Following yesterday's announcement that the ECB had purchased a new record total of €207 billion in peripheral bonds, many were focused on today's ECB sterilization announcement to see if, like last week, there would be a failure in the repo market, and less than the full amount of bonds to be sterilized, would be bid. As it happens today the ECB lucked out, after 113 bidders submitted bids for €236 billion in bonds, at a rate of 0.65%, with the threshold €207 billion amount being covered comfortable at 1.19x. Yet one wonders what is it that caused the €50 billion swing in available capital for European banks (last week the tendered for amount was €194 billion). What is ironic is that earlier today, the ECB provided €252 billion in a liquidity providing operation (MRO) to 197 banks at a fixed rate of 1.00%. In other words, banks borrowed €252 billion at 1% from the ECB to lend €207 billion back at 0.65% to the ECB. And that is called a "successful" sterilization.
Those wondering what caused the accelerated reacquaintance of the EURUSD with gravity on its way to what UBS has just dubbed the "beginning of the end" (report to be published shortly), need look no further than the ECB where the ECB had its first failed sterilization since the expansion to monetize Italian and Spanish bonds was launched in August. As noted yesterday, the ECB had to sterilize €203.5 billion in cumulative bond purchases. Instead, it only got bids for €194.2 billion from a paltry 85 bidders. This means that for the first time, as shown on the chart below, the ratio of Bids to Bonds for Sterilization fell under 1. What is much worse, is that this happened on the day of the weekly 7-day MRO, during which a total of 192 banks took a combined €265.5 billion from the ECB's weekly 1.25% handout. The amount tops the 247 billion that 178 banks took last week and is the second week running that demand hit a new two-year high. In other words, despite demanding the most amount of money in 2 years, the banks were unable to flip all that cash and "sterilize" monetized paper. This is very bad news as it confirms that the SMP program is coming to a forceful close as banks withdraw in their shells and any further PIIGS bonds purchases will be no longer sterilized above some threshold level, somewhere in the high €100's, low €200 Bns. Whether this is the final straw that pushes the ECB to print outright remains to be seen: it is surely providing the needed dead cat bounce to the EURUSD as hopes that Draghi will finally do as the banks demand have once again resurfaced.
As usual, the bond market has already an idea on how this will pan out. Looking at various yield curves we get the following picture:
- Greece is “off the chart” (in the “toast” zone)
- Portugal will not make it as debt and interest is not sustainable and the EFSF struggles to raise bailout funds.
- The “soft Euro-zone” could survive by aggressive monetarization of debt by the ECB – once the German hardliners quit. Inflation would probably follow in a few years, but that is another question.
- The “hard Euro-zone” would consist of Germany and the Netherlands. They unilaterally quit the Euro-zone and introduce a pegged currency pair.
- France is really the only unsolved question in this puzzle. Bond yields have peeled away from Germany a bit too far. Historically, France was a “soft” currency country with frequent realignments of exchange rate under the European ERM (Exchange Rate Mechanism). Given the strong political ties France will probably be forced to stay married to Germany, but it will be an unhappy marriage, with an eventual break-up at a later date.
- I have included Hungary just out of curiosity, since their love-hate relationship with the IMF is slightly entertaining.
Ever the contrarian, we were somewhat taken aback by the overwhelming majority of respondents to JPMorgan's fixed income manager survey who expect LSAPs in 2012. With 80% expecting QE3, a majority expecting to add to Agency MBS (and high yield and investment grade credit), it seems the Fed's bang for buck from actually enacting the balance sheet expansion will be significantly lower than it hopes. Maybe third time is the charm but it seems evident from discussions that traders have become numb to this manipulation - even if it does have short-term portfolio rotation impacts - but the difference between managers who expect to reduce EUR assets and those that expect to increase USD assets suggests everyone and their cat is waiting to jump in. The diversification/currency trade seems popular as local denominated EM assets are among the classes managers expect to add the most to but duration risk seems very evenly split as the great majority expect 10Y to hold the 1.5% to 2.5% range. Given the survey results, it seems the lack of belief in any significant fiscal stimulus is being discounted by the strong belief that the Fed will ride to the rescue once again.
Italy, Spain, France and Belgium will each go to market this week to auction bonds worth billions of euros...GASP!
