High Yield

Today for the first time ever Greek 10 year bonds slide to below 20% of par (5.9% of 2022 dropped to 19.145 cents) as expected some time ago, as increasingly the revulsion to post reorg bonds gets greater and greater courtesy of that now meaningless cash coupon of 2% through 2015. When considering that the country will redefault within a year, it explains why nobody has any interest in holding Greek paper even assuming there is an EFSF bill sweetener. Also, today's ISDA decision did not help. What is most amusing is that as of this morning, the country's 1 Year bonds hit an all time high yield of 920.2%. Well, if Greek bonds crossing 100% just 5 months ago was not quite attractive, perhaps 1000% will. At this rate we expect said threshold to cross some time today.

After 22 crosses yesterday, and 12 more today, the Dow managed to close above 13000. Transports were lower but less so on Oil's modest retracement (though the Brent-WTI spread remained around $15). While stocks closed modestly higher, volatility and correlation markets remained considerably higher than would be expected and along with quite considerable relative weakness in HYG (the high yield bond ETF) into the close as well as a clear up-in-quality rotation was evident as investment grade credit outperformed notably (not exactly a high-beta risk-on shift). Apple's meteoric rise helped drag Tech to first place overall today and also YTD followed closely (YTD) by financials both up around 14%. The last week or so of slow bleed higher in stocks has notably not been led by a short-squeeze in general - based on our index of most shorted names - but as is becoming more and more clear, divergences (and canaries) are appearing all over the place but we suspect can be traced back to Apple in many cases for its over-weighting impact. Treasuries slid lower (higher in yield) after Europe's close but remain better on the week and modestly flatter across the curve. Aside from a hiccup around the macro data this morning, EUR pushed higher all day against the USD shifting into the green by the US close as JPY stabilized. The USD weakness helped Copper and Gold leak higher but Silver was the massive winner, now up an impressive 4.3% since Friday and 30% YTD as WTI lost $107 and is now down over 3% on the week. The IG rotation coupled with vol decompression makes some (nervous) sense heading into the LTRO results but it seems the new safe-haven trade is Apple (whose option prices are now the most complacent since early 2009).

Bill Gross' monthly letters are always a fresh source of jovial imagery, although the bond king may have outdone himself in his latest monthly letter which collapses the principles of investing onto the football field: "My point about pigskin offense and defense is the perfect metaphor for the world of investing as well. Offensively minded risk takers in the markets have historically been the ones who have dominated the headlines and won the hearts of that beautiful gal (or handsome guy).... Canton, however, has an approximately equal number of defensive in addition to offensively positioned inductees, so there must be a universally acknowledged role for both sides of the scrimmage line. What fan can forget Mean Joe Greene, Deion Sanders or Mike Ditka? The old, now politically incorrect showtune laments that “you gotta be a football hero, to fall in love with a beautiful girl,” but football and any of life’s heroes can play on either side of the line, it seems." And it only gets better. While at its heart Gross' latest is merely yet another lamentation against the confines of the financially suppressive regime that arises from ZIRP and ends with what many expect is a whimper (when in reality they all forget to factor in the facility of hitting the CTRL+P keys as many times as necessary), the flourish of abandon this time around is palpable. We would not be surprised to soon see Gross hang up his offensive (and defensive) jersey, and sit back and enjoy the coming lunacy from a distance (but hopefully not before he allocates just a little to the Ron Paul SuperPAC).

NYSE volume was the 3rd lowest of the year so far (while ES was just below average) as stocks leaked lower all day to small net losses by the close. Financials led the drop in stocks as they start to catch up the credit market weakness we have been pointing to for over a week but while HY (the high yield credit spread index) continues to underperform (and stocks following at a lower beta), IG (investment grade credit spread index) modestly outperforms (the up-in-quality rotation) but HYG (the high-yield bond ETF) surged today into a world of its own once again. We suspect this is driven by 'arbitrage' flows between HY's recent richness and HYG's cheapness (as well as potential HY new issue impacts). Gold (and to a lesser extent Silver) was the story of the day as it exploded (perhaps on the Greek gold-collateral news) over $1780 intraday (now up over $55 in the last 3 days) although the USD did nothing (FX was quiet with JPY inching lower and EUR small higher as DXY leaked higher on the day to -0.25% on the week). The rest of the commodity complex jumped also (with WTI losing ground into the close even as Brent kept going - suggesting the spread decompression was in play). Treasuries rallied from early in the European day with yields dropping 6-8bps from the peaks and shifting the entire curve into the green for the week now (10y and 30Y around 1bps lower in yield). ES couldn't get significantly above VWAP today and CSFB's fear index (which tracks equity option skews) is at record highs which both suggest a preference to sell/cover is appearing (even as VIX diverged modestly from stocks today with implied correlation rising).

Volumes were below average but not dismally so as the sad 6.5pt drop in ES (the e-mini S&P 500 futures contract) from Sunday's open to today's close is incredibly the largest drop since 12/28 [correction: 2/10 saw a slightly larger open to close drop] