Bond

Once again the desperation level is high as seemingly the core driver of overnight strength was a rumor that China would inject €700 billion in the EFSF, coupled with the even more desperate expectation that in a few short hours Ben will launch the LSAP version of QE: something that is virtually impossibly unless stocks drop to triple digits, and a fact that the market with its constant attempts at Fed frontrunning makes practically impossible. Yet this was good enough to tighten the all critical Italy-Bund spread to 422bps overnight (recall it hit the catastrophic 455 bps yesterday). However some news since then have put a major damper on sentiment, notably another recessionary data point from Europe, where the October Manufacturing PMI printed at 47.1 on expectations of 47.3, and German unemployment posting a rare disappointing miss printing +10K on consensus of -10k. Yet the nail in the coffin for today's European action was that the EFSF, which as we noted already reduced its €5 billion Irish bailout package to €3 billion on subpar market demand, pulled the entire issue citing the trusty old fallback "market conditions" confirming that not only is the latest China bailout rumor a complete fabrication yet again (as explained both here and here). What is more troubling is that the EFSF has set off on its path to raise €1 trillion+ with an epic failure and an inability to raise even €3 billion. That realization has finally spread to the market and not only is the Italy-Bund spread back to morning wides at 438, but, just as disturbing, the French-Bund spread is back to all time wides of 123 bps! That the European interbank liquidity market just collapsed again with ECB deposit facility usage hitting a three week high of €229 billion, coupled with Euribor-OIS spread jumping +6 bps in a week to 0.86% and just off the 3 year highs of 0.89%, is certainly not helping things. Look for more mayhem out of Europe as the G-20 meeting slowly unwinds over the next day, and the complete lack of organization in Europe is exposed for all to see all over again.

We commented earlier on the precipice of LCH.Clearnet's margin rules for Italian debt and the 450bps spread Maginot Line. Well, as always, there is some wiggle room in here and instead of using what seems 'obvious' as a benchmark (Bunds), LCH uses a blended AAA sovereign benchmark (consisting of Germany, France, and Holland). This makes a significant difference, obviously, and with Bunds massively outperforming today (now 86bps tighter than this archaic benchmark), ITA 10Y bonds ended the day at a spread of 355bps (not 440bps). So as long they keep France or Holland 'weak' then ITA margin calls should be safe for now and their benchmark becomes less and less realistic as a AAA index.

Stunned horror, even from the ECB which is not even pretending to be able to put a floor under Europe's fulcrum security - the Italian 10 year. Popcorn not optional. If this thing hits 8X, cue panic. It also appears, that contrary to Fast Money's expectations, the dump in BTPs was not "entirely driven" by MF liquidations, and the bankruptcy was not a "wildly bullish" event.

Well, they are right: 50% and the gun next to your head does not go off, hence "voluntary" or push for fair treatment in bankruptcy, get exiled from the ponzi in perpetuity, and hope for a 0% recovery at best. Next steps: the upcoming 90% haircut, which make no mistake is coming once the 50% one is deemed insufficient, just like the 21% before it, will also be voluntary? Thank you ISDA for confirming whose interests you have truly at heart, and for forcing everyone to take a quick peek at the members on your "determinations committee."

Reaching for yield (and prospectively capital appreciation) while shortening duration had become the new 'smart money' trade as we saw HY credit curves steepen earlier in the year (only to become the pain trade very quickly). The attraction of those incredible yields on short-dated sovereigns was an obvious place for momentum monkeys to chase and it seems that was the undoing of MF Global. The Dec 2012 Italian bonds (in which MF held 91% of its ITA exposure), as highlighted in today's Bloomberg Chart-of-the-day, appears to be the capital-sucking instrument of doom for the now-stricken MF. As if we need to remind readers, there is a reason why yields are high - there is no free lunch - and while some have already leaped to the defense of the bet-on-black Corzine risk management process with comments such as 'He was simply early and will be proved correct' should remember that only the central banks have bottomless non-mark-to-market pockets to withstand the vol. It also sets up a rather useful lesson for those pushing for EFSF leverage to buy risky sovereign debt - but given today's issue demand, perhaps that is moot.

