Bond

When a week ago we observed the Onionesque reality of life in the Ivory Coast, where deposed president Gbagbo is threatening to wipe out bondholders of $2.3 billion in debt (Corporate Ticker: NUTZ) unless he becomes formally recognized, we made the following bold prediction: "we are sure that Blythe Masters and her team were recently in
Yamoussoukro discussing the most effective way to corner the cocoa
market (paper Cocoa ETF?), thus getting the price of the sweet powder up
by a few trillion percent (in exchange for a nice 25% of all upside
going to Jamie Dimon's firm of course)." Sure enough, when it comes to our track record of macabre predictions we continue to be near 100%. The FT has just reported that Alassane Ouattara, Laurent Gbagbo's opponent in the presidential election (and the man formally acknowledged by the UN as the country's president) has just imposed a one-month export ban of cocoa, ostensibly in an attempt to oust Laurent Gbagbo. In other words, the international community has to choose: bond recoveries or chocolate. That said, we are certain that it is none other than noted commodity market cornering expert JPM that can claim league table advisory credit for what according to the FT will be a 10% jump in the price of cocoa on opening Monday. The immediate retaliation by Gbagbo will most certainly be to force a technical default on the country's bonds which are already in their grace period, and start a localized mini liquidity (and solvency) crisis in Africa... As if the developed world did not have enough of those as is. And in the meantime, we sense a great disturbance in the inflationary Force, as if millions of fatty voices suddenly cried out in terror, and were suddenly silenced: prepare for the next round of food inflation worldwide.

Ok this is it. Someone (preferably of the less than multi-millionaire Wall Street marionette variety) in Congress has to look into the blatant bond churn-cum-flip (that was happening behind the scenes a few months ago and is now so blatantly in your face it is a slap to all US taxpayers) which has the Fed paying Primary Dealers billions in commissions for a trade that has absolutely no value added. And while we have been complaining about this for months, today just takes the cake. Below we present the entire list of permitted issues to be monetized by Frosty-Sack. Note that there were 29 CUSIP eligible for buybacks. What happened - the Primary Dealers flipped virtually the entire operation in the form of the just auctioned off 3 Year PQ7! This is half the entire Primary Dealer allocation in the bond auction that was completed on January 11 (whose technical original issue date was yesterday). One more 3 Year POMO, the next of which is on January 31, in which PDs flip a like amount, and the Fed will have monetized the entire auction, but in the process having paid at least a few hundred million of taxpayer capital to the PDs for absolutely no value added! This is a daylight robbery and has to stop.

We often disparage the Wall Street Journal for being too spineless to tell it like it is when reporting on the state of the economy, but with last Friday’s lead story, New Hit to Strapped States, they pulled no punches. You can almost pick a paragraph at random and get a sense of how serious the cities’ credit problems are. This paragraph, for instance “Municipalities borrowed $122 billion of variable rate demand debt in 2008, roughly twice the amount of these types of loans borrowed the year before…” How did they get in so deep?

The reverse dutch auction model for Europe's insolvent countries is dead. Earlier today Spain announced it would cancel its planned bond auction for January 20, and instead plough ahead with syndicated issuance. For those unclear with what this means, Spain is essentially saying the market pricing mechanism on its debt is too transparent and adds "volatility" and therefore the country would rather have banks underwrite the whole issue i.e., take the issuance risk on their books, thus spare Spain the embarrassment of a failed bond auction. And Spain is just the start: Portugal and Belgium have followed suit, in an action that is sure to stretch the already frayed nerves of European sovereign bond investors as this kind of last ditch effort is always taken before something is about to go "snap." From the Irish Times: "Spain's Treasury, facing a volatile market as it looks for ways to keep its debt costs under control, cancelled a bond auction planned for Thursday and said it would issue a syndicated bond over 10 years. Belgium is also seeking an opportunity to place debt with a syndicate of banks and Portugal also plans one for the first quarter, as fiscally stretched sovereign issuers elsewhere in Europe also seek to cut spiraling financing costs." And lest readers get the impression that this is purely a European development, China just announced that it is suspending its sterilization bill sales for the balance of the week. Did the European bond market suddenly die?

Some good charts ...

