Across the Curve
Despite Yellen, Bullard, and Evans on the tape, markets limped lower on the day. Of course, we had the standard POMO-based ramp but once again credit markets and VIX indicated more than a few were seeking protection rather than loading the boat at these all-time high round-numbers. Stocks had reached their 'richest' in 3 months relative to the Fed's balance sheet and so were perhaps due a little more turmoiling but Treasuries sold off all day (and not on growth expectations) to end unchanged across the curve on the week. The USD oscillated but ended lower (JPY unch on the week) and commodities dribbled higher (though all remain red on the week). Perhaps the most worrisome thing today was the total disconnect between stocks and FX carry after Europe closed...
The overnight global scramble to buy stocks, any stocks, anywhere, continued, with the Nikkei soaring higher by 2% as the USDJPY rose firmly over 100, to levels not seen since May as the previously reported speculation that more QE from the BOJ is just around the corner takes a firm hold. Sentiment that the liquidity bonanza would accelerate around the world (with possibly more QE from the ECB) was undented by news of a surge in Chinese short-term money market rates or the Moody's one-notch downgrade of four TBTF banks on Federal support review. The release of more market-friendly promises from China only added fuel to the fire and as a result S&P futures are now just shy of 1800, a level which will almost certainly be taken out today as the multiple expansion ramp continues unabated. At this point absolutely nobody is even remotely considering standing in front of the centrally-planned liquidity juggernaut that has made "market" down days a thing of the past.
When it comes to US equities today, the picture below summarizes it all... the only question is whether the NYSE breaks to celebrate the year's overhyped social media IPO.Aside from the non-event that is the going public of a company that will likely not generate profits for years, if ever, the overnight market has been quiet with all major stock indices in Asia trading modestly lower on the back of a modestly stronger dollar, although the main currency to watch will be the Euro (German Industrial production of -0.9% today was a miss of 0.0% expectations and down from 1.6% previously), when the ECB releases its monthly statement at 7:45 am Eastern when it is largely expected to do nothing but may hint at more easing in the future. On the US docket we have the weekly initial claims (expected at 335k) which now that they are again in a rising phase, have been the latest data item to be ignored in the Bizarro market, as well as the latest Q3 GDP estimate, pegged by consensus at 2.0%.
Just as Friday ended with a last minute meltup, there continues to be nothing that can stop Bernanke's runaway liquidity train, and the overnight trading session has been one of a continuing slow melt up in risk assets, which as expected merely ape the Fed's balance sheet to their implied fair year end target of roughly 1900. The data in the past 48 hours was hot but not too hot, with China Non-mfg PMI rising from 55.4 to 56.3 a 14 month high (and entirely made up as all other China data) - hot but not too hot to concern the PBOC additionally over cutting additional liquidity - while the Eurozone Mfg PMI came as expected at 51.3 up from 51.1 prior driven by rising German PMI (up from 51.1 to 51.7 on 51.5 expected), declining French PMI (from 49.8 to 49.1, exp. 49.4), declining Italian PMI (from 50.8 to 50.7, exp. 51.0), Spain up (from 50.7 to 50.9, vs 51.0 expected), and finally the UK construction PMI up from 58.9 to 59.4.
Despite NFLX giving back half its after-hours gains, the NASDAQ is surging to new 13-year highs, the S&P cash crosses 1750 (to new all-time highs), and the Dow Transports explodes higher (to yet another record) for the ninth of the last 10 days. All of this as the USD is monkey-hammered and the EUR surges to 2-year highs... Treasury yields are dropping fast (down 5-7bps across the curve). As we noted last week, US equities have caught up entirely to the Fed balance sheet. Gold (back above its 100DMA) and silver are surging and oil is pressing back up towards $100. The reason for all this exuberance: the jobs number was sufficiently horrible it has moved the tapering consensus to March 2014 of beyond...
Spot the odd 4-week bill auction out...
The last 4 days have seen the price of protection against a default on US Treasuries spike by the most in 4 years. While USA CDS trade on both a default and devaluation basis (as well as technical issues related to which Treasury is cheapest to deliver) this spike to 5-month highs (from what was extremely high levels of complacency) is very notable in light of today's Kocherlakota "whatever it takes" speech. While still well off 2011's debt ceiling debacle panic highs, this move does suggest more than just the politicians are worried about a technical default occurring on US debt. By way of comparison, Germany trades at 23bps and Japan at 61bps against USA's 32bps. But there is a way to trade the debt-ceiling debacle that doesn't invlove leveraged speculation in credit derivatives...
Another day, another POMO pump followed by a collapse to close at the the lows as the S&P 500 has its first 5-day negative closing run in 2013. Only the NASDAQ remains above Un-Taper levels with the Dow back below 'Summers' levels and the S&P heading that way. Treasury yields slid further (-4 to 5bps) to 7-week lows (down 10 of the last 11 days) as the 7Y broke back below 2.00%. Gold and Silver rallied (after the ubiquitous opening smackdown idiocy) with both positive on the week now. The USD sold off as JPY strengthened to the week's highs and EUR pushed back to unchanged on the week. WTI was slammed lower (in a seeming mirror of the PMs) ending back at $102.28 (-2.4% on the week) nearly 11 week lows. For the second day in a row VIX closed lower as stocks sold off (unwinding hedges and reducing underlying exposure perhaps?)
