Across the Curve
Central Banks United have the upper hand these days. So don’t mess with them…
At least not this week…
There is still some compression margin, but where to put the credit spread, real or “perceived”, from a (real) default possibility point of view or even from the shunned convertibility point of view?
No exactly fireworks, but anything that isn’t totally bad these days is good to have.
Good news, but then not so good news?! So, no QE, after all?
After declining to an overnight session low of 1.2260 following very disappointing Japanese GDP news, which saw another Q/Q drop in nominal terms and missed every economist expectation, the market leading indicator - the highly leveraged EURUSD pair which is a proxy for risk when it is rising, and ignored when dropping (because the ECB will lower rates, or so thinking goes) was boosted higher starting at 5 am eastern time. What happened then? Greek Q2 GDP was announced, and instead of declining from -6.5% to -7.0% annualized, the number declined at "only" a 6.2% annualized run rate. Apparently that was the only catalyst needed to launch today's risk on phase, sending the EURUSD 70 pips higher, and futures back to green. So to summarize: the world's 3rd largest economy grew far less than expected despite 30 years of central planning, while Europe's worst economy imploded by just that much less than the worst case expected, and this is "good enough." What's worse is that this may well be the high point of the day as there is nothing else left on the docket.
A funny thing happened in European peripheral bond markets: they sold off - Spain is wider across the board, with the 2 Year back over 4%, and the 10 Year threatening to blow out above 7% for the first time since the market was re-re-fooled by Draghi. Same in Italy, where the 2s10s is once again in flattening mode. In other words after getting Draghi right for one day, then flipping and confusing what he said for the next week, the market is back to being right in itis initial kneejerk reaction to the ECB head's words. One reason (among many) - a Rabobank report by Richard McGuire and Lyn Graham-Taylor which states that Spain won’t ask for more aid if more conditions are attached add to likelihood "crisis must worsen before it improves." Hmm, where have we seen an identical turn of the phrase before. Oh yes, here. Rabobank also adds that the ECB will have to show willingness to buy across the curve (not just in tenors of less than one year) when it does intervene. Of course, for that to happen, things must get far, far worse. Just as we explained to the five-year olds in charge of the market this past weekend.
While some have talked of the 'credit-easing' possibility a la Bank of England (which Goldman notes is unlikely due to low costs of funding for banks already, significant current backing for mortgage lending, and bank aversion to holding hands with the government again), there remains a plethora of options available for the Fed. From ZIRP extensions, lower IOER, direct monetization of fiscal policy needs, all the way to explicit USD devaluation (relative to Gold); BofAML lays out the choices, impacts, and probabilities in this handy pocket-size cheat-sheet that every FOMC member will be carrying with them next week.
While it seemed somewhat inevitable given the trend, the dismal reality from Europe has sent investors scurrying for the 'safety' of the US Treasuries overnight. The entire yield curve has fallen to all-time record lows with 10Y trading below 1.40% and 30Y below 2.48%. 7Y - the seeming cusp of Twist - is below 90bps now and 2Y below 20bps. The shortest-dated T-Bills still trade around 4-6bps (as opposed to the deeply negative rates in Switzerland and Germany this morning with FX risk premia expectations, and Twist+, affecting this differential). Not a good sign at all - and definitely not yield curve movements on the basis of renewed QE as we see stock futures plunging to the old new reality (as those pushing dividend yields as the 'obvious move here may note that since Friday's highs, you've lost half a year's dividend as equity capital has depreciated 2%). Perhaps the sub-1% 10Y we noted yesterday is not such a crazy idea after all...
UPDATE: AXP (down AH) and IBM (up AH) miss top-line; QCOM misses everything and guides down (up AH - AAPL staggered a little but unch now), EBAY beat (small up AH); KMI miss (down AH)
Far be it from us to say but once again equity markets spurted far and away beyond credit, interest rates, FX carry, commodities, and reality would have expected with only good-old VIX crashing to breathe that levered life into them. Ending the day with a 15 handle, VIX closed at its lowest in over three-and-a-half months and notably beyond where equity and credit relationships would expect as the front-end of the curve remains under huge pressure. Gold, the USD, and Treasury yields all played along on the day - trading with a decent correlation in a relatively narrow range but the open of the US day-session saw the appearance of the infamous equity rally-monkey who lifted us 1% in 30 mins then extended 10 more points into the European close. EUR roundtripped on the day leaving USD practically unch but -0.35% on the week. Credit markets were quiet (cash busier than synthetic) as IG, HY, and HYG all underperformed for the second day. Gold and Silver limped lower on the day as WTI surged back above $90 to two month highs. Treasuries traded in a very narrow range ending the day -2bps across the curve. Financials underperformed as Tech and Industrials reached for the skies with a 1.75% boost today (makes perfect sense after the earnings?). Decent average trade size on the day which was more prevalent up above 1365 suggests more unwinds of blocks into strength but something has to give with VIX for this train to stop running.
Something is different this morning. Whether it is the aftermath of yesterday's inexplicable 10 Year auction demand spike, or more explicable plunge in the ECB's deposit facility usage, or, the fresh record low yield in the supreme risk indicator, Swiss 2 Year bonds, now at under 0.5%, market participants are realizing that the status quo is changing, leading to fresh 2 year lows in the EURUSD which was at 1.2175 at last check, sliding equity futures (those are largely irrelevant, and purely a function of what Simon "Harry" Potter does today when the clockworkesque ramp at 3:30pm has the FRBNY start selling Vol like a drunken sailor), and negative yields also for German, French, and Finland, with Austria and Belgium expected to follow suit as the herd scrambles into the "safety" of the core (which incidentally is carrying the periphery on its shoulders but who cares about details). Either way, Europe's ZIRP is finally being felt, only not in a way that many had expected and hoped and instead of the money being used to ramp risk, it is further accelerating the divide between risky and safe assets. Look for the Direct take down in today's 30 Year auction: it could be a doozy.
