Flight to Safety
The European debt struggle may have just entered a new phase. Don’t blink. Like any classy magician’s trick the idea is to get you looking one place while the real action is going on somewhere else. And that has been the recipe over the past week or so. While everyone has been watching the Spanish and Portuguese debt auctions, the real damage was done in Germany where the German government’s bid-cover ratio on a ten-year bund auction came in less than ‘one.’
Last Friday saw the release of a below-expected US Non-Farm Payrolls figure, causing flight to safety in particularly thin markets, with equity futures spiking lower and US T-notes making significant gains. Data from this week so far in Asia has shown Chinese CPI is still accelerating, coming in above expectations at 3.6% against an expected 3.4% reading. Looking ahead in the session, there is very little in the way of data due to the reduced Easter session in the US and the European and UK markets closing for Easter Monday.
While most of the time, it seems, investing in Emerging (or Growth) market countries is entirely focused on just that - the growth - with little thought given to the lower probability but high impact event of a growth shock. Goldman uses a variety of economic and corporate factors to compile a Growth Vulnerability Score including excess credit growth, high levels of short-term and/or external debt, and current account deficits. Comparing growth expectations to this growth shock score indicates the BRICs are now in very different places from a valuation perspective. Brazil remains 'fair' while India looks notably 'expensive' leaving China and Russia 'cheap'. It seems, in Goldman's opinion that markets are discounting large growth risks too much for China and Russia (and not enough for India). Finally, for all the Europeans, Turkey is richest of all, with a significant growth shock potential that is notably underpriced. Goldman's China-is-cheap perspective disagrees with Nouriel Roubini's well-below-consensus view of an initially soft landing leading to a hard landing for China as 2013 approaches as he notes the pain that commodity exporters feel in 2012 is only a taste of the bleeding yet to come in 2013.
In only three more years you're talking $20 trillion in public debt for the USA and a GDP going nowhere fast. Add to this that demographics are not encouraging and taxes of all sorts will have to rise. Cuts will be symbolic because the political pain will be unbearable. Without productive new investment, then debt service soon outstrips income growth and the economy enters a death spiral of declining productive investment, ever expanding debt and ever higher debt service costs.
Swiss money manager and long term bear Marc Faber, aka "Dr Doom", says political risk in the Middle East has increased significantly with war between Iran and Israel “almost inevitable”, and precious metals and equities investments offer some safety. "Political risk was high six months ago and is higher now. I think sooner or later, the U.S. or Israel will strike Iran - it's almost inevitable," Faber, who publishes the widely read Gloom Boom and Doom Report, told Reuters on the sidelines of an investment conference. Brent crude traded near $123 per barrel in volatile trade on Tuesday on fears of a disruption in Iranian supplies. Israeli Prime Minister Benjamin Netanyahu showed no signs of backing away from possible military action against Iran following a Monday meeting with U.S. President Barack Obama. "Say war breaks out in the Middle East or anywhere else, (U.S. Federal Reserve chairman) Mr Bernanke will just print even more money -- they have no option...they haven't got the money to finance a war," said Faber. "You have to be in precious metals and equities ... most wars and most social unrest haven't destroyed corporations - they usually survive," he said. He said that Middle East markets had largely bottomed out, though regime changes from the Arab Spring revolutions were unlikely to be investor-friendly.
Asian equities too a hit, posting their biggest two-day loss this year. The MSCI Asia Pacific Index dropped 1.2%. The losses were situated in the Hang Seng, which fell 2.2% and China’s Shanghai Composite, which declined 1.4%. Meanwhile, Europe is off 1.6% in the aggregate after the second take on Q4 GDP confirmed the 0.3% drop from the initial estimate. And, after yesterday’s sell-off, equity futures are pointing to a weaker open at home across the major indices driven in part by concerns that the Greek PSI will not get the required 75% participation as reported here yesterday. In the US, government bonds are in rally mode with the 10-year Treasury note yield down 4bps, to 1.97%; the long bond is rallying 5bps, to 3.10%. Across the pond, government bonds are performing as one would expect. Benchmark German bunds are rallying 4bps, to 1.78% while France, Italy, and Spain are selling off anywhere from 5 to 9bps. In the FX market, the US dollar is enjoying a flight to safety bid against major currencies. The DXY index is up 0.5%. Not surprisingly, with risk being taken off the table, commodities are taking a hit. WTI crude oil is down 60 cents, to $106.10 per barrel. Industrial metals are taking a hit too; copper is off 1.6% to its lowest level since mid February. In Europe, the LTRO continues to not work at all as the ECB deposit facility rose to a new all time record of €827 billion as cash parked with the ECB is not being used for any other purpose, and the net money from LTRO 1 and 2 is now less than the cash added to the ECB from Europe's banks.
