France

The New Year has ushered in a new pattern for the market - or perhaps has clarified an old one. The last 3 days has seen European credit markets notably underperform equity markets but stage a significant rally around the equity close each day. This rally then flops into US markets. Today was no different from yesterday - EURUSD leaked lower (holding under 1.28 here) all through the European day session - the question is whether we will see the same stability we saw during yesterday's US afternoon session in FX which will enable the equity strength to hold. We suspect not given that broad risk assets (CONTEXT) has notably not participated in the equity markets pull higher so far. At the same time as Europe closed, with financials massively underperforming, US financials were breaking out as XLF went green and BofA broke above $6. Volumes are above yesterday but below Tuesday for this time of day - still notably low on a medium-term basis. TSYs have been very volatile this morning but European sovereigns have been on a one-way path wider all day - closing near their wides. Commodities are lower (USD strength) but Gold is holding up relatively best for now - well above $1600.

Was Iran born to bluff, or is it really much closer to building a nuclear weapon than anyone really knows? Now that the Islamic Republic has made its intentions clear, one has to assume that it has given away a certain measure of strategic surprise. If it really wants to get the most that it could – militarily – from an attack on tankers moving through Hormuz, it should have never even raised it as a possibility. By discussing it, we figure Iran has given the US “notice” that it might not have had in the event of an attack from the blue. Weren’t the maneuvers in the Straits (by Iran) enough to raise the question without raising alert conditions from the West and from Israel?

• ECB Cash Averts ‘Funding Crisis’ for Italy, Spain (Bloomberg)
• Bailout talks in Greece ‘crucial’, Premier says (WSJ)
• Spain sees €50bn of new bank provisions (FT)
• Fed says expand Fannie, Freddie role to aid housing (Reuters)
• France’s Borrowing Costs Rise at Bond Sale (Bloomberg)
• Europe worries linger after French auction (Reuters)
• PBOC Suspends Bill Sale as Money Rates Rise Before Holiday (Bloomberg)
• Turkey warns against Shi'ite-Sunni Cold War (Reuters)
• New capital rules for banks ‘delayed to 2H’(China Daily)

UPDATE: EURUSD is moving to new lows for the day now at 1.2831

French 10Y bond spreads had widened almost 50% (from 100bps to 149bps) in the last week of trading ahead of this critical auction and the EURUSD is over 200pips lower. The auction results are in and it is not a total disaster but the bid-to-cover dropped significantly to its lowest since October 2010 and they missed their maximum target.

• *FRANCE SELLS TOTAL EU7.963B VS MAX TARGET EU8B OF BONDS
• *FRANCE SELLS EUR4.02 BLN 3.25% 2021 BONDS; YLD 3.29%
• *FRANCE SELLS EUR690 MLN 4.25% 2023 BONDS; YLD 3.5%
• *FRANCE SELLS EUR1.088 BLN 4.75% 2035 BONDS; YLD 3.96%
• *FRANCE SELLS EUR2.165 BLN 4.5% 2041 BONDS; YLD 3.97%
• *FRANCE SELLS 2021 BONDS AT AVE. YIELD 3.29% VS 3.18% DEC. 1
• *FRANCE 2041 BOND BID-TO-COVER 1.82 VS 2.26 AT DEC. 1 SALE
• *FRANCE 2021 BOND BID-TO-COVER 1.64 VS 3.05 AT DEC. 1 SALE

EURUSD is leaking a little lower and 10Y French spreads are widening modestly but the initial reaction is unimpressive for now.

UPDATE: EFSF said to get EUR4bn of orders for 3Y issue is providing some cover (at what rate? We offer to buy 1tn at 300% yield...)