And so the one thing that was supposed to be set (if only briefly) in stone, the terms of the Greek creditor haircut, has now fallen apart. From Reuters: "The Greeks are demanding that the new bonds' Net Present Value, -- a measure of the current worth of their future cash flows -- be cut to 25 percent, a second person said, a far harsher measure than a number in the high 40s the banks have in mind. Banks represented by the IIF agreed to write off the notional value of their Greek bondholdings by 50 percent last month, in a deal to reduce Greece's debt ratio to 120 percent of its Gross Domestic Product by 2020." And confirming that the IIF has now lost control of the situation, "the country has now started talking to its creditor banks directly, the sources said." And because the NPV is only one component in determining what the final haircut really is, this means that the haircut just got higher or the actual coupon due to creditors will be slashed, a move which will see Sarkozy balking at this overture in which Greece once again sense weakness out of Europe. We can't wait to hear what France says to this latest escalation by Greece, which once again has destroyed the precarious European balance.
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.
Our good friend Doug B., a financial advisor based in Boulder, CO, has done well for his clients by keeping them heavily weighted in bonds. In the essay below, he explains why he intends to stick with this strategy even though many of his peers expect a rebounding stock market to outperform fixed-incomes in the years ahead. For Baby Boomers in particular, the deflationary trend that buttresses Doug’s strategy holds stark implications.
When discussing European sovereign bond purchases it is never polite to say the ECB "monetizes" when talking to "very serious people" - after all they "sterilize", or in other words, don't see an actual balance sheet expansion, as they offload the entire cumulative balance (which as of this week was €194.5 billion) onto other financial institutions. In this way, the bank supposedly does not take on interest rate risk, which in a feedback loop, is the cause and event of such modestly unpleasant monetary expansion episodes as the Weimar republic. What few discuss, however, is just where the banks get the money to actually buy bonds from the ECB. Well, as it turns out, all the money used for sterilization comes from, you guessed it, the ECB, in what is one massive several hundred billion circle jerk. In essence what the ECB does, by pretending to not monetize and pretending to sterilize, is taking on not only interest rate risk one level removed, but also bank solvency and liquidity risk! In turn, this makes the central bank even more undercapitalized in practice than it is (and at 50+ leverage, it is already pretty, pretty undercapitalized), as once the banking dominos start crumbling, it will be the ECB that is left on the hook... and thus the Fed and the US taxpayer. So perhaps while Germany is complaining every single day about the possibility of outright money printing by the ECB, it will be wise to ask itself: who is giving Europe's insolvent banks, which just borrowed a record amount of short-term cash from the ECB to be recycled precisely into such indirect monetization, their cash?
Pick the odd one out of the following 7 banks, while in the process pointing out what they have in common: Bank of America Corp, Citigroup Inc, Deutsche Bank AG, Goldman Sachs Group Inc, Jefferies Group Inc, JPMorgan Chase & Co and Royal Bank of Scotland Group Plc. As it so happens 6 of the 7 are Bank Holding Companies, and have access to the Fed's various emergency facilities. The seventh, Jefferies, which a few years ago, boasted that it is now the largest remaining true investment bank after all its competitors had converted to BHC status, may soon regret it said that and did not join its peers. Why? For the same reason why on November 1, the day after MF Global filed for bankruptcy, we tweeted: "Here is why Jefferies is in deep doodoo: http://1.usa.gov/uNBhzq" The reference of course is to the now legendary prospectus for the MF Global 6.25% notes of 2016 that had the infamous Corzine key man event: "interest rate applicable to the notes will be subject to an increase of 1.00% upon the departure of Mr. Corzine as our full time chief executive officer due to his appointment to a federal position by the President of the United States and confirmation of that appointment by the United States Senate prior to July 1, 2013." At this point the only appointment Obama may give Corzine is that of a presidential pardon for a criminal felony offense (assuming of course Corzine brings a sleeping bag to Zuccotti square: the only offense for which he may ever be arrested). Alas, Jefferies, and the 6 other banks, do not have that luxury: as of late this afternoon, all six were sued by pension funds "who said the bonds' offering prospectuses concealed problems that led to the futures brokerage's collapse." Precisely as Zero Hedge expected. And unfortunately for Jefferies, this may well be the final nail in the coffin - because while the market had punished the bank for its Exposure, the biggest unknown in the past 2 weeks was whether and when it would be sued precisely for its MF Global liability. That time is now: next up - every single entity that was impaired in part or in whole as a result of the MF Global bankruptcy will follow suit and sue the same 7 banks... of which only Jefferies does not have the benefit of an infinite backstop.