If it was the Treasury's intent to make auctioning of Treasury paper increasingly more fraught with risk, it has succeeded. Moments ago, in the second auction of the week and month, another $24 billion were added to the gross US debt, when the Treasury sold 10 year paper at a yield of 2.620%, pricing through the When Issued yield of 2.623% So far so good. However, as was shown last week, the trouble is in the internals. Recall that as Zero hedge first demonstrated in January and as the TBAC reconfirmed in their refunding presentation, the Bid to Covers have been declining across the curve. It should perhaps come as no surprise then that the just completed 10 Year auction was completed at the lowest Bid To Cover, or 2.44, going all the way back to March 2009.
While the Fed is posturing daily whether it will or it won't monetize an ever greater portion of gross US issuance (and considering the drop in US funding needs, unless the Fed tapers it will soon very soon buy more than 100% of all 10 Year equivalent issuance going forward), foreigners have made their position vis-a-vis US paper loud and clear. What is their position? The following chart from today's TBAC presentation to the Treasury makes it very clear. With an ever declining, and recently the smallest on file, notional amount of Treasurys at auction going to foreigners since 2009 (and certainly much further back), they are not sticking around to see what happens.
Risk assets are not quite (yet) back to the ‘melt-up' of May but equity markets are trading in a confident mood after Bernanke caused sentiment to flip from glass ‘half empty' to ‘half full'. China Q2 GDP data did not derail price action as equity futures anticipate a positive start of the week. The semi-annual testimony of the Fed Chairman is typically a seminal event on the market calendar but do we dare say that the one coming up this week is a non-event following last week's message on policy accommodation? The VIX index dropped 7 points over the last three weeks of which 2 points alone came last Thursday and Friday as stocks roared to new highs and shrugged off the candid observation on the Chinese economy by finance minister Lou Jiwei. If a 6.5% growth rate is tolerable in the future, there is little doubt that commodities and the AUD have further to fall. Chinese GDP slowed from 7.7% to 7.5% according to data released overnight and prospects for the second half don't look much brighter after evidence of slowing credit growth. Data on Friday showed declines of narrow money from 11.3% yoy to 9.1% in May, with broad money growth slowing to 14% yoy. Non-bank credit and new foreign currency bank lending also weakened.
Today, as per the latest ICAP data, the collateral shortage is back on, with the 10 Year moving from -0.10% in repo yesterday to 0.85% ahead of Wednesday's second re-re-opening of 912828VB3. But what is more curious is the repo shift, because while the On The Run shortage was to be expected with the 10 Year getting pounded to 2.75% on Friday, it was the 3 Year that saw a plunge in repo, with the repo rate soaring from -0.13% to -1.45%: ostensibly the widest it has been in our records database. In other words, the collateral shortage just ahead of the 3 and 10 Year auctions is back and while the shortage of the 10Y OTR is somewhat more manageable than last month, it is the 3 Year, or the short-end, that is now in very short inventory supply.
In the brief but tempestuous fight between Abe and the "deflation monster", the latter is now victoriously romping through an irradiated Tokyo, if last night's epic (ongoing) collapse in the Nikkei is any indication: down 6.4%, crushing anyone who listened to Goldman's "buy Nikkei" recommendation which has now been stopped out at a major loss in three days, and now well in bear-market territory, it would appear that a neurotic Mrs. Watanabe is finally with done with daytrading the Pennikkeistock market, and demands Shirakawa's deflationary, triumphal return to finally clam the market. Only this time the Japan's selling tsunami is finally starting to spill, if not to the US just yet (it will) then certainly to Asia, where the Shanghai Composite which was down 2.7%, and is once again well down for the year, and virtually all other Asian stock markets. Except for Pakistan - the Karachi Stock Exchange is an island of stability in the Asian sea of red.
As we noted just two weeks ago - before the hope-and-change-driven exuberance in Japanese equities came crashing down - "those who believe in Abenomics are suffering from amnesia," and Nomura's Richard Koo clarifies just who is responsible for the exuberance and why things are about to shift dramatically. Reasons cited for the equity selloff include Fed Chairman Ben Bernanke’s remarks about ending QE and a weaker than expected (preliminary) Chinese PMI reading, but, simply put, Koo notes, more fundamental factor was also involved: stocks had risen far above the level justified by improvements in the real economy. It was overseas investors (particularly US hedge funds) that responded to Abe's comments late last year by closing out their positions in the euro (having been unable to profit from the Euro's collapse) and redeploying those funds in Japan, where they drove the yen lower and pushed stocks higher. Koo suspects that only a handful of the overseas investors who led this shift from the euro into the yen understood there was no reason why quantitative easing should work when private demand for funds was negligible... The recent upheaval in the JGB market signals an end to the virtuous cycle that pushed stock prices steadily higher.