Bond

Today's 7 year auction capped a miserable week, in which the 2 and 5 Years auctioned off placed at very ugly terms, although none probably quite as ugly as today's 7 Year. The $29 billion QT0 priced at a 3 bps tail to the when issued, replicating yesterday's action, and pricing at 2.43%, the same as last month, but at a Bid To Cover of just 2.62, the lowest BTC since March 2010 when QE1 was ending and the future was unclear. And like during the past two auctions, the internals were decidedly ugly as Dealers had to take up 56.07% of the amount offered: the most since May 2009, when however the Direct bidder category was a non-factor. Indirects continued their trend of stepping away from all issuance and bought just 32.17% of the bond, the lowest since March 2009. Additionally the hit rate on the indirect bid was a whopping 86%. If anyone has figured out just how foreign banks will step in to fund US bond issuance, please let us know, because we are confused. And Dealers will not be all that excited to have to convert risk assets into paper yielding just over 2%, in the absence of the Fed's vacuum pump... Certainly not at these rates. Slowly, the realization that OT2 is not coming a week ago is starting to soak in as the Treasury complex is finally realizing that Gross was right all along. Exhibit A for the past statement: the performance of the 5 year in the past 3 days, whose 32 bps blow out is the 3rd biggest such move. Ever.

Following yesterday's very disappointing 5 Year $35 billion auction by the US Treasury, Germany followed up today with its own unsubscribed bond auction failure, after Germany sold just €4.825 billion in 5 year bonds at the 2011 low yield of 2.16%. The problem - the auction remained technically undersubscribed as the €6 billion offer only received €5.445 billion in bids. Even on a sugar coated basis, the BTC was just 1.1, a plunge from the 1.9s seen recently. But such is life without the backstop of Primary Dealers who buy up everything there is, until they themselves are no longer able to flip the shell game. From Dow Jones: "The Bundesbank said all bids at the lowest price were accepted and it satisfied all the non-competitive bids at the weighted average price. The amount retained for market-tending purposes was about EUR1.175 billion, bringing the total issue size to EUR6 billion, as previously announced." Bottom line, with the pristine economy of Germany unable to sell bonds, what does that mean for the US and the rest of the insolvent "developed" world?

Time to push out even more cash bond shorts:

In accordance with the Sovereign Credit Risk Framework and in response to the yield differential of 10 year Portuguese government debt and 10 year Irish government debt against a AAA benchmark, LCH.Clearnet Ltd has revised the risk parameters for Portuguese and Irish government bonds cleared through the RepoClear service.  The additional margin required for positions of Portuguese government bonds will consequently be increased to 65% for long positions.  The additional margin required for positions of Irish government bonds will be increased to 75% for long positions. These amounts will be adjusted for the current bond price*.  Short positions will pay a proportionately lower margin.

Stocks outperformed credit at the index level today but there was a significant shift in internals in corporate credit that provides the context for continued weakness in risk assets.

Today's 10 Year bond (CUSIP: QN3) priced at a solid 2.967%, just wide of the when issued 2.961%, the lowest high yield since November's 2.636% when QE2 was starting (in the form of POMOs, QE2 had long been priced in). The Bid To Cover confirmed the strength of the auction coming at 3.23, a jump from May's 3.00, and higher than the LTM average of 3.10. Indirect Bidders for the first time in 3 months surpassed 50%, taking down 50.6%, with Dealers allotted 41% and the remaining 8.3% going to Directs. Look for QN3 OTR to dominate POMOs over the next 2 weeks. Since there will likely be at most two more 10-year focused buybacks, Dealers will be able to promptly flip this bond to the Fed. As for next month, when the US is on the verge of a full blown default, it is unclear what happens.

