB BY FITCH, OUTLOOK NEGATIVE
And some sheer brilliance from Fitch:
- In Fitch's opinion, the eurozone crisis will only be resolved as and when there is broad economic recovery.
And just as EUR shorts were starting to sweat bullets. Naturally no downgrade of France. French Fitch won't downgrade France. In other news, Fitch's Italian office is about to be sacked by an errant roving vandal tribe (or so the local Police will claim).
While the ubiquitous pre-European close smash reversal in EURUSD (up if day-down and down if day-up) was largely ignored by risk markets today (as ES - the e-mini S&P 500 futures contract - did not charge higher and in fact rejected its VWAP three times), some cracks in the wondrously self-fulfilling exuberance that is European's solved crisis are appearing. For the first day in a long time (year to date on our data), European stocks significantly diverged (negatively) from credit markets today. While EURUSD is up near 1.3175 (those EUR shorts still feeling squeezed into a newsy weekend), only Senior financials and the investment grade credit index rallied today, while the higher beta (and better proxy for risk appetite) Crossover and Subordinated financial credit index were unchanged to modestly weaker today (significantly underperforming their less risky peers). European financial stocks have dropped since late yesterday - extending losses today - ending the week up but basically unch from the opening levels on Monday. High visibility sovereigns had a good week (Spain, Italy, Belgium) but the rest were practically unchanged and Portugal blew wider (+67bps on 10Y versus Bunds, +138bps on 5Y spread, and now over 430bps wider in the last two weeks as 5Y bond yields broke to 19% today). The Greek CDS-Cash basis package price has dropped again which we see indicating a desperation among banks to offload their GGBs and needing to cut the package price to entice Hedgies to pick it up (and of course some profit-taking/unwinds perhaps). All-in-all, Europe's euphoric performance has started to stall as perhaps the reality of unemployment and crisis in Europe combine again with US's GDP miss to bring recoupling and reinforcement back.
In what is likely a long overdue move, Iran has finally decided to give Europe a harsh lesson in game theory. Instead of letting Euro-area politicians score brownie points at its expense by threatening to halt imports and cut off the Iranian economy, the Iranian government will instead propose a bill calling for an immediate halt to oil deliveries to Europe. The move, with most reports citing the Iranian news agency Mehr, has come about in response to the EU agreement to impose sanctions against Iran, which were announced earlier this week. And why not? After all if Europe is indeed serious, sooner or later Iran will be cut off but in the meantime experience significant policy uncertainty, which is precisely what the flipflops on the ground need. The one thing that Europe, however is forgetting, is that all that whopping 0.8 Mb/d will simply find a new buyer. And with China, India and Russia already having bilateral agreements with Iran in place, we are confident that said buyer will have a contract signed, sealed and delivered within an hour of the proposed bill's passage. Furthermore, as SocGen speculated, the fact that Europe will be even more bottlenecked in its crude supplies (good luck Saudi Arabia with that imaginary excess capacity), and which just may force the IEA to release some more of that strategic petroleum reserve (and thus give JPM some more free money on the replenishment arbitrage) will send Brent to $125-150 - something which Iran will be delighted by. That is of course unless some "experts" discover that Iran may or may not have a complete arsenal of shark with fricking nuclear warheads attached to their heads (despite what Paneta has already said) which gives the US the green light for a full blown incursion, which in turn will send oil over $200, and the world economy into a global coordinated re-depression.
With everything from stocks and bonds to 'roo bellies rising as one trade, it may be a good time to ask: what's priced into the market's uptrend? We say "bad news is priced in" when negative news is well-known and the market has absorbed that information via the repricing process. When the market has absorbed all the "good news," then we say the market is "priced to perfection:" that is, the market has not just priced in good news, it has priced in the expectation of further good news. Markets that are priced to perfection are fiendishly sensitive to unexpected bad news that disrupts the expectation of continuing positive news. So what have global markets priced into this uptrend across virtually all markets?
Remember back in long distant memories (from a month ago) when all the chatter was for the US to decouple from Europe as the former (US) macro data was positive and a 'muddle-through' consensus relative to the European debacle took hold. Since 12/14, European markets have significantly outperformed US markets (both broadly speaking and even more massively in financials - which is impressive given the strength in US financials). Furthermore, we saw a decoupling of correlation (de-correlating) between EUR and risk as a weaker EUR was positive for risk as USD strength showed that the world was not coming to an end (and Europe was 'contained'). Well things are changing - dramatically. EUR and risk were anti-correlated for the first two weeks of the year and since then have re-correlated. The last few days have seen EUR weakness (Greek PSI and Portugal fears) coincident with risk weakness (ES and AUD lower for instance as US macro data disappoints and a dreary Fed outlook with no imminent QE). Given the high expectations of LTRO's savior status, European financials have been the big winners (+20% from 12/14 and +15% YTD in USD terms) compared to a meager +12% and +8.8% YTD for US financials - with most of the outperformance looking like an overshoot from angst at the start of the year in Europe (which disappeared 1/9). With EUR and risk re-correlating (and derisking very recently), perhaps it is time to reposition the decoupling trade (short EU financials vs long US financials) though derisking seems more advisable overall with such binary risk-drivers as Greek PSI failure, Portuguese restructuring (yields have crashed higher), and the Feb LTRO pending (which perhaps explains the steepness of vol curves everywhere).