InIn diametrical contrast to the rumor that the ECB and the IMF would collaborate to bail out the insolvent continent whereby the ECB prints and the IMF distributes, something which every German on record has said will not happen, we now get news from German newspaper Frankfurter Allgemeine that the ECB has agreed on a €20 billion cap on sovereign debt purchases: something which means all chimeras of an all out monetization orgy can once again be summarily short down. Bloomberg reports: "European Central Bank governing council members have agreed on a 20 billion-euro ($27 billion) weekly upper limit for sovereign debt purchases as resistance among members grows, the German newspaper Frankfurter Allgemeine Zeitung reported. The ECB council meets every other week to decide on an upper limit for bond purchases used to stem rising yields as the European debt crisis widens, the newspaper reported, without saying where it obtained the information. Members met again late yesterday to discuss lowering the level, FAZ said. Council members from the Netherlands and Austria have added their voices to skepticism over the bond-purchase program, the newspaper said. Those objecting to buying include Bundesbank President Jens Weidmann, Executive Board member Juergen Stark and Yves Mersch, governor of Luxembourg’s central bank, FAZ said." Ah, to loosely paraphrase Amadeus, "the Italians Germans... Always the Italians Germans. "
....or else you will figure out not only that there is such a thing as sovereign crisis spillover into financials, but why UniCredit was once again the most active name on Sigma X yesterday, and why earlier today it is rumored that the bank is scrambling for emergency ECB assistance. But such is life when your equity is €14.5 billion and your total holdings of Italian bonds ar... €40 billion! If we were betting people, we would probably out a dollar down that UCG is the next Dexia.
Following a relatively quiet overnight session which despite various bond auctions in Europe did not see any flagrant contagion, and in which ongoing ECB buying of Italian bonds led the 10 Year BTP spread back to 6.75%, things have taken a very quick turn for the worse once again, and the BTP is now back at the day wides at 7.10%, following the following Reuters headline which is rather self explanatory: RTRS-UNICREDIT CEO, IN MEETING WITH ECB, TO ASK FOR MORE ACCESS TO ECB FUNDING FOR ITALIAN BANKS BY WIDENING TYPE OF COLLATERAL USED-SOURCE CLOSE TO BANK. Hmmmmm, UniCredit....where is that name familiar from. Oh wait, that's right - it was, once again, the top name on yesterday's Sigma X report of most actively traded companies by Goldman's special clients. Good to see there was no leakage here at all, none. And making things worse across the Mediterranean is the rumor that LCH Clearnet will promptly follow suit, and hike Spanish margins now that the spread to German Bunds is over 450 bps. Bottom line: Same Europe, Different Day. Here is our perfectly uneducated guess - market plunge in the morning in which institutions dump, ramp in the afternoon in which retail and HFTs buy.
The primary reason for today's (and last week's) dramatic overnight market weakness was the fact that several auctions, either Italian, or Spanish, went off about as badly as they possibly could. But luckily that's over, right: all the auctions in the near term are over and there is nothing to worry about for at least a few more days so traders don't have to get up at 3 am Eastern to see just how abysmally bad the latest Italian Bill issuance was? Uhm, no. Below we present the balance of Europe's bond auctions for November, for December... oh, and Bills as well, because apparently issuing 3 Month paper in Europe is about as difficult as selling 30 Years.
There is that thing we said about the European "communicating vessels/whack-a-mole" - the second one is down, several others pop up. Today, it is Spain's turn, whose 10 Year bond yield just passed 6%: the first time it has done so since August 5. The catalyst was the discovery earlier that Spanish bank borrowings from the ECB rose to €76 billion ($104.1 billion) in October, the highest level in more than a year, as the ECB remains the LOLR contrary to Jen Weidmann's claims to the opposite. So which bonds does the ECB buy next? When we said last week that Mario Draghi should hire all the fired bond traders from UBS, RBS, HSBC and Jefferies we were not kidding.