Heading into the North American open, equities are trading lower with the benchmark EU volatility index up 1.6%, with financials underperforming on concerns that the latest Greek bailout deal will need to be revised yet again. Officials said that the deal will require Greece’s private creditors to take a deeper write-down on the face value of their EUR 200bln in holdings than first agreed. The haircut on the face value of privately held Greek debt will now be over 53%. As a result of the measures adopted, the creditors now assume that Greece’s gross debt will fall to just over 120% of GDP by 2020, from around 164% currently, according to the officials. However as noted by analysts at the Troika in their latest debt sustainability report - “…there are notable risks. Given the high prospective level and share of senior debt, the prospects for Greece to be able to return to the market in the years following the end of the new program are uncertain and require more analysis”. Still, Bunds are down and a touch steeper in 2/10s under moderately light volume, while bond yield spreads around Europe are tighter.
Hands up anyone who is surprised that the Bank of England has added another £50 billion to the quantitative easing pot? The same hands will also believe that the Greeks have agreed terms for the next bail out tranche with the Troika (the European Union, the IMF and the European Central Bank). This ongoing epic odyssey of the voyage to nowhere has grabbed the headlines, but the BoE’s quiet announcement is equally significant to us Brits. Central banks never utter the words quantitative easing, so the Bank calls it an addition to its “asset purchase programme”, which was only hiked to £275 billion back in October. The accompanying rhetoric states that inflation is on the way back down and may fall below their target of 2%, mainly as a result of the VAT increase last January falling out of the equation and lower energy prices, (despite Brent crude being over 10% higher Y-o-Y in sterling terms..); a convenient excuse perhaps.
Luckily they are easy to spot: the demagogues, the manipulators and the hired claqueurs. Unfortunately, there is no lack of media willing to provide a platform to perform their insidious game. “We need more, not less, government spending to get us out of our unemployment trap. And the wrong-headed, ill-informed obsession with debt is standing in its way.”How can a Nobel-prize carrying economist, who is presumably smart, write such nonsense? “He knows better”, says Jim Rickards (author of “Currency Wars”). And that makes Krugman so dangerous. Decision makers will reference his “debt does not matter” mantra over and over again – until it’s over. Thank you, Mayfly. You really understand debt – and how to make others believe it doesn’t matter.
Over the past hour the EURUSD has tumbled by nearly 100 pips on what some believe is a liquidation program, but is largely driven off continued European data weakness (and with the recession here, we will be getting much more of this in the days to come), as well as continued scramble for safety. Germany auctioned off a 5 year note which received €9billion bids for €4billion target; the bund yield 2.3bps was indicative of a safe haven bid, and explains why bank deposits with the ECB rose to a new record €486billion. The strength is somewhat peculiar as it was earlier reported that the German economy contracted by 0.25 bps in Q4, which is never a good thing, but the assessment is that German weakness will hit others more than Germany itself. Elsewhere, Spanish industrial production declined -7.0% Y/y vs an estimated -5.4%, the worst decline since Oct. 2009. Spain 2-year yield down -34bps, causing spread to bunds to fall 33bps. We doubt that this contraction will last, or the BTP yield flirting with the 7% barrier especially after Rabobank finally noted what we have been saying for a while, namely that LCH will soon have to hike Italian margins again. In Greece, CPI rose 2.2% Y/y vs est. 2.7%; a decline which is seen as a symptom of economic downturn. Confirming the slowdown, we learn that Euroarea Q3 economic growth was reduced to 0.1%, meaning that the recession likely started in Q4. Hungary is again a center of attention, after the forint drops following an EU statement it may suspend Hungary funding (unless the country hands over its legislative apparatus to the EU entirely). Finally, we find out that French Fitch is now channeling France, after saying that the ECB must do more to prevent a cataclysmic Euro collapse. All this leads to a drop in the EUR to under 1.27, a slide in crude to under $102, and a decline in gold to $1634 after nearly hitting $1650 in overnight trading as the world realizes that a return in Chinese inflation (that SHCOMP surge isnt coming on its own) courtesy of a loose PBOC, will mean a prompt retrace of the metal's all time highs.