Just in case the broad speculator public did not get the message earlier this week after the CME lowered ES margins, just in time for the market to sell off and send realized vol surging (while of course ignoring plunging vol in gold, silver and all other commodities), the CME has completed the "paint by Rahmian numbers" puzzle, and has made clear which other asset class has the investment "go ahead" by the administration. As of a few minutes ago, the initial and outright margins for 10Y and 30 Y Treasury Bond Futures, 10 Year On The Runs, 7 Year Interest Rate Swaps and LT US Treasury Bond Futures were all lowered by up to 19%. Good thing the move comes 4 weeks before the end of QE 2. Were it to just precede, or, gasp, coincide with June 30, one may get ideas that this is not quote unquote risk management, such as that expressly not exhibited by the CME's refusal to hike ES margins following their cut, but is nothing but another glaringly obvious means of directing speculative capital into preferred asset classes.

Today, very quietly, the Treasury released its latest refunding announcement, in which it disclosed it would issue another $66 billion in 3, 10 and 30 Year notes next week. The irony of course is that the US is and continues to be at its debt ceiling limit (or just $25 million short of it), at a total of $14,293,975 million. Furthermore, as was also disclosed by the Treasury, this gross issuance will also be the net amount added in marketable debt, as upon settlement on June 15, there will be no redemptions of maturing bonds. Which simply means that the continued "disinvesting" (which is merely a polite word for plundering) from intragovernmental debt, also known as retirement accounts, is about to kick into high gear. As a reminder, the only solution that Geithner currently has to run the government, at least until August 2 when even this runs out, is to slowly drain the debt in non-marketable accounts, in the form of Suspension of G-Fund and ESF reinvestments, as well as the Redemption and suspension of of CSRDF Investments, measure which when combined will provide a short-term buffer of $232 billion. Yet for all practical purposes, what is happening is that retirement accounts are now being seriously plundered, and if the unthinkable were to happen, and the debt ceiling would not rise, not only would the US be in technical default, but various retirement funds, which already are underfunded, would find themselves even more severely in the Red. As the chart below shows, the total amount of intragovernmental debt currently outstanding, has dropped to levels last seen in early April, even as total debt has continued its steadfast move higher. The scary thing is that by the time August 2 rolls around, the current total of $4.608 trillion in various Trust Funds, will drop to well about $4.4 trillion, or an implicit 6% underfunding in 2 months merely to keep the bloated government operating for a few more months.

Risk is solidly bid this morning as the EURUSD has jumped to overnight highs of just under 1.45, and the DXY has just dropped to a one month low, following two Spanish bond auctions which saw yields surge yet came at far higher bids to cover than previously. From Reuters: "Spain saw strong demand for 3.95 billion euros ($5.67 billion) of medium-term bonds on Thursday, though a broad drop in risk appetite and lingering uncertainty over how talks on fresh aid for Greece will pan out kept yields high. In a litmus test of investor appetite for peripheral euro zone debt as policymakers thrash out a plan to avert a Greek default, the 2014 bond, with a 3.4 percent coupon, sold 2.75 billion euros at an average yield of 4.037 percent. That compared with 3.568 percent at the previous auction in April, while the bid to cover rate rose to 2.5 compared with 1.8. The 2015 bond, last issued in September of last year and with a coupon of 3 percent, sold 1.2 billion euros at an average yield of 4.230 percent, slightly lower than yields on the secondary market. The bond was 2.9 times subscribed after being 1.6 times subscribed at its last auction. "Since the (2014) launch early April, we've had an escalation on the peripheral side, so a firm selling since then, which is why (the yield) jumped so much," economist at 4Cast Jo Tomkins said. "You'll see plenty of buyers coming in at that level, especially since the Greek deal seems to be moving in a positive direction." Also adding to the risk appetite are statements from Trichet that in the longer term, he could suggest forming a finance ministry of the European Union, adding there is no crisis in the EUR. Lastly, he added that if aid programs fail, as a second stage he could consider deeper integration of economic policy, more central command of domestic policies. Of course they will: once all is plundered, the ECB will become the defacto "protector" of its colonies. And falling solidly into the trap is Greece where according to a government source the privatization plans may run faster than expected.

