Understanding the complexities of the sovereign CDS market is tricky... so we are constantly bemused by the mainstream media's constant comment on it as if they have a clue. The fact is that the USA CDS market is indicating a higher risk of imminent technical default now than in 2011. As we explained in painful detail previously, you cannot compare a 71bps (+8 today) 1Y USA CDS spread to a 1200bps JCPenney CDS spread - they are apples and unicorns. Having got that off our chest, the fact that the cost of 1Y protection is at 2011 extremes (implying around a 6.5% probaility fo default) and has been higher (inverted) relative to 5Y now for 3 weeks is a clear indication that investor anxiety is very high this time (just look at T-Bills!).
A quiet day unfolding with just Chicago Fed permadove on the wires today at 1pm, following some early pre-Japan market fireworks in the USDJPY and the silver complex, where a cascade of USDJPY margin calls, sent silver to its lowest in years as someone got carted out feet first following a forced liquidation. This however did not stop the Friday ramp higher in the USDJPY from sending the Nikkei225, in a delayed response, to a level surpassing the Dow Jones Industrial Average for the first time in years. Quiet, however, may be just how the traders at 72 Cummings Point Road like it just in case they can hear the paddy wagons approach, following news that things between the government and SAC Capital are turning from bad to worse and that Stevie Cohen, responsible for up to 10-15% of daily NYSE volume, may be testifying before a grand jury soon. The news itself sent S&P futures briefly lower when it hit last night, showing just how influential the CT hedge fund is for overall market liquidity in a world in which the bulk of market "volume" is algos collecting liquidity rebates and churning liquid stocks back and forth to one another.
Many have argued that sovereign CDS markets 'caused' the problems in Europe - as opposed to simply 'signaled' what was in fact being hidden by cash market manipulation. But as the IMF notes in a recent paper, there are times when the CDS market leads the cash bond market and other times when it lags. But as far as looking at risk in Europe and the US, based on a wonderful model that uses Markov-switching to predict what the probability of the world being in a low-risk or high-risk state, we are as 'low risk' as we have been since the crisis began. Each time that level of complacency was reached before, equity markets have rapidly sold off. What is perhaps most notable is the systemic compression of every risk indicator, first VIX (Kevin Henry and the fungible excess reserves of every prime dealer whale), then the liquid SovX index (via Greece CDS auction uncertainty and 'naked' short bans), then the Euro TED Spread (via LTRO), then individual Sovereign CDS (via Draghi's 'promise'). The result, the 'free-market' signal of risk is non-existent.
Just this week we had: TVIX, MF Global & “customer money”, CPDO, Greek CDS auction, BATS.... I’m all for some complexity and innovation, but it does seem after a week like this, that the financial markets have become too complex, and some real effort should be made to simplify things and put everyone on an even playing field.
While Europe is once again back on the radar, having recently disappeared therefrom following the uneventful Greek CDS auction (which in itself was never an issue - the bigger question is any funding shortfall to fund non variation margined payments, as well as the cash to make whole UK and Swiss law bonds) following Buiter's earlier announcement that Spain is now in greater risk of default than ever, coupled with Geithner and Bernanke discussing how Europe is 'fine' in real time, here are three quick charts which will remind everyone that nothing in Europe has been fixed. In fact, it is now worse than ever. As a reminder, when thinking of Europe, the shorthand rule is: assets. And specifically, the lack thereof. Why is the ECB scrambling to collateralize every imaginable piece of trash that European banks can procure at only some valuation it knows about? Simple - quality, encumbrance and scarcity. When one understands that the heart of Europe's problem is the rapid "vaporization" of all money good assets, everything falls into place: from the ECB's response, to Europe's propensity for infinite rehypothecation, to the rapidly deteriorating financial system. It also explains why America will be increasingly on the hook, either via the Fed indirectly (via FX swaps), or indirectly via the IMF (such as two days ago when US taxpayers for the first time funded the first bailout check to the ECB using Greece as an intermediary).
One of the central premises of CDS is that the “basis” package should work. An investor should be able to buy a bond, and buy CDS to the same maturity and expect to get paid close to par – either by the bond being repaid at par and the CDS expiring worthless, or through a Credit Event, where the price of the bonds the investor owns plus the CDS settlement amount add up to close to par. The settlement of the Greek CDS contracts worked well, but that was pure dumb luck. This leaves playing the basis in Portuguese bonds and CDS as a much riskier proposition than before Europe's PSI/ECB decisions - and perhaps explains why at over 300bps, it has not been arbitraged fully away - though today's rally in Portugal bonds suggests a new marginal buyer which given the basis compression suggests they may be getting more comfortable.
