Bond

Is the Mother of all bubbles about to pop?

Irish CDS, which recently was trading wide of 300, tightened materially after the country, most likely with a very direct ECB intervention, managed to place two €0.75 billion auctions, the first a 4% due 1/15/2014, and the second: 5% due 10/18/2020. The Bid To Cover on the first was 5.4, compared to a BTC of 3.1 at the last auction held in May, explained simply by the surge in the rate from 3.11% to 3.627%. The 2020, however, saw the BTC drop from 3.0 to 2.4 as the yield dropped from 5.537% to 5.386%. In other words, the ECB overbid for the near maturity, and likely just put in for a token amount. And for some odd reason, CDS traders see this latest central bank intervention to extend and pretend as a favorable development, and have decided to run away from Irish risk for the time being. The question of how long the ECB can continue this charade is relevant: after all the Fed has just one country to deal with. And continuing with Ireland, the country's central bank stated that the net cost of Anglo-Irish to the government may be €22-25 billion, even as it cleared up hypocritically that capital raising via taxing banks' excessive reliance on short-term borrowings would be preferable. Of course, the central bank should keep its mouth shut, and be happy that the ECB will continue to support any part of the curve, as in its absence the country would be long insolvent.

The surge in the 10 Year has just gone full retard. In the meantime, behind the scenes of Wall Street's rates desks there are some serious Tijuana donkey shows going on.

Today's Treasury International Capital data had some unpleasant disclosures about the flow and size of international capital flows. The gross headline number of inflows was as expected higher, coming in at $44.4 billion, consisting of $33.9 billion in net foreign purchases of long-term securities ($16.6 billion purchases by private investors and 17.3 billion by official institutions), as well as $10.4 billion in sales of foreign securities by US individuals. This brought total foreign holdings of US securities to just over $4 trillion for the first time ever, or $4,009 billion. So far so good, however looking at the composition of purchases, it appears that foreigners were frontrunning the Fed already in June - they bought $33.3 billion in LT Treasuries, and $18.2 billion in agencies, precisely the categories that the Fed would be monetizing, even as they sold $13.5 billion in corporate bonds (the highest amount since January 2010), and $4.1 billion in corporate stocks, the most since July 2008. What are foreigners seeing that all the mutual funds are also seeing (with 14 straight outflows from domestic equity funds), yet the HFT, Primary Dealer group is so stubbornly ignoring? Most importantly: Chinese Treasury holdings dropped to a 1 year+ low of $843.7 billion, following reductions in both long-term and short-term treasurys. China now has almost $100 billion less in USTs compared to the peak of $940 billion in July 2009. One wonders what China is buying with the sale/maturity proceeds.

Kurt Brouwer highlights something that may substantiate the claims of those who claim there is a treasury bubble in the forming. Using the suddenly all too popular ICI data (which we have been presenting for well over a year), JPMorgan has tallied the total flows into stocks in advance of the tech bubble (April 1998 through March 2000) and compared it to the period since the Lehman collapse (July 2008 through June 2010), the result is surprising: there has been over $50 billion more allocated to bonds in the past 2 year period ($476 billion), than to stocks in advance of the biggest market bubble pop before the housing/credit bubble popped in 2007/8. Is this indicative of anything more than just everyone going on the same side of the trade? Not at all, however even that in itself should be sufficient for bond bulls to reconsider pushing every last cent of capital into what at least on the surface has all the makings of a an even bigger bubble than tech stocks in 2000.

Just in case there was any confusion which way SocGen's Albert Edwards may be leaning after the recent however many percent rally in the AUDJPY, sometimes known affectionately as stocks, it is hereby resolved: "My views on the outlook could not be clearer. They may be wrong, but at least they are clear. We still call for sub-2% 10y bond yields and equities below March 2009 lows." In other words, according to AE the market is well over 50% overvalued.

Even as stocks continue pricing in QE2 (presumably some time in the next 2 years), bonds keep on laughing. The $38 billion in 2 Year Bonds just auctioned off at a 0.665% high yield, the lowest yield for a 2 Year primary issue. The bid to cover came in at 3.33, compared to 3.45 previously, and 3.15 average. Indirect participation plunged to 32.8%,compared to 41.41% previously. As the directs took down "just" 13.5%, the Primary Dealers ended up taking down a majority of the $38 billion bond auction, or 53.7%. The recycling of cheap Fed money has now fully arrived, and with an Discount Window to 2 year arb of 0.4% (0.66% - 0.25%), it shows just how bad things must be for the PDs.

With global economic activity picking up steam, and global equity markets humming along, the only question I have is how long before we see a significant backup in global bond yields? More importantly, are pensions and other institutional investors prepared for a big bond hiccup? We'll find out soon enough.