With plenty of time left until France unleashes its supply (and a dismal consumer confidence print earlier), there is a plethora of notable market moves: Unicredit is halted down 7.9% (seems to be the culprit for the initial risk-off turn in Europe), but Deutsche Bank is down over 5% on liquidity problem rumors, EURUSD traded under 1.2850 at its lowest level since September 2010, 10Y Italian bonds have pushed well above 7% yields and 510bps spread to Bunds as Unemployment rises to 8.6%, Belgian 10Y yields are over 4.5% - highest in 3 weeks, and the rest of European Sovereigns are all leaking wider (near wides of the year). Risk assets (CONTEXT) broadly are under pressure but ES (the S&P 500 e-mini futures contract) is holding off yesterday's early morning lows for now. Commodities are all dropping fast with Gold (actually outperforming in this slide) back at $1615, Oil at $102.50, and Copper approaching $340. Treasuries are bid but trading in line with Bunds' movements so far in general. Some chatter of ECB buying in the last few minutes is stabilizing things a little here.

And once again, US taxpayers are asked to create high-level jobs overseas. Contenders: Germany, Japan, France, and China....

Politically speaking, austerity is a challenge. While we would expect that governments imposing spending cuts on their voting public may face electability issues, in fact, a recent paper from the Center for Economic Policy Research finds that there is no empirical evidence to confirm this - i.e. a budget-cutting government is no less likely to be re-relected than a spend-heavy government. However, what the CEPR paper does find as a factor in delaying austerity is much more worrisome - a fear of instability and unrest. The authors found a very clear relationship between CHAOS (their variable name for demonstrations, riots, strikes and worse) and expenditure cuts. As JPMorgan notes, austerity sounds straightforward as a policy, until the consequences bite. It remains unclear that the road Europe is taking is less costly in the long run, in economic, political and social terms. The history of Europe over the last 100 years shows that austerity can have severe consequences and outcomes and perhaps most notably, the independent variable that did result in more unrest was higher levels of government debt in the first place. Judging from France's Noyer's recent jab at Britain's credit rating, at a time of increasing budgetary pressures and declining growth, there may also be limits to European solidarity.

Remember when the world was watching the OAT-Bund spread with bated breath every day in late November until the Fed came in and reliquifed the world with a "half off blue light special" on the OIS+100 bps? Well, it's time to get your OAT tracker out, because quietly the OAT-Bund spread has blown out back to 145 bps, the widest it has been since late November when the world was ending, and before even the S&P announcement it would downgrade France (which incidentally we have not forgotten about - how is that "ASAP after the December 9 summit" thing going for you guys?). Whether the market is pricing in the downgrade or merely noticing that French banks were forced to dump a record amount of US debt in the last month as only Zero hedge has pointed out so far is unknown. What is known is that the Santa rally int eh EURUSD and for Europe lasted all of one day. Which is more than can be said about the Shanghai Composite: it is already down for the year on its first day of trading.

• Iowa result leads to GOP confusion (FT)
• Romney ekes out Iowa caucus victory (FT)
• MF Global sold assets to Goldman before collapse (Reuters)
• China’s Wen Jiacao sees ‘relatively difficult’ first quarter (Bloomberg)
• German Scandal Adds to Pressure on Merkel (WSJ)
• US mortgage demand fell at year-end, purchases sag (Reuters)
• Bank worries hit Europe stocks, euro down (Reuters)
• Martin Wolf: The 2012 recovery: handle with care (FT)
• SNB Chief’s Wife Defends Dollar Trades (Bloomberg)
• China Home Prices Slide Amid Reserve-Ratio Speculation (Bloomberg)

History is full of other examples of once proud nations that, facing problems for decades (or even centuries), completely unwound in a matter of years. The Ottoman Empire. The  Ming Dynasty. Feudal France. The Soviet Union. Bottom line, when the real change comes, it comes very, very quickly. Think about the pace of change these days. It’s quickening. Europe is a great case study for this– when concerns about Greece first surfaced, European leaders were able to contain the damage. There was disquiet, but it soon dissipated. Fast forward to today. We can hardly go a single day without a major, market-rocking headline. And European politicians’ attempts to assuage the damage have a useful half life that can be measured in days… sometimes hours now. Like the Ottomans, the Soviets, the Romans before them, Western civilization is entering the phase where its rate of decline will start looking like that upside-down hockey stick.