Today's $35 billion 5 year bond auction was one of the strongest auctions completed in recent years, with a Bid To Cover of 3.20, the highest in the series, compared to 2.77 before and a 2.79 average in the last twelve auctions. This happened despite the yield dropping from 2.124% to 1.813%, the lowest since December 2010. Total competitive bids tendered surged from $97 billion to $112 billion, primarily due to Indirect bids rising from $18.6 billion to $24.4 billion, resulting in a drop in the hit rate from 74.9% to 67.5%. The Primary dealer hit rate also dropped from 25.7% to 20.7%. Indirect take down at 47.1% was the highest since September 2010. Completing the internals, was the -1.7 tail. As a reminder, on March 18 Goldman advised clients to short the 5 Year. That trade did not work out too well. As for the fact that this auction takes total Marketable Debt even further above the debt ceiling, that's irrelevant: the Treasury can just underfund retirement account holdings by another $35 billion.

Yesterday 55%, today 65%, tomorrow: all cash, next week: Greek gold only (and evil silver speculators think they had a rough day).

A month ago, we reported that the Japanese public pension fund, which holds JPY152 trillion in total reserves, would for the first time withdraw 6.4 trillion yen in order to cover pension payouts, a process which once started, eventually ends up with the "Illinois" conclusion where it has to issue bonds to pay accrued pension obligations. The reason why the Japanese pension fund is particularly important for japan is that not only does it have implications for the welfare system of the land of the rising sun, any future dispositions will explicitly affect the supply and demand of JGBs, of which pension funds have traditionally been a major buyer. Not only that, but as Dylan Grice reminded us some time ago, a liquidation process would also impair US Treasury holdings: " As Japan's retirees age and run
down their wealth, Japan's policymakers will be forced to sell assets,
including US Treasuries currently worth $750bn, or Y70 trillion "eight
months" worth of domestic financing." Today, another SocGen analyst, Takuji Okubo, presents a realistic outlook of what will happen when one takes government projections to the pension system and applies realistic assumptions. In a nutshell, instead of a build up of JPY100 trillion over the next 15 years, pension reserves will likely decline by JPY36 trillion, a swing of almost 140 trillion, or nearly $2 trillion in incremental and very marginal JGB and treasury demand actually becoming supply. And in a world in which the Fed is suddenly (allegedly) pulling out as the biggest source of sovereign paper demand, this swing factor out of Japan will have substantial implications for the bond market, especially when coupled with a Japanese economy that suddenly finds itself on the rocks.

Just because the US is having so much success convincing the world its debt is money good (but don't anyone dare count the $6+ trillion in GSE debt to the total US debt), the good old US of A has now decided to backstop the debt of... Egypt. Bloomberg reports: "Egypt plans to raise $1 billion by selling Eurobonds this year to diversify borrowing and finance a widening budget deficit after its economy was rocked by the worst political crisis in 30 years. The five-year bonds will be backed by a U.S. “sovereign guarantee,” Finance Minister Samir Radwan said by telephone from Cairo today...President Barack Obama promised last week $2 billion in loan guarantees and debt forgiveness." And when it comes to Uncle Sam giving his assurances to the developing world, size does not matter: "The size is not significant but the backing from the U.S. will help raise the money at a relatively inexpensive cost." Uh, should Congress perhaps have something to say about the fact that America is now somehow the guarantor of recently revolutionary African countries? Because if, heaven forbid, should the extremely stable and economically viable, but otherwise revolutionary Egyptian country suffer default and bondholders demand to be made whole, guess out of whose pocket the deficiency claims will have to be funded...