The circus in Europe can't come to an end soon enough. As Zero Hedge posted and speculated previously, according to a draft document, it has now been confirmed that banks will only be tested for sovereign debt exposure just on trading books, not on debt held to maturity. Guess what: about a month ago, all banks almost certainly decided to quietly reclassify their hundreds of billions of sovereign exposure from "trading" to "held to maturity," thus taking advantage of the same FASB 157 accounting abortion that America has gripped tightly on to for almost two years now, as accounting fraud follows the Bernanke Put in going global. If this is supposed to inspire confidence, then the market has truly lost it. As we explained last week, "the haircut will only pertain to
trading books. In other words this is Europe's equivalent of FASB 157:
everything that banks hold "to maturity" will not see a major haircut,
and very likely not see any haircut at all. Which simply means that all
European banks that hold such debt will merely reclassify their Greek
exposure from trading to a "held to bankruptcy at par" category. The
surreality of European banking assets (which as we pointed out
previously is a $100 trillion circle jerk where one bank's assets are another bank's liabilities) has now passed well into the twilight zone." In other completely irrelevant news, the micro trading books will see the following haircuts, as presented by Bloomberg.

Earlier today Germany announced the "successful" placement of €3.195 billion in 30 Year bonds at a 3.33% Yield and a glowing 1.2 Bid To Cover.... Only if one were to take out the €805 million retained by the Bundesbank as so often happens these days, the auction was really undersubscribed. As the government sought to place €4 billion and received just €3.764 billion in total bids (of which €2.691 billion were in competitive bids and just €1.073 billion were non-competitive), there is no other way to classify the auction than a failure. And with the 'allotted at high' (or low price) coming in at 95%, there was certainly less than an enthusiastic reception for this latest auction which sported a coupon of 3.25%, the lowest coupon ever for a long-dated eurozone bond.

In an odd development, today bond traders have been fielding calls to express an interest in a $50 million bond BWIC. Two observations: traditionally any recent BWICs percolating have usually involved loans, and typically in the form of much larger baskets. This one, however, is all bonds, consists of 17 names, the largest of which are UPS, DIAG, TGT, HARVRD and PEP, and even more interesting is that this is for the most part 2030 and longer-maturing paper. It appears some fund has decided to unwind a big portion of its duration exposure. Granted, the bonds are mostly IG, with the biggest coupon at 7.9%, but nonetheless, the fact that $50 million in HY can not be placed in the traditional bond pipeline speaks volumes about the lack of liquidity in the bond market, especially for longer-dated, and thus inflation sensitive paper. As for stocks, it is very obvious that any liquidity in equities has long gone, as stocks undergo 0.5% rallies in the span of seconds, on no news, just momentum-driven HFT block order frontrunning.

Broke US states are probing new lows with each passing day, as money continues to stubbornly refuse to grow on trees (unless you have discount window access of course). The latest funding fiasco comes from Texas, which Reuters reports is planning on selling $2 billion in debt just to refill its empty unemployment trust fund. We are confident that bondholders will be ecstatic to put their money into a extremely rapidly amortizing "asset" that will begin depleting from day one and will likely have no collateral recourse in under a year. But after all, it is other people's money, so we are confident this particular Citi/BofA led bond offering will close and price and sub Treasury rates.

The US government is another $35 billion in the debt sink hole. The cost of this marginal addition to our existing debt load ($10 trillion? $100 trillion? who cares) was just 1.055%, which was gobbled up briskly at a 3.20 Bid To Cover. The bulk of the buying came from Primary Dealers who took down the highest portion of the auction, or 45.1%, since May of 2009, when PDs were responsible for 56.6% of the takedown. Indirect bidders, coming in at 40.6%, was the lowest indirect take down since January, when they were responsible for just 38%. The balance of 14.3% was left to the Direct Bidders. The Bid To Cover at 3.20 came in well above the LTM average of 3.03%.

Two more European auctions have closed at terms that show continued deterioration in sovereign demand conditions. Earlier, Italy auctioned off €7.5 billion in one year BOT (bills) at a yield of 1.399% and a 1.659 bid to cover. This compares to the precious auction that closed at 1.377% and a 2.359 BTC. Elsewhere, the German government had to retain 15%, or €807 million, of a €5 billion 6 month bubill issue to "sell" as much as had been hoped for. The issue came at a 1.9 bid to cover, excluding the government retention, compared to 2.2 previously, and had to double the yield on the issue from 0.1923% to 0.4226%. Of the €2.153 billion in non-competitive bids were obviously accepted 100%, it is the non-competitive ones that were problematic. It was the 5.765 of competitives that were an issue: just 2 billion of the competitive bids were found to be "acceptable" to the government, meaning €2.8 billion offered rates far too high to be accepted. Is the German curve starting to bear flatten as well?

The ten year Treasury bond yields we saw at a stunning 2.91% are telling us that the government can borrow nearly infinite amounts of money at the lowest interest rates in history. The expiration of the Bush tax cuts next year and recovering economy will bring a return of tax revenues, eliminating 79% of this year’s deficit, even is Obama does nothing. This is the writing on the wall the bond market is attempting to focus our blinkered eyes on.