Adding insult to injury for holders of muni bonds, whose assets have plunged in value in the past month, pretty much as expected in light of pervasive state insolvency which is no longer being masked by the government's generous "Build America Bonds" distraction, is Charlie Gasparino's breaking news that now the SEC has gotten into the fray, and is looking into muni bond prospectus disclosures. Per Gasparino: "What they are looking at whether municipalities, cities and states, are adequately disclosing their budget woes to investors who buy these bonds." Which only means that as the risk of further pervasive impropriety is unearthed, and the muni space ends up being as much of a fraud as the MBS one, that the risk of holding on to MUB-derivative equivalents will only get higher, leading to yet another round of sell offs now that the muni bond situation has entered a toxic spiral where, in the inverse of the stock market, any news creates merely greater selling pressure.

While Illinois' desire to finally tackle its unsustainable fiscal situation is admirable, the process is starting to disclose some very stinky rot below the surface. On the heels of the recent hike in the corporate tax rate, today Bloomberg reports that governor Pat Quinn is asking lawmakers to authorize an $8.75 billion bond sale. The use of proceeds? To pay $6 billion in backlogged bills: read invoices that the state has been unable to pay so far due to what technically should be classified as a liquidity crunch, and non-technically as complete lack of cash. Luckily, entities that are owed money by the state at least have a chance to get paid. Earlier, state House of Representatives defeated a borrowing bill that was designed to
eliminate the pile of invoices that is at least five months old. The state's payment delinquency also includes pension funds: local underfunded pensions are owed almost $4 billion in payments by the state. In the meantime, Chicago CDS dropped on the news of the tax hike, declining from 28 bps to 300 yesterday, the lowest since December 9. Whether this means that the state will be able to find sufficiently stupid investors whose capital will go to nothing besides funding overdue invoices, is a totally separate matter however. Perhaps a good indication of the ravenous appetite for muni debt (in addition to the fresh 52 week low in virtually every single muni bond fund), is that the New Jersey agency has shrank the size of a proposed $1.2 billion refinancing offering by roughly 40% and hiked yields on the sale as it struggled to market bonds to investors on Thursday. As the secondary muni market is plunging, the primary market for issuance is on the verge of shutting down completely. Cue in QE3.

Who would have thought that all it takes for a proposed ETF to be pulled is a complete loss of faith in the underlying. Today, Vanguard has announced it has canceled plans for a short, intermediate and long-term muni ETFs. "We believe that this delay is prudent given the high level of volatility in the municipal bond market, which began in November 2010 and continues today," said John Woerth, spokesman for the Valley Forge, Pennsylvania-based firm. "This volatility could impede the funds' abilities to tightly track their respective benchmarks, deliver on the funds' objectives, and meet shareholders' expectations." Well, what if shareholders expectations were to short the ETFs? It would certainly meet that particular set of expectations.

While the fact that PIMCO is not a big fan of Europe is not surprising, nor is it surprising that Bill is talking his BAB book, and is therefore bullish on the muni question (especially on a relative basis, in essence saying that the US Treasury is in the same insolvency boat as California), what is surprising is that Newportbeachian, at least superficially, appears honestly confused what happens in June when QE2 ends. Which is funny: Fed's Fisher earlier said that the central bank has reached its limit of asset purchases... barring unexpected shock. Which of course means completely expected to the Fed. And since the Fed has to continue monetizing all the deficit issuance, it has no choice but to continue QE2. The conclusion is that in April or May, something "unexpected" will happen to give the Fed ammo to continue monetizing. May 6 anniversary anyone?

The reason for today's most recent bizarro boil up per Bloomberg: "The European Central Bank spent between 1 billion euros ($1.3 billion) and 1.5 billion euros in government bonds in the last two days, according to Nomura International Plc estimates." No news yet on how much Japan, China, the Smurfs, and Uranus ended up having to purchase to bring you today's 1% surge in stocks.

The most expected yet anticlimactic bond auction for 2011 has come and gone: after getting the backstops of the ECB, China and most recently, Japan, Portugal managed to sell €1.25 billion in 4 and 10 year paper. And while the the yield on the 10 year was better than expected, and notably lower than the 7% where the point had been trading on the curve recently, the 4 year priced notably weaker compared to previous. Of course, none of this would have been possible had the ECB not been buying Portuguese bonds in the open market for two days this week, and continuing into Wednesday, into the biggest farce of a market currently operating in Europe.

