Bond

The latest targeted leak in the European "stress" tests is that according to German bank sources, the discount on Greek debt will be in the 16-17% ballpark. This compares to an earlier rumor leak of a 10% discount on Greek debt which however did not sufficiently spike the market, leading to rumor #2 which so far has done a good job at pushing the AUDJPY (aka stocks) higher. The quid pro quo however, is to take not only German but now French bonds, will be out of the "stressed" picture. As Reuters reports: "The presumed markdown applied to French sovereign bonds will be 0.7 percent, one of the sources, both of which are based in Germany, added. "German sovereign bonds will not be stressed," both sources confirmed." Of course, with Greek bonds being stressed to market (which is where the discount actually implies they are tested), French bonds would would suffer a far greater markdown than 0.7%. But then again, the EU has already bought up a ton of Greek bonds, and little if any French. Can't have the bank pick and choose which country to bail out now, can it.

What's driving bond yields to their lowest level since April '09? Could it just be an ominous 1930s echo...

I am more convinced than ever that a Treasury bond short will have its day in the sun. The next financial crisis will be a chain reaction that has already started in small, peripheral European countries, will spread to large European countries, and then eventually hit Japan and the US. Debt service will soar from the current 11% of the federal budget to a gob smacking 28% as early as 2014. Washington is doing nothing to avert the impending crisis.

One of the less discussed topics by the propaganda machine is that with bond yields approaching record yields, and in the case of the 2Y below them, the S&P has no place trading over 1,000. There was a time when bonds and stocks would correlate, and as bond prices surged, equities would plunge and vice versa. Now that we live in HFT days where stock values are completely disconnected from fundamentals, and even the bond market, courtesy of the Fed's seemingly endless market interference,  it makes sense to extrapolate what the fair value of stocks would be implied purely based on bond yields stripping away for the Fed. Attached we present a very simple regression analysis between simple 10 year spreads and the S&P, and the 2s10s (steepness between the 2 and 10 Year) and the S&P. What both analyses indicate is that stocks are approximately 30% overvalued, at least based on historical regression patterns relying on yields to imply stock prices. Yet even though this analysis is purely statistical, here is a simple extension: with US stocks at about $13 trillion in market cap, if one assumes the suggested 30% haircut the result is $9.1 trillion in fair market value. Considering that the Fed has pumped $2.5 trillion in the form of monetary stimulus, and Obama's various fiscal stimuli now amount to just over $1 trillion, that explains the delta. Bonds are implying where stocks should be almost to the dot, absent the $3.5 trillion pumped into stocks by the administration and the Chairman. Fair value of stocks, when stripped away from the printer and Congress, is 750.

A week ago we highlighted that Hungary, in addition to liquidity problems, is now back to experiencing solvency issues, after suffering a bond auction failure. Today, Hungary had its second failed auction in a row, after it was unable to raise enough money as had been initially planned. "The state debt management agency sold 40 billion forint ($174 million) of bills, 10 billion forint less than planned, at a yield of 5.41 percent compared with 5.35 percent on June 10." The domino effect in Europe (contrary to the lies by G-Pap) is now in full force and nothing can stop it. Country by country will now need to be bailed out (for a few months - recall that Greece is supposedly solvent, yet its CDS are now wider than ever) or be forced to default. Which brings us to our second point: in a note to clients (attached), Citi's Willem Buiter goes so far as to say that Europe's current €860 billion bail out facility is insufficient by more than half, and a new rescue package will promptly need to be created to the tune of €2 trillion or more. He also slams the ongoing stress tests for the vile, malicious joke (which just so happens is squarely on Europe's middle class) they are.

Just reported on CNBC. The yield on the issue is massive and is certainly a means to encourage basis traders to cover their naked CDS positions at a profit. Look for 5 year CDS to widen to the neighborhood of the new issue spread. BP better hope this is all the liquidity it will need, as the next bond offering will have to come at 10-15%, the third even wider, etc. By then, of course, there would be no equity value left.

How much do you want to buy at a 28 year market top? Last year, a staggering $375 billion poured into bond funds, a record, while $40 billion exited equity funds, despite a Dow that rose 23%.

Title says it all

The ECB has announced that new bond purchases that settled in the past week amount to €6.5 billion, bringing the total to €47 billion. This amount likely accounts for the various "successful" auctions in Spain, Portugal and Italy. The €6.5 billion is higher than the €5.5 billion in incremental bonds that had settled in the prior week. As a result, the ECB will now conduct another fresh (and "quick") term deposit tender on Tuesday at 9:30 GMT, to drain the incremental liquidity from all the recent bond purchases, thus continuing the path of acute schizophrenia as the bank is worried as being seen too easy in its monetization ways by a hawkish (but increasingly less so) Germany. Lastly, "The ECB intends to carry out another liquidity-absorbing operation next week" - after all there are ongoing sovereign auctions in Europe that have no other bids aside from the ECB.

"We cant stop here. This is bat country"

True story.

The idiocy in Europe knows no bounds. Just as the EURUSD was about to stabilize a little, and we use the term very loosely, Italy comes out and announces that due to its Robin Hoodesque task of rescuing Greece, and the need to shore up even more liquidity, that it would increase its bond issuance to €240-250 billion. As Market News reports: "Italy’s contribution to the EU’s Greece aid package is E14.736 billion out of a total E110 billion package from the EU and IMF, under the three-year economic and financial policy program. This year’s contribution is estimated to be around E5.4 billion. The first tranche of this loan E2.921 billion was paid in early May." Alas, unlike in the US where every new trillion in bond issuance
somehow results in a 50 bps tightening in the 10 year, Italy is not
quite so lucky. The result of this announcement: new all time high for Italy 10 year Bund spreads at 173 bps. And it doesn't end there: Reuters has just reported that talks between Sarkozy and Merkel, previously scheduled for today, have been rescheduled for June 14 (and probably cancelled as the two European leaders can't stand each other any longer) - is it all now falling apart in Europe behind the rosy rhetoric?

The latest casualty of the European contagion is sleepy, quiet, french-fry and beer specialist Belgium. The country's 10 Year bonds have gone vertical on ever increasing concerns the European core is just as messed up as the periphery. Look for this hockeysticking to add even more tightness to German Bund spreads, until one day the market wakes up and realizes the only country it can now short is Germany itself. That will be game over for Europe.

Earlier we predicted that the dirt in Eastern Europe is about to clog up Bernanke's liqduity swap Hoovermatic, but had no idea we would be proven quick so fast. Romanian website zf.ro reports that in a 600 million lei auction conducted earlier, the "Public Finance Ministry has rejected all bids submitted considering them an unacceptable level of offer price." In other words, the Romanian government now thinks it is Greece and it doesn't need money it finds too expensive. In yet other words, this means a failed auction. This follows the news of a semi-failed auction in Hungary earlier today, and a busted auction in Germany two weeks ago. Does anyone know if there is an iPad app that magically makes direct bidders appear whenever and whereever needed, leading to a 10x Bid To Cover at 0.00% for any bond auction? If Jobs can come up with that, we would immediately bet the concrete bunker on AAPL stock.

As we embark on what will likely be another painful week for European markets, here is where all the cross country spreads are as of this moment. As compared to the stable German 10 year benchmark, the worst 5 continue to be the PIIGS, in the following order - Greece, Ireland, Portugal, Spain and Italy. The tightest spreads are for Finland, Holland, France, Austria, and Belgium. We anticipate some further divergence between the PIIGS and the rest of Europe by the end of the week.