Hmmm… Should we be impressed?
SSDD. Europe has a late night conference, regurgitates stuff, gives no details, makes lots of promises, peripheral bonds tighten only to blow out, etc, etc, etc. Seen it all before. Unlike a week ago, Spanish bonds, when Spanish bonds ripped by 1%, this time we can barely muster a 25 bps move tighter, with the 10 year "down" to 6.82%. It was 6.25% a week ago. Expect the blow out as has been empirically proven time and again. Hint: there is no magic money tree nor is there a magic collateral tree.
Last week, Europe was the source of transitory euphoria on some inexplicable assumption that just because the continent has run out of assets, and the ECB has no choice but to expand "eligible" collateral to include, well, everything, things are fixed and it is safe to buy. Today, it is the opposite. Go figure. Call it pre-eurosummit burnout, call it profit taking on hope and prayer, call it Brian Sack packing up his trading desk (just 5 more days to go), and handing over proper capital markets functioning to a B-grade economist, or best just call it deja vu all over again.
Whether it is the need to soak up all of the Fed's sub 3-year sold on an almost daily basis by the Fed courtesy of Operation Twist (which despite ending in 2 weeks, has already brough the average SOMA holding maturity to a record 105.5 months despite the Fed's implicit target of 100 months, meaning the Fed has overshot its duration ramping target by a lot), or because dealers are suddenly very concerned with having equity exposure, in its last update, the NY Fed has disclosed that as of June 6 Primary Dealers held a record $128 billion in Treasury holdings, a massive 41% increase over the prior week's $91 billion. Whatever the reason, Dealers are now firmly into Trasurys, having increased their net holdings across the curve by $170 billion from -$48 billion last April. And just as notably, for the first time since May 2010 Dealers held no offsetting short positions anywhere on the curve. In conclusion: absolutely everyone is now on the same side of the UST trade.
Futures are well bid overnight even though following a modest short covering squeeze of the new record number of EUR shorts, the primary driver of risk, the EURUSD is now back to mere pips above its 2010 lows. It is somewhat confusing why equities are so jubilant about what can only be more imminent bailouts, following statements by the ECB's Nowotny who made it clear that the ECB is not discussing the renewal of bond purchases and that the central bank provides "liquidity not solvency." Adding to the confusion was a release in Chinese daily Xinhua which said that China has no intention of introducing large scale stimulus. All this simply means that the only possible source of liquidity remains the Fed, whose June FOMC decision could make or break the global stock markets, pardon economy, and why this Friday's NFP print is so critical. Absent a huge miss, it will be difficult to see the Chairman pushing through with another $750 bn-$1 trillion in LSAP. Which Europe desperately needs: first we got Italy pricing €8.5 billion in 6 month bills at much worse conditions than April 26, with the yield rising over 2%, or 2.104% to be precise, compared to 1.772% previously, and a BTC of 1.61, declining from 1.71. More importantly, the Spanish economic deterioration gets even worse after Spain just recorded a record (pardon the pun) plunge in retail sales. From AP: 'A record drop in retail sales added to Spain's woes Tuesday as the country struggles to contain the crisis crippling its banking industry and investors remained wary of the country's ability to manage its debt. Retail sales dropped 9.8 percent in April in year-on-year on a seasonally-adjusted basis as the country battles against its second recession in three years and a 24.4 percent jobless rate that is expected to rise. The fall in sales was the 22nd straight monthly decline, and was more than double the 3.8 percent fall posted in March, the National Statistics Institute said Tuesday." So all those focusing on the Greek economic freefall may want to shift their attention west.
If there was one catalyst for the market to be "convinced" of an imminent coordinated liquidity injection, as Zero Hedge first hinted yesterday, or simply a 25-50 bps rate cut from the ECB as some other banks are suggesting and Spain's ever more desperate Rajoy is now demanding, it was the overnight battery of European Flash PMI, all of which came abysmal, throughout Europe, the consolidated Eurozone PMI posting the worst monthly downturn since mid-2009, the PMI Composite Output and Manufacturing Index printing at a 35 month low of 45.9 and 44.7 respectively. PMIs by core country were atrocious: France Mfg PMI at 44.4 on Exp of 47.0 and down from 46.9, a 36 month low; German Mfg PMI at 45.0 on Exp. of 47.0 and down from 46.2. The implication, as the charts below show, is that GDP in Europe is now negative virtually across the board. Adding insult to injury was the UK whose GDP fell 0.3%, more than the 0.2% drop initially expected. The cherry on top was German IFO business climate, which tumbled from 109.9 to 106.9 on Expectations of 109.4 print, as the European crisis is finally starting to drag the German economy down, or as Goldman classifies it, "a clear loss in momentum." What does it all add up to? Why nothing but a massive surge in risk, as the market's entire future is now once again in the hands of the #POMOList, pardon, the central banks: unless the ECB steps up, Europe will implode due to not only political but economic tensions at this point. Sadly, as in the US, by frontrunning this event, the markets make it more improbable, thus setting itself up for an even bigger drop the next time there is no validation of an intervention rumor: after all recall what sent stocks up 1.5% yesterday - a completely false rumor of a deposit insurance proposal to come out of the European Summit. It didn't, but that didn't prevent markets to not only keep their massive end of day gains, but to add to them. it is officially: we have entered the summer doldrums, when bad is good, and horrible is miraculous.