Belgium

The decoupling/recoupling we discussed earlier in the EURUSD pair seemed the biggest deal in Europe this week as the 2.5% gain is thge most in a month and takes the cross back to near 3-month highs. Not to be outdone, the VSTOXX (Europe's VIX equivalent) dropped notably and now stands at its lowest in 7 months - dramatically outperforming equity and credit markets on its way as selling vol appears the easiest trade ever (until of course your arms and legs are ripped off by a risk flare). Credit markets outperformed this week as equity underperformed - bringing the two asset classes closer into sync after last week's plunge in credit. Sovereign credit markets were mixed but clearly the high-beta compression trend has stalled as Portugal underperformed dramatically followed by Belgium with the rest generally tracking sideways (and Spain outperforming modestly). JPY weaknes balanced the EUR strength to keep the USD (DXY) from getting completely crushed on the week -1.35% (as Oil has rallied over 5%).

As the banks in Europe report out earnings; or the lack thereof in most cases, it becomes clear that the LTRO is helping with liquidity but not with solvency past some very short term point. This is always the case of course but it is beginning to hit home. The balance sheets for many European banks have now swelled on the liability side with more and more debt piling up courtesy of the ECB while their assets decrease due to the Basel III mandates so that the financials of these banks begin to deteriorate. It is not just the losses from their Greek debt holdings that are coming into play but also their potential future losses from sovereign debt write downs markedly for Portugal soon I think but also perhaps for Spain and Italy in the near term as the recession in Europe brings new problems to the fore which will further reduce the value of sovereign and bank credits in Europe.

Belgium's total exposure to its bank bailouts: 41% of GDP. But finally there is some resistance.

An explicit contagion path chart, since you probably won't get info like this anywhere else... 

Now everybody's bank bashing, of course the reason to bash the banks is 4 years old, despite Bove-like analysis to the contrary. I will discuss this on CNBC for a FULL HOUR tomorrow from 12 pm to 1pm.

You know there is a reason why Europe just came crawling with an advance handout looking for US assistance: Moody's just went apeshit on Europe.

• Austria: outlook on Aaa rating changed to negative
• France: outlook on Aaa rating changed to negative
• Italy: downgraded to A3 from A2, negative outlook
• Malta: downgraded to A3 from A2, negative outlook
• Portugal: downgraded to Ba3 from Ba2, negative outlook
• Slovakia: downgraded to A2 from A1, negative outlook
• Slovenia: downgraded to A2 from A1, negative outlook
• Spain: downgraded to A3 from A1, negative outlook
• United Kingdom: outlook on Aaa rating changed to negative

In other news, we wouldn't want to be the company that insured Moody's Milan offices.

Since last Wednesday, European financials have seen credit spreads widen dramatically. After some initial gains today, they once again retreated and traded out to their widest levels in two weeks as both financials and non-financials closed wider and at their worst levels of the day in European credit. Sovereigns also deteriorated significantly after around 8amET with 10Y BTPs for instance adding 20bps or so to close unch (as the rest of the major sovereigns saw de minimus +2 to -4bps changes). Bunds and Treasuries stayed close together and we note TSYs rallied 7bps (from +4 to -3bps) from early morning Europe trading and leaked off a little into the close. WTI is holding above $100 even as Copper is down 1% while Gold and Silver's gains are in sync with USD's modest losses - though EUR is leaking back lower (holding just above 1.32) into the close to around unch. While this post-Thanksgiving Day rally was perhaps predicated on global growth (US decoupling, China soft landing) and extended by LTRO (contagious bank insolvency runs risk containment), the underperformance of banks' credit risk in the last few days should be very worrisome with Senior unsecured credit wider by over 30bps in 3 days, its largest deterioration in two months.

All you need to read.

Anyone who went to bed with the EURUSD about to breach 1.30 to the downside may have been surprised this morning to see it trading nearly 150 pips higher. Checking the headlines for news of a Greek deal however would be futile, as one did not occur. Instead what did, were more promises of a deal being "imminent" even as Greece is doing all it can to appease intransigent creditors, offering GDP upside warrants (something that did not work too well for Argentina), with the IMF stating it demands guarantees that this time Greece will follow through with promises. Oddly enough the German demand for fiscal overrule has gotten lost in the noise but is certainly not forgotten and last we checked Merkel has not withdrawn this polite request. Still futures are up, primarily on a smattering of better than expected PMIs, in China and Europe. Alas, the Chinese PMI beat as discussed last night, was more of a cold water shower as the market had been hoping for much more defined promises of PBoC intervention and instead got a lukewarm Goldilocks economy which could last quite a bit longer without RRR-cuts. As for European PMI numbers being better than expected, we only wonder if these now correlate with the prevailing unemployment rate throughout the Eurozone.