Earlier today Italy had an extended bond auction in which it sold 3, 6, 8, and 10 year bonds. The auction did not go quite as planned. The reason: far less than the maximum €8.5 billion target was raised, all the Bids to Cover slid and all the yields soared with a particular emphasis on the 10 Year BTP which everyone is following with great interest as it sternly refuses to trade inside of 6% despite all the worthless promises with the word "trillion" in them, lobbed in Italy's general direction from Europe, which knows too well that if the Italian bonds complex goes, so does the rest of Europe. As Reuters summarizes: 'Italy paid the most since joining the single currency to sell new 10-year debt on Friday in the first euro zone bond auction after European leaders agreed new steps to tackle the debt crisis. The auction yield on Italy's March 2022 BTP bond rose to 6.06 percent from 5.86 percent a month ago."  So... when is the next "Italy bailout" summit?

The European sovereign debt markets are dominated by the haves and the have-nots today as risk transfer is the key phrase of the day. Away from the technicals of the CDS markets and the liquidity of the CDS indices, the critical yields on sovereign bonds are not exactly exuberant in most cases. Obviously GGBs are improving but still not dramatically and while we would expect the PIIGS to all be benefiting greatly, we note that from the exuberant opening levels, BTPs (for instance) have leaked lower in price (higher in yield) all day long. As 10Y BTPs inch back up towards 6% and EFSF bonds slide lower in price, it seems, as Peter Tchir points out below, that "it's like throwing a surprise birthday party and not inviting the person whose birthday it is".

Paul Brodsky does not trust the bond markets. That position may seem strange coming from someone who has spent most of his professional career trading bonds, but it's precisely this insider knowledge that has led him to start directing investors to safer harbors. In fact, he thinks our credit system is so far out of control that it will cause a massive - and largely unavoidable at this point - devaluation of the US dollar (and most other fiat currencies, as well). Ultimately, Brodsky recommends investors concerned with protecting the purchasing power of their wealth today get exposure to hard assets that can't be so easily inflated away.

Well, it is not just the CDS ban, the fact that Greece is now done is also a modest factor, but since nobody can short Greek default risk unhedged, the only option is to short the bonds. As they did today en masse. Greek 1 Year bonds: the most liquid proxy for default in the absence of 1 Year CDS, closed at 183%, after hitting an all time high of 188%, following yesterday's 173% close. To all those who bought 1 Year Greek bonds when yields hit 100% a month ago because "they just couldn't possibly drop any more, and you would double your money in one year guaranteed", condolences for the 50% loss. We are certain that a new batch of bottom callers will emerge, this time calling for doubling your money in six months.... Then three.. Then one and a half... etc... Until finally Zeno's paradox catches up and you either double your money overnight or you lose it all.

Like yesterday when just before 10 am we had a big gap down in PIIGS bonds, represented in this case by Italy's BTPs, only to be followed by ECB buying of peripherals, so today, same time, same place, the ECB gets involved to prevent yet another market rout, this time amplified by the fact that one can not longer short PIIGS using CDS and shorting cash bonds is the only option. Alas, as the chart below demonstrates, as yesterday the ECB intervention merely delayed the downward price trajectory of Italian bonds, so today we expect the same result. In the meantime, ECB buying has driven the EURUSD, and thus the ES higher, however briefly.