Ever since Repo 105 (and long before that), it has been well-known that Primary Dealers enjoy padding their books before the end of every quarter, typically collapsing their asset holdings in the week just before the quarter end in order to have cash on the books, and to make their capitalization ratios appear better than they really are. Well, the "book padding" that just occurred in Q4 2010 was a doozy, with total PD asset holdings plunging by a stunning $126 billion in the past month, the bulk of which was due to a drop in PD holdings of Treasurys. Was this huge selling by the Primary Dealer community, either for window dressing reasons, or due to expectations of future increases in Treasury yields, one of the main reasons for the drop in bond prices? It is unclear, but the massive selling certainly has not helped. And now that window dressing is again over for at least three more months, PD holdings can only go up (or so the myth goes). So with PDs now back with fresh books for 2011, and once again lifting offers, is the sell off in bonds about to be replaced with a major buying spree?

A few days ago some were very surprised by the previously announced decision from the SNB that it the bank would cease accepting Irish bonds as collateral. Considering that the Swiss National Bank is now the only responsible institution left in Europe, now that floundering Jean Claude Trichet is willing to accept even used condoms at a 120% LTV as long as they have a sterling CCC- rating by S&P, we fail to see how this is surprising. That said, those same people may be even more surprised that the SNB has just added Portugal to its "restricted" list. The FT reports: "The Swiss National Bank confirmed on Friday that it had stopped accepting Portuguese government securities as collateral for repurchase (repo) agreements, adding Lisbon to Dublin among the eurozone governments on its ineligible list. The decision to exclude both countries follows steep downgrades of Portuguese and Irish debt and was based on the Swiss central bank’s strict, but highly transparent, acceptance criteria." What this means is that on Monday JCT will be very busy BTFD in Portuguese bonds. He will have many opportunities to do so, as everyone holding the paper will be bailing in droves. Furthermore, this disclosure could not have come at a worse time: with Portugal slated to hold another major bond auction next week (following last week's abysmal 6 Month Bill auction), there is actual risk the entire affair could be a failure and set the European sovereign market ablaze, kicking off the 2011 round of "bail out Europe."

Well, that lasted all of 3 weeks: after ICI reported outflows in taxable bond funds for all of the prior four weeks (for a whopping combined $5 billion after hundreds of billions in inflows in the past year), the bond inflows are once again back in the last week of 2010, as bond investors placed $2.5 billion with taxable bond funds. The only category that saw outflows was mutual bond funds, which in itself is obviously quite troubling as it indicates that the state funding situation is about to get rather dire especially in light of the non-renewal of the BAB program. Basically this is exactly as we suspected would happen: following the major drop in bond prices in December, investors are now back and are in fact more interested in buying bonds at more attractive prices. Which of course means that that other trend: inflows into equities is about to taper off as well, as money flows shift out from equities and into bonds once again. Indeed, last week's inflow of $335 million in domestic equity funds was revised to just $14 million, and the last week of 2010 saw another token (and probably soon to be revised downward again) inflow of just $493 million. Should the equity inflow indeed reverse to an outflow shortly, the propganda machine will be doubly confused to explain how, a mere few weeks after it made such a story out of the first inflow in 33 weeks, outflows are again back.

RanSquawk reports that the European Union has priced the marketed EUR 5bln 2015 bond, 2.5% interest, at 99.594 reoffer, swaps +12 BP, according to Leads. As a reminder, this is what Brian Yelvington had to say about this notable issue early today: "The €5B EFSF debt sale scheduled for today was reportedly 3x
oversubscribed with pricing expected to be mid swaps +15bp.  The
markets should keenly watch the actual pricing of the deal and its
secondary trading as well as the knock-on impacts on traditional Euro
sovereign issuance.  We still believe that a finite capped facility
that effectively crams down traditional issuance will cause further
pressure on spreads.  A new EU draft proposal suggests that bondholders
take losses on ailing banks rather than upstreaming the responsibility
to the sovereign level and bailouts being taxpayer funded."