Below are some of the key events to have transpired in the overnight session. According to Bloomberg's TJ Marta, sentiment is broadly higher, with stocks, bond yields, FX higher, EU sovereign spreads tighter as markets focus on German unemployment, ebbing EU concerns, shrug off German retail sales, Greek debt.  Whereas German retail sales unexpectedly fell -1.4%M/m vs est. +0.8%, unemployment fell more than expected -34k vs est. -10k. Italy December unemployment climbed to 8.9%, highest since the data series began in Jan. 2004, from a revised 8.8% in November. Commodities mostly higher, led by WTI +1.5%, 1.0 std. devs. EU leaders agreed to accelerate rescue fund, deficit control treaty . Greek debt negotiations remain in flux with Greece reporting progress, Germany expressing frustration over Greece’s failure to carry out economic. Portugal 10-yr yields fell after earlier touching euro-era record; yields of AAA-rated Finland, Norway, Sweden and Germany higher even as Coelho Says Portugal’s Debt Is 'Perfectly Sustainable.' Treasuries decline for first time in five days; 5-yrs yields yesterday touched record-low 0.7157%. SNB Says Currency Reserves Declined to 257.5 Billion Francs. Foreign Investment in Spain Shows EU38.6 Bln Outflow in Jan-Nov. ECB’s Nowotny Says ‘Can’t Be Sure’ Greece Will Stay in Euro. Belgium Borrowing Costs Rise at 105-Day, 168-Day Bill Auction. Finally, according to KBC, Irish Consumer Confidence Up As ‘Armageddon’ Averted. So every day the world does not end consumer confidence should be higher. Brilliant.

With a Greek default imminent, and this time ISDA having no chance to kill CDS as a hedging mechanism as the trigger event will be more than present, investors have once again jumped at the opportunity to close lucrative basis trade opportunities, as a result sending all of Europe broadly red in spread terms. Notable: Portugal CDS, which contrary to media reports elsewhere has been trading points up front for a few weeks now, just hit a record 40 pts up. And what is worse is that the 5/10s, which should be inverted for a country as distressed as this, isn't.

You've just crossed over...

Festive Friday fun:

• FITCH TAKES RATING ACTIONS ON SIX EUROZONE SOVEREIGNS
• ITALY LT IDR CUT TO A- FROM A+ BY FITCH
• SPAIN ST IDR DOWNGRADED TO F1 FROM F1+ BY FITCH
• IRELAND L-T IDR AFFIRMED BY FITCH; OUTLOOK NEGATIVE
• BELGIUM LT IDR CUT TO AA FROM AA+ BY FITCH
• SLOVENIA LT IDR CUT TO A FROM AA- BY FITCH
• CYPRUS LT IDR CUT TO BBB- FROM BBB BY FITCH, OUTLOOK NEGATIVE

And some sheer brilliance from Fitch:

• In Fitch's opinion, the eurozone crisis will only be resolved as and when there is broad economic recovery.

And just as EUR shorts were starting to sweat bullets. Naturally no downgrade of France. French Fitch won't downgrade France. In other news, Fitch's Italian office is about to be sacked by an errant roving vandal tribe (or so the local Police will claim).

While the ubiquitous pre-European close smash reversal in EURUSD (up if day-down and down if day-up) was largely ignored by risk markets today (as ES - the e-mini S&P 500 futures contract  - did not charge higher and in fact rejected its VWAP three times), some cracks in the wondrously self-fulfilling exuberance that is European's solved crisis are appearing. For the first day in a long time (year to date on our data), European stocks significantly diverged (negatively) from credit markets today. While EURUSD is up near 1.3175 (those EUR shorts still feeling squeezed into a newsy weekend), only Senior financials and the investment grade credit index rallied today, while the higher beta (and better proxy for risk appetite) Crossover and Subordinated financial credit index were unchanged to modestly weaker today (significantly underperforming their less risky peers). European financial stocks have dropped since late yesterday - extending losses today - ending the week up but basically unch from the opening levels on Monday. High visibility sovereigns had a good week (Spain, Italy, Belgium) but the rest were practically unchanged and Portugal blew wider (+67bps on 10Y versus Bunds, +138bps on 5Y spread, and now over 430bps wider in the last two weeks as 5Y bond yields broke to 19% today). The Greek CDS-Cash basis package price has dropped again which we see indicating a desperation among banks to offload their GGBs and needing to cut the package price to entice Hedgies to pick it up (and of course some profit-taking/unwinds perhaps). All-in-all, Europe's euphoric performance has started to stall as perhaps the reality of unemployment and crisis in Europe combine again with US's GDP miss to bring recoupling and reinforcement back.

Somehow the fact that the PIIGS can issue Bills (sub 1-year debt) in an environment in which both the ECB and the Fed have made any debt investment under 3 years risk free is taken as a positive sign. But in a continent starved for even the most optically irrelevant good news, this may be all it gets, which it did last night after Italy auctioned off €8 billion 182 bills at a 1.97% rate, the lowest since May. A far more relevant question is where peripheral debt with a maturity greater than 3 years, and thus with implicit risk, would price. But for now at least some of the banks appear to be dipping their toe into a very short-term carry trade, with ECB deposits declining from €484.1 billion to €464.8 billion overnight. Whether or not this is on the back of the assumption that a Greek default is contained remains to be seen: it would be truly laughable if Europe believes things are ok and thus underutilizes the next LTRO in one month only to find itself with a several trillion euro shortfall 3 weeks later. Yet this, being Europe, is the most likely outcome. Offsetting Bill issuance optimism is the ongoing uncertainty over the outcome of the Greek PSI talks, which for now at least have stalled with the cash coupon being the straw man sticking point. The truth is that if hedge funds want a default to proceed with international litigation arbitrage, that most lucrative of hedge fund strategies, they will get a default. Everything else is irrelevant. Below is Bloomberg's summary of how the newsflow is affecting markets.