Bond

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.

From Expected Returns Blog

So what will work?

Is China about to start dumping its $630 billion in eurozone debt holdings? Maybe not yet, although the FT reports that China's State Administration of Foreign Exchange, the central bank's foreign reserves manager, has "expressed concern about its exposure" to the PIIGS. Obviously, with China moving away from dollar denominated assets for the past six months would represent a "big strategic shift" as "last year, the Chinese were trying to reduce their exposure to dollar assets by buying eurozone assets. This would be a complete reversal." Additionally a Chinese diplomat noted that, "The euro’s fluctuation will have an impact on China’s thinking, but it’s only one element” in any decision to allow the Chinese currency to rise, He Yafei, a vice foreign minister, said, according to Bloomberg." The question then arises of just what assets China would be comfortable holding? Alas, the only readily available answer we can come up with rhymes it old and has 79 protons.

If Greece follows in the footsteps of Argentina (which is quite possible) many financial institutions will be in a world of hurt - forced to take 60-70% losses on instruments that they levered up 20x on. We're talking real pain here people, and it is highly unlikely Greece will be the only one. For all of those who may call me a doomsayer, let's walk through the numbers...

The bond market in Greece and Portugal is now rumored to now be shut down for the day due to total chaos, not to mention potential imminent revolution in Athens. We expect the US to "decouple."

Look up the word ludicrous in the dictionary and you may just get a picture of the Greek bond curve. The 2 Year spread has exploded by over 400 bps just today, and is now back to 14% - the market is now convinced that even with €110 of additional money the country is done for in just over one year. The problem, as we pointed out earlier, is that the IMF can not appeal for greater assistance without appearing totally clueless (which it is), while any additional funding requests will may finally provoke the US taxpayers into recognizing they are being fleeced to save a country 5 thousand miles away. As the attached curve indicates, the bond vigilantes still think that Greece could remain solvent for about 1 year, however with the rate of widening, we expect the 1 year point on the curve to defy gravity quite shortly.

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The Greek bond holiday is here. Greece's bond pricing administration HDAT has withdrawn bond prices as spreads have hit 650 bps. Greece acknowledges it is game over as 10 Years are at 10%, and 3 Years at 13%. Stock liquidation are rampant as Greeks are on the verge of panic: the ASE is down 3% and investors are now widely expecting a 10% correction to below 1,700 on the ASE. And Portugal is now officially part of the party Portuguese - CDS just hit 310 bps.In the meantime Germany is starting to feel the burn - German FinMin Schaeuble has stated he is determined to defend the stability of the euro by asking that Greek talks with IMF conclude by weekend. He also said that he anticipates that Euro zone and IMF want to free up Greek aid simultaneously and does not favour idea of granting Greece moratorium on debt. Alas, the time for speeches is over. Making matters worse, Germany’s SPD says will not back accelerated parliamentary process to approve Greek aid, rendering all rhetoric useless. Lastly, Angela Merkel will make a statementon Greece at 13:00 GMT. We can't wait to hear the powerlessness in her voice.

In their last solvent days, the Greeks sure are learning fast from the US - first America makes shorting prohibitive (and where it is still possible, various repo desks tend to force short covering at their whim just as the market is about to crash and burn), and now Greece has proceeded to make shorting of Greek bonds impossible. After realizing that its CDS scapegoating campaign was the most miserable and idiotic plan ever conceived, the lunatics who have taken over the Greek insane asylum have now decided to make shorting of GGBs virtually impossible. This is ostensibly the last step before the total collapse as the liquidity that will be removed will make swings in GGB so big it will make the holders of options in FNM, FRE, C and AIG green with envy. The mechanism by which Greece seeks to accelerate it own demise, is by introducing daily repurchase auctions to cover short positions, according to Reuters. Next stop: selling of any Greek (and soon US) security becomes treason and is punishable by death.

Life for Greek administrators can not be much fun these days - anywhere they look they just see more bad news. The latest comes from (appropriately named if you are Greek) S&P analyst Marko Mrsnik who told Reuters that "if the high borrowing cost persists and the consequent deviation from the consolidation path is not addressed, this would in our opinion, delay the reversal of the government debt trajectory and could lead to lower ratings." Nothing yet from Moody's - should Greece and the linked NBG be downgraded even one more notch by Moody's then all sorts of colletaral trigger horrors will be triggered and the liquidity crisis will reach a whole new level of pain.