A year after an insolvent European continent realized it is long overdue to implement fiscal consolidation, aka tightening, also known as 2010's keyword of choice: "austerity", the political regimes who have supported fiscal prudence are one after another falling victim to the general population's dissatisfaction with the gradual elimination of a myriad of socialist policies. Following recent electoral losses in Germany, not to mention the overthrow of the Portuguese government, which like Belgium, continues to be in limbo, today we move on to the second to last domino in the PIIGS chain: Spain (and Italy is next: S&P took the time at 6pm on Saturday to remind everyone about that particular unpleasant fact). Per Reuters: "Spaniards began voting on Sunday in local and regional polls expected to deal heavy losses to the ruling Socialists, who are blamed for widespread unemployment that has off a wave of pre-election protests. Tens of thousands of Spaniards demonstrated in the past week in city squares around the country against austerity measures that have kept a fiscal crisis at bay but aggravated the highest jobless rate in the European Union. [as a reminder a webcam of the Madrid protests can be found here]. The protesters have called on Spaniards to reject the Socialists and the center-right Popular Party, the main two political options in Spain." The problem is that when you overthrow socialists, it is unlikely that you will get more socialism down the road. Which, however, is what everyone in this country of 21% unemployment, and nearly 50% joblessness in the 18-25 age group really wants.

And while the US is no longer allowed to auction off debt, in China the PBoC appears to be no longer able to auction off debt. As Business China reports, "the central bank scheduled the auction of RMB 20 billion worth of
one-year treasury bonds and RMB 10 billion in six-month bonds on the
country’s interbank bond market for May 13. But banks, faced with tight
liquidity, only purchased RMB 11.71 billion worth of one-year bonds and
RMB 9.63 billion worth of six-month bonds, the report said." In other words, there was a nearly 50% miss on the 3 month auction. The key reason: "The reference yield of one-year treasury bonds was raised to 3.0246% from the previous issuance, while the bond yield of 182-day discounted treasury bonds was 2.91%, the paper said." It appears investors don't agree with the central planners that 3% is an appropriate rate to compensate them for surging inflation. That, and also the fact that banks suddenly have no liquidity: "Tighter liquidity was behind the under-subscription, as the central bank resumed selling three-year notes on May 12 after a hiatus of more than five months, a bank analyst who was not named was cited as saying. The central bank also raised banks’ RRRs by 0.5 percentage points on the same day, effective May 18, the fifth consecutive month its has raised RRRs this year." And so the Catch 22 emerges: the more China fights inflation through RRR or rate hikes, the lower the purchasing power of domestic banks to purchase bonds (and yes, the US deficit is just a few hundred billions dollars too wide for it to come to China's rescue). Should the "15 minute" inflationary conundrum continue to express itself, and China be forced to rise rates even longer, very soon the country, just like the US to which it is pegged monetarily, will also be unable to raise any incremental capital.

We hadn't heard much from legendary investor Stanley Druckenmiller since last August when he decided to shut down his Duquesne Capital hedge fund. Until today. In a must read interview, the man who took on the Bank of England in 1992 and won, says that he join the camp of Bill Gross et al, making it all too clear that all the recent fearmongering about the lack of a debt ceiling hike by the likes of Tim Geithner, Ben Bernanke and, of course, all of Wall Street, is misplaced, and that the real threat to the country is the continuation of the current profligate pathway of endless spending. From the WSJ: "Mr. Druckenmiller had already recognized that the government had
embarked on a long-term march to financial ruin. So he publicly opposed
the hysterical warnings from financial eminences, similar to those we
hear today. He recalls that then-Secretary of the Treasury Robert Rubin
warned that if the political stand-off forced the government to delay a
debt payment, the Treasury bond market would be impaired for 20 years. "Excuse me? Russia had a real
default and two or three years later they had all-time low interest
rates," says Mr. Druckenmiller. In the future, he says, "People aren't
going to wonder whether 20 years ago we delayed an interest payment for
six days. They're going to wonder whether we got our house in order." Which begs the question: if interest rates are so low today, is the market not appreciating the current path of "financial ruin"? And here is where Druckenmiller joins the Grosses and the Granthams of the world. Asked if the future is not so bad judging by today's low bond rates he says, "Complete nonsense. It's not a free market. It's not a clean market." The Federal Reserve is doing much of the buying of Treasury bonds lately through its "quantitative easing" (QE) program, he points out. "The market isn't saying anything about the future. It's saying there's a phony buyer of $19 billion of Treasurys a week." Of course, there is another name for this type of arrangement and so far only Bill Gross has used it: Ponzi Scheme.