Now that we already had one notorious bond bear in the house with a late afternoon appearance by Bill Gross, who in a very polite way, apologized and said that while he may have been wrong in the short-term, he will be proven correct eventually, it is now time for the second uber-bond bear to make himself heard. In a CNBC interview with Jim Rogers, the former Quantum Fund co-founder, who back in July said he was had shorted US Treasurys, exhibited absolutely no remorse, instead reiterated a 100% conviction in his "bond short" call: "Rogers said when there is a bubble, such as the one being experienced in U.S. Treasurys, prices could go up for long periods of time. Bill Gross of Pimco, who also had a bearish view on Treasurys, threw in the towel earlier this year. But Rogers is sticking to his opinion that Treasurys will eventually fall. "Bernanke is obviously backing the market again and the Federal Reserve has more money than most of us - so they can drive interest rates down again. As I say they are making the bubble worse." The reality is that while Bill Gross has to satisfy LPs with monthly and quarterly performance statements (preferably showing a + sign instead of a -), the retired and independently wealthy Rogers has the luxury of time. And hence the core paradox at the heart of modern capital market trading: most traders who trade with other people's money end up following the crowd no matter how wrong the crowd is, as any substantial deviation from the benchmark will lead to a loss of capital (see Michael Burry) even if in the longer-term the thesis is proven not only right, but massively right. Alas, this means most have ultra-short term horizons, which works perfectly to Bernanke's advantage as he keeps on making event horizons shorter and shorter, in the process killing off any bond bears which unlike Rogers can afford to wait, and wait, and wait.

The "benefit" of Operation Twist for the long end shone through today as the Treasury priced $13 billion in a 30 Year reopening, which came at a record low yield of 3.12%: this was 4 basis points inside the When Issued of 3.16% so at first sight the auction was a stunning success, confirmed by the second highest Bid To Cover in the auction history of 2.94. Perhaps... The only problem is when one looks at the internals, where just like yesterday, the most prominent observation was the total collapse in the Indirect Bid, which accounted for just $3.7 billion of the take down or 28.7% of the total, less than the Direct portion which despite having plunged in all other recent bond auctions soared to a virtual record 29.5% of the total auction (less than just the 29.6% from March 2010). And now the question again arises: are the Directs merely London-based offshore entities doing China's bidding away from the Indirect bidder spotlight, or, is this some other operation that kicks in every time when a plunge in Indirects is expected, such as over the past two days with China seemingly doing all it can do show it is telegraphing a plunge in interest for US paper. We will know more today when at 4:30 pm the Fed discloses its most recent custodial Treasury holdings for the past week. In the meantime, the Primary Dealers and the Directs have the long-end firmly under control.

Yesterday was one of the strangest days in awhile - and that is from a long list of strange days. The most confusing part is that over the weekend Dexia went through some form of nationalization - the details of which and the need for which remain sketchy. Erste decided to take some big write-downs on CDS positions it had written, and Merkel and Sarkozy yet again held a joint press conference to announce that now they were really serious about saving everything and everyone. European stocks and credit had a relatively muted reaction. Stocks were up small. The Dax for example was drifting from slightly down to up less than 1%. SOVX was a touch wider and MAIN was a few bps tighter. Then the US came along and told Europe that they didn't realize how good they had. Yes, US equity players came along and told Europeans they didn't understand what had happened in their own backyard. The US stock market dragged Europe higher and tighter with it. Investors who were short IG17 or HY17 were hitting bids in MAIN, XOVER, and buying JNK, LQD, and HYG, along with SPX. Today, Europe was basically treading water and tried to do better at 7am as the US opened for business. Since then we have started to drift wider and lower. Part of this is going to be funds getting their positions squared away as they can now sell some IG17 and buy back their other hedges. Credit traders who are left scratching their heads about how things were "fixed" over the weekend are back and fading this rally.

A week ago our post announcing that the Greek deficit target was going to be revised higher once again, from 7.6% to 8.5%, started with the following sentence: "As the Greek parliament meets to finalize huge public sector job cuts, Reuters is reporting that Greece will miss the deficit targets set in its EU/IMF bailout this year and next... We would say "again" but at this point "as usual" makes far more sense." Guess what: it is time to "as usual" re-re-revise it once again.

Michael Lewis’ latest piece in Vanity Fair, “California and Bust,” begins with a lengthy defense of Meredith Whitney’s prediction that there would be a wave of defaults in the municipal bond market. I was not planning on writing a response to his article – frankly, defending Whitney’s call at this point is very much like defending Harold Camping’s prophesy on May 22^nd, after even the most gullible people have realized that they euthanized their pets for nothing. Who really cares about the intransigent believers that remain, for whom a forceful narrative has always been more relevant than facts?