"Whocouldanode?" that Apple would do something like pay a de minimus dividend and begin a modest buyback program? Indeed, initial reactions for the stock seemed to be 'sell the news' but of course, it wouldn't be a day ending in 'y' if Apple didn't close green and sure enough, with seconds to spare, Apple managed to close over $600 for the first time. BofA, not so much. After pinging $10 (a healthy double of recent lows), chatter of a secondary began the process of 'normalizing' its recent behavior (the stock is still up 17% post JPM-divi/Stress test news, a whopping 10% better than any of its peers in that 4 day period). The leak in financials dragged on the S&P which limped back lower to close almost perfectly at its VWAP as NYSE trading volumes (after almost record-breaking high levels on Friday OPEX hedge removal day) dropped back to near their lows . Credit outperformed equities today but its a very 'technical' day for credit in general with the CDS/index rolls tomorrow (meaning the major credit indices will move to new maturities and new components) though HYG staggered notably early in the day. USD and Treasury weakness were the headlines of the day (aside from AAPL of course - which apparently has a great new screen) which of course helped commodities rally with high-beta Silver the best on the day +1.2% from Friday and WTI breaking $108 as Gold limped higher (tortoise-like) over $1660 at the end. VIX rose once again and the term structure flattened a little but once again post-OPEX and futures roll, there are some more difficult apples-to-camels comparisons there. Finally we note average trade size in ES today was its largest since 7/1/11.
The Hellenic Republic Greek CDS Auction has ended, pricing at 21.5%, just slightly less compared to the Initial Market Midpoint of 21.75 of par. As explained back in January 2009, those who had bought the Cheapest to Deliver Greek bonds trading in the teens coming into the auction, made a quick buck, as these will be taken out at a nice premium to purchase price. For those who bought at par, we can only hope they have arrangements with the ECB to fund the shortfall, especially since only the ECB can "book a profit" by buying up Greek bonds at 80 cents on the euro and seeing these terminate at 21.5. Limit buy orders that were satisfied ranged from 22.75 (where there was just under 70 million in bids by accounts using JPM and DB as dealers), all the way to 21.625, where the breaking bid was courtesy of 120 million in indicated bids, spread evenly between HSBC and Barclays: these satisfied the 291.6 Million in outstanding Open Interest. Overall, there was 3,362.7 million in total limit buy orders across the stack. The laugh of the day once again comes courtesy of an account using JPM, which submitted a total of €135 million in bids between 8 cents and 1 cents (50 million at the former). If they had been hit on that it would have made quite a payday. On the offer side, the dealers showing the biggest Physical settlement requests were HSBC with €332 million, and BNP at €158 million. And the joke of the day once again comes courtesy of RBS, which as usual seems to have one of the most "entertaining" bond trading desks: the reason for the RBS "Adjustment Amount", as speculated earlier, was that the bank's Bid of 22 was above the market midpoint of 21.75: the good news is that unlike before at least they did not confuse price and discount.
With a economic calendar devoid of virtually any events, the only two events worth of note this morning are the Greek CDS auction (where RBS appears to once again be confusing price and discount), and the Apple cash announcement due in just over an hour. The result is Apple stock which in the premarket session has traded as high as a new record high og $606, even as concerns emerge that the growth phase is over as the company transitions into a MSFT-type, post-Steve Jobs existence. Details of the 9 am call can be found here. Aside from that risk is broadly flat as hungover American traders take their seats.
The results from the Greek CDS auction are starting to come in (the full calendar can be found here). Moments ago ISDA, via Creditfixings.com released the initial results of the Auction, which indicate a preliminary market midpoint based on bids and offers of the defaulted bonds of 21.75, which is roughly in line with where bonds had been trading ahead of the PSI completion, if a little higher than the Cheapest to Deliver, indicating some modest upside to those who bought the CTDs in the final days. The Net Open Interest going into the bidding period which begins at 13:30 GMT and lasts for 30 minutes is a modest €291.6 million, with an offer-heavy side. Then final results will become pulbic in 4:30 hours, at 15:30 GMT.Once again, a full generic run down of the whole physical settlement process can be found here. Finally, what's with the RBS "Adjustment Amount": did the bank once again forget there is a difference between "discount" and "price"? Nothing less would surprise coming from the world's most incompetent bank.