European credit and equity markets rallied today but there was considerable relative underperformance by the former (especially in financials). Sovereign spreads leaked wider all day and started to lose it more rapidly into the close. It looks like Senior versus Subordinated decompression trades were placed in the European afternoon (a bearish trade ion financials) and even with the ECB in the market, BTPs closed above 500bps over Bunds (just shy of 7% all-in yields). Broad risk assets also lost ground as Europe's bid eased off as Oil eased back off its best levels and FX carry came off its highs of the day. US Treasuries are rallying after trying to converge earlier and 2s10s30s is also dragging risk lower for now.

• Market talk of a French sovereign downgrade continues to do the rounds – Unconfirmed
• German Unemployment Change (000's) (Dec) M/M -22K vs. Exp. -10K (Prev. -20K, Rev. to -23K)
• EU says the commission and member states have submitted amendments for new EU treaty

While nothing out of Italy or France was on the bond docket today, other countries in Europe will be issuing bonds on a virtually daily basis as the continent prepares to roll an record amount of debt in Q1, and in January as well (full calendar here). As such we saw new Bill issuance from Belgium and from Netherlands. The waffle country sold €1.280 billion in 3 Month T-Bills at a 2.13 Bid To Cover, a plunge compared to the 8.59 previously, albeit with the yield dropping from 0.78% to 0.264% as it falls flatly within the risk-free period defined by the 3 Year LTRO. Belgium also issued €1.155 6 Month T-Bills at a 2.01 Bid To Cover compared to 2.76 previously and a rate plunging from 2.438% to 0.364%. Elsewhere the Netherland also took advantage of the now mixed LTRO euphoria to sell €4.65 billion in Bills, specifically €2.99 billion in March 2012 Bills pricing at 0.00% (compared to negative -0.007% before), and €1.66 billion December 2012 Bills at a yield of 0.05% - obviously the market is still enamored with Netherlands as a safe haven on par with Germany. And speaking of the LTRO, that carry trade concept is now dead with the year end cash parking theory scrapped following the announcement thet banks parked the second highest amount in history at the ECB, or €446 billion, just shy of the €452 billion hit on December 27.

Fitch admits, via Bloomberg headlines, what we already knew:

*FITCH: EFSF DEBT 'AAA' RATING DEPENDS ON FRANCE REMAINING 'AAA'

*FITCH SAYS RISK OF EFSF DOWNGRADE HAS INCREASED

While certainly humorous, entertaining and very, very childish, the recent war of words between France and Britain has the potential to become the worst thing to ever happen to Europe. Actually, make that the world and modern civilization. Why? Because while we sympathize with England, and are stunned by the immature petulant response from France and its head banker Christian Noyer to the threat of an imminent S&P downgrade of its overblown AAA rating, the truth is that France is actually 100% correct in telling the world to shift its attention from France and to Britain. So why is this bad. Because as the chart below shows, if there is anything the global financial system needs, is for the rating agencies, bond vigilantes, and lastly, general public itself, to realize that the UK's consolidated debt (non-financial, financial, government and household) to GDP is... just under 1000%. That's right: the UK debt, when one adds to its more tenable sovereign debt tranche all the other debt carried on UK books (and thus making the transfer of private debt to the public balance sheet impossible), is nearly ten times greater than the country's GDP. To call that "game over" is an insult to game overs everywhere. So here's the bottom line: France should quietly and happily accept a downgrade, because the worst that could happen would be a few big French banks collapsing, and that's it. If, on the other hand, the UK becomes the center of attention (recall this is the same UK that allows unlimited rehypothecation of worthless assets, and the same UK that unleashed the juggernaut known as AIG-FP's Joe Cassano - after all there is a reason why the UK has 600% its GDP in financial liabilities - financial innovation always goes there where it is least regulated), then this island, which far more so than the US is the true center of the global banking ponzi scheme, will suddenly find itself at the mercy of the market. At that point the only question is whether the vigilantes will dare to take down the UK, as said take down will result in an implosion in the very fabric of modern finance, much more so than what even a full collapse of France could ever achieve, or if due to the certain Mutual Assured Destruction that would follow a coordinated UK onslaught, the market will simply very quietly proceed to ignore the elephant in the room.