Bond

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.

Well, about 99% of the world’s bankers, politicians, and finance ministers are demanding that the ECB step up its purchases of sovereign debt.  Basically anyone who will make money, gain power, retain their jobs, etc., has voiced their desire to see the ECB change the rules yet again, and grow their  balance sheet to support the sovereign debt (and banks) of nations that are insolvent or bordering on insolvent. The only problem, so far, is that the country with the money and credibility is still saying NO.  German 2 year bonds yield 0.34%.  That is a fraction of the ECB’s overnight rate.  France, by comparison trades at 1.37%.  Maybe someone should listen to the one country that has been able to manage its credit?  The issue seems to be print and all is good, or don’t print and risk disaster.  Neither of these views are necessarily true.  Without a doubt, printing, and buying massive amounts of sovereign debt, would give a short term benefit to the markets and to the politicians.  Yet, there is no evidence that it would help longer term.  The EU and ECB have changed, bent, or broken rule after rule, and the consequences have been universally bad.  They let countries in that didn’t really meet the criteria.  They let annual budgets slip.  The ECB changed rules so that they could lend to countries and banks that were below investment grade.  Every time they have broken a rule to get a solution to a “temporary” problem, it has turned out that only the solution is temporary.

Unlike in the past week, when the ECB had a clear agenda of getting Berlusconi out, and thus let 10 Year BTPs tumble to a record low price of 82 cents before even pretending to intervene, all it took today was a modest drop from 88.80 to 87.80 before Mario Draghi sent his bond traders out in the market lifting every offer. As for the sell off catalyst: the auctioning off of €3 billion in 5 year bonds which cleared at a record 6.29%, the highest pricing yield since 1997. This compares to the last auction of 5.32% on October 13 and a bid to cover at the current auction of 1.47 compared to 1.34 last. Yet once again, mysteriously like last week's 1 year auction, the bonds came in well inside of the prevailing yield just before the auction which was 6.43%. Once again one wonders: precisely how do these auctions continue to clear with no tail whatsoever, and why would anyone buy the bonds in the primary market at a price that is much higher than the secondary one. But we can wonder: in the meantime the EFSF will assure us it is not a ponzi scheme. Either way, just as the 10 Year BTP price threatened to take out early support following a very aggressive selloff beginning just as the 3 Year came to market, the ECB stepped in and started buying bonds up. No wonder the EURUSD is well below the Friday closing price, and trading at 1.3670 at last check. For those interested, below are the kneejerk Wall Street analyst responses to the Italian auction.

Spreads across Europe are tighter today, and stocks higher, as investors hope that a power shuffle at the top in Greece and Italy, where the placement of two Fed and ECB puppet rulers, would change decades of flawed fiscal planning and destructive habits. Of note, the catalysts inducing a substantial rise in French, Italian, Belgian and Irish bonds, is the expectation of a new Greek government as well as the Italian Senate voting on approving the 2012 budget and passing austerity measures (which it has already done before, and nothing happened) such as increasing the retirement age by 2 years in 15 years. The vote itself is a symbolic ouster to Berlusconi who has previously said he would retire the second the budget is passed. The question remains what happens after Berlusconi falls: elections or a new technocratic consensus government, headed by Mario Monti, and whether the ECB will support whatever course Italy takes. So needless to say prepare for vicious 50-100 pip moves in the EURUSD, and with every pip amounting to 1-3 DJIA point, the volatility in the market today will be significant. Buckle in. In other news, the one fundamental question that needs some answer before all this is over, namely how Italy will fund €300 billion in debt maturities and interest payments over the next year, with the EFSF now a formal dud, remains unanswered, and will, as there is no answer.

For years I have warned of the impending European collapse. Now, as it is happening, we still have banks getting away with nonsensical 60% writedowns on essentially worthless debt. LGD > 100+% - You ain't seen the worst of it, not by a long shot!

The much dreaded LCH margin hike came and went and while initially the market participants thought it was just a joke as nothing bad is ever allowed to happen anymore in these neverneverland markets, a few hours later the realization that this is all too real has finally dawned. The result is an epic bloodbath everywhere, but nowhere more so than in Europe, where one can kiss Italian bonds goodbye, and shortly French too, as the bond vigilantes demand that the ECB print now or else. Visually this is presented as follows: a 30 point drop in the ES, an unseen collapse in Italian bonds, and an explosion in the French-Bund spread. And since nobody can demonize CDS any more, we expect Europe to make selling sovereign bonds illegal next.

BNP Paribas SA and Commerzbank AG (CBK) are unloading sovereign bonds at a loss, leading European lenders in a government-debt flight that threatens to exacerbate the region’s crisis.

BNP Paribas, France’s biggest bank, booked a loss of 812 million euros ($1 billion) in the past four months from reducing its holdings of European sovereign debt, while Commerzbank took losses as it cut its Greek, Irish, Italian, Portuguese and Spanish bonds by 22 percent to 13 billion euros this year.

When last week Italian bonds threatened to plunge every single day (to levels seen earlier today, when the spread between the 10 Year BTP and the Bund has soared to 490 bps), many speculated that the ECB intervened every single day, and occasionally two or even three times daily. Now we have confirmation that in his first week on the job, Mario Draghi is already well on route to undoing everything that his predecessor did previously: his first action as head of the ECB was a surprise lowering of rates, and now he has bought double the amount that the ECB purchased in the prior several weeks, and the most since September 16. Altogether the ECB has monetized, granted with sterilization for now until of course Europe's banks end up being unable to sterilize these purchases and the ECB ends up holding the full unsterilized bag, a whopping €188 billion since its inception in May 2010. Of this, €110 billion has been dedicated exclusively to Spain and Italy, or rather, just Italy. This is in three short months. Good luck to the ECB as its winds down its SMP program, as mandated by Germany, and the EFSF is supposed to commence buying Italian paper in the open market.

Three months ago, in exchange for the ECB's expansion of its sterilized monetizations of bonds to include Italian BTPs, allegedly the only backstop that has prevented Italian bonds from experiencing an all out collapse to date, Italy was presented with a list of strict "austerity" demands, among which were spending cuts, higher revenues and labor reform. Since then none of these has occurred... or will occur, simply because Berlusconi has no control over the government, yet neither does anyone else, although everyone in the local government enjoys having a scapegoat for the total chaos. It appears that the ECB has just made it clear that the status quo is about to end, unless Italy does in fact push with something. And unlike other cases, where politicians on both sides of the table are happy to spout rhetoric while knowing well that nothing will change, in this case, courtesy of Italy largely untenable debt profile in which €166 billion in debt and interest are due in 2012, the ECB will have no choice but to play hard ball. Reuters has just confirmed that, reporting that  The European Central Bank often discusses the possibility ending the purchase of Italian government bonds if it concludes Italy is not adopting promised reforms, ECB Governing Council Member Yves Mersch said. "If we observe that our interventions are undermined by a lack of efforts by national governments then we have to pose ourselves the problem of the incentive effect," Mersch said according to extracts of an interview with Italian daily La Stampa to be published on Sunday. In other words on Monday the market will have to not only digest the implications of what the implications of the Greek vote of confidence are (last we checked G-Pap is still PM, and likely will be for quite a while), but also what happens now that the ECB has issued an ultimatum to Berlusconi to get his house in order. The problem is that he can't. Not without stepping down, that is. At that point the Italian pseudo stability that everyone has been taking for granted knowing full well it is nothing but an illusion, will fall and expose all the rot underneath. At that point we will truly see just how "hedged" all those Primary Dealers are, who have perfectly offsetting short positions to all their longs.