In The Meantime Belgium Bond Yields Jump, ECB "Flight To Safety" Facility Usage Soars To Highest In 15 MonthsSubmitted by Tyler Durden on 10/10/2011 06:32 -0500
We would point out that USD Libor is wider again this morning but at this point it is irrelevant: for a multi-billion core European bank to go insolvent "overnight" (nobody could have foreseen it and all that), and with Libor to still be trading under 1%, and specifically, under the USD FX swap line penalty rate, it means that the BBA market is either completely broken or criminally corrupt and colluded. Take your pick. So instead we will focus on what actually does matter in the market, such as the fact that ever more banks are exhibiting the fear and loathing discussed earlier this weekend, with an unprecedented scramble to dump every last eurocent in the "safety" of the ECB's clutches: as of Friday, a whopping €255.6 billion ($345 billion) in cash stood idle, and hence as far away as possibl;e from normal interbank liquidity, parked with the ECB: the highest since June 30, 2010. Expect this number to jump even more tomorrow when the Monday, aka "post-Dexia" number is released. And elsewhere, as expected, Belgium sovereign bonds are already starting to take on ever more water, as Belgium and France 10 year notes fall and the French 10 yield hits highest in over a month. Belgium and France govt bonds will be pressured as fallout from Dexia highlights risks and costs to state from banks’ exposure to peripheral debt, Padhraic Garvey, strategist at ING, writes in note. Specifically, the Belgium 10 Year yield is at +7bps to 4.05% while the 2-yr yield +4bps to 2.34%. At least the curve is not massively inverting just yet. In France, the 10 Year yield is +7bps to 2.83%, the highest since Sept. 2. The spread widening in these two countries will not stop as an imminent rating agency downgrade overhang is now a threat to bondholders of both countries. Said otherwise, the Dexia-Belgium CDS compression trade is alive and profitable.
Yesterday's last minute short covering rally has been all but eliminated and then some, on fresh European concerns following a Deutsche Bank report that the agreed writedown of 21% from the July 21 second Greek bailout agreement could be executed, and that instead an orderly default with an up to 50% haircut is being considered. Generally, broad concerns that Greece can and will go bankrupt any minute once again dominate and have undone any favorable market sentiment from yesterday's G20, also known as the Full Tilt Ponzi Group, announcement, which was also followed up by an ECB statement that the central bank would do everything to prevent further contagion. Judging by the risk waterfall this morning, and the liquidations in gold (driven by a vague but ever stronger rumor of a winddown at a GLD-heavy hedge fund that is now down 50% YTD), virtually nobody believes anything coming out of any European institution. Alas, this is what two years of relentless accrued lying will do to your reputation. Adding fuel to the fire is a report from Credit Suisse that the chance of a "general European break up" is about 10% and that European banks would fall by about 40% on a disorderly Euro breakup and that peripheral European banks' net foreign liabilities would rise by €800 billion. In other words, European banks would blow up, which is nothing really new. Next, we hear from Dexia which yesterday got annihilated and today is down another 2.5% despite promises from the Belgian central bank governor Luc Coene that the bank is not in trouble and has not sought dollars from the ECB in a long time: obviously an attempt to prevent an all out attack on the insolvent bank, which as is well known bypasses the ECB and goes straight to the Fed for emergency funding. Overall, there is a very distinct sense that it's the end of the world as we know it, and the market does not feel all that fine anymore.
USDCHF Plunges To Record Low Following Generali CEO Comments Eurozone Faces Risk Of Breakup, Flight To Safety ResumesSubmitted by Tyler Durden on 08/05/2011 09:43 -0500
Yep. Europe again. Following comments from Generali's CEO Giovanni Perissinotto based on a transcript from a conference call earlier that the Eurozone is at risk of breakup (something which everyone knows, but nobody dares to say, especially not anyone whose CDS is trading in lockstep with those of Italy), the USDCHF just plunged to fresh all time lows. And so all the goodwill created by the robotic buying on the NFP headlines is gone.
The unprecedented moves in the yield curve continue: even as the blow out in (ultra) short term liquidity persists, notably in GC and in Bills maturing just after the August 2 D-Day, the scramble to cover long-dated shorts has collapsed the 10 and the 30 Year by an epic amount in the last few days, with the 10 Year trading at 2011 lows of 2011. Why is this number relevant? Because the last time we saw it was in August 2010, a few weeks before Ben Bernanke announced QE2. In other words, history is repeating itself verbatim from last year. As to whether the move is due more to a flight to safety or a short covering crunch we will know only next week when the CFTC releases its latest COT spec short data. One thing can be ascertained, however: the Fed models that look at rate-implied deflation indicators are currently screaming bloody QE. And it will come... As soon as the stock market finally realizes that it has to tumble before it surges to new and Weimerian highs.
And while stocks once again float off in some imaginary universe of their own which has no correlation to reality (and all correlation to the frequency of 19 year old math quants' night life excursions), Europe is getting worse, as the FX flight to safety accelerates. Following earlier speculation that Dexia may be in trouble, or who knows why, the CHF just spiked higher as both USDCHF and EURCHF pairs snapped lower, with the second hitting a fresh all time low. Keep an eye on what is going on here, as for the time being this is the flight to safety trade. In the meantime, and as usual, our condolences to Swiss exporters.