With Greece seemingly well-and-truly in the mainstream media's rear-view mirror, we thought it useful to go over a few details that are 'evolving' as we approach the CDS auction and foreign-law bondholder participation deadline. In a nutshell, there are now seven (count them seven) classes of debt in the Greece capital structure ranging from Old GGB holdouts to Troika- and EFSF-subordinated 'loans'. Critically though, just as we have written extensively, it is the size of the holdouts that will become a growing headache for the European Greek government. As BNP notes today, there are at a minimum EUR2.5bn but potentially up to EUR11bn of holdouts that leaves the Hellenic Republic with the chance of achieving 100% participation practically impossible and some very difficult choices between a disorderly failure-to-pay default on these holdouts (with all the ugly ramifications of out-of-control bankruptcy and litigation) or 'unfairly' pay this 'small' group of desperadoes out as normal (i.e. pay interest and principal to Par at maturity - no haircuts). This is exactly the 'blocking-stake-Foreign-Law-bond' strategy we suggested that hedge funds would undertake and it appears successful given the record price differential that now exists between Greek- and Foreign-Law bonds.
The Greek CDS auction has not yet taken place, nor has one quantified how many Greece-guaranteed orphan bonds with UK-law indentures have to be made whole (at a cost to Greece of course, no matter how much Venizelos protests), and somehow the world is already moving on to bigger and better risk strawmen. Because if one sticks their head in the sand deep enough, it will be easy to ignore that European banks have gradually over the past year or quite suddenly (as in the case of Austrian KA Finanz) taken about €100 billion in now definitive losses on their Greek bonds and CDS exposure. Luckily, just like in the US, there is now over $1.3 trillion in fungible cash sloshing in the system, allowing banks to 'fungibly' fund capital shortfalls and otherwise abuse every trace of proper accounting, when it comes to a post-Greek default world. The problem is that none of this actually solves the fundamental insolvency issues plaguing the 'old world', but what it does do, is force the accelerated depletion of an aging and amortizing asset base. That's fine - as Draghi said the ECB can "always loosen collateral requirements even more." So while we await to hear just who will sue Greece and Europe, and how much cash will have to be paid out to UK-law bondholders (before the Greek default is even remotely put to rest), here is a listing of what Bank of America (recall - BofA is the one bank most desperate to remove any lipstick from the pig due to its need for more QE) believes will be the biggest risks to its outlook going forward. In order of importance: 1) Oil prices (remember when a month ago we said this then ignored issue may soon hit the very top of investors worry lists?), 2) Europe; 3) US Economy; and 4) China. That about covers it. Oh and massive debt issuance supply too as well as the even more epic straw man that is this Thursday's stress test. Remember: stress tests will continue until confidence in the ponzi returns!
Total confusion around this, as there is no formal Press Release from ISDA yet, but since this one comes from Bloomberg, let's assume they have double checked their data. From Bloomberg:
- ISDA EMEA DETERMINATIONS COMMITTEE: RESTRUCTURING CREDIT EVENT
- ISDA SAYS CREDIT EVENT HAS OCCURRED WITH RESPECT TO GREECE
- COMMITTEE DETERMINES AUCTION TO BE HELD ON MARCH 19
- ISDA EMEA: AUCTION TO BE HELD ON OUTSTANDING CDS TRANSACTIONS
This despite refutations from ISDA 15 minutes ago that no decision had been reached. Of course, if this is a spoof PR that has gotten half the media world confused, the farce will be 100% complete.
At 2PM Eastern, CIT's CDS auction was priced at a final recovery of 68.125. This was over 2 bps lower than the inside midpoint market announced earlier. Going into the auction, there was $728.98 billion of open interest, indicating that basis traders were a dominant force and exlipsed correlation desks' influence in the auction. The 13 participating dealers submitted $4.5 billion worth of limit order, with an average bid of 65.66, just 3.6% away from the final settlement price, indicating that the option to low-ball into the Dutch auction and get hit on some insane bid has disappeared.
Today's RH Donnelley CDS auction closed at an abysmal 4.875 final price (on top of the IMM). When will DTCC/JPM change the default recovery on bonds for the CDSW calc from 40 to 10? Why 10% - because, as the chart below demonstrates, that is what the weighted average CDS auction recovery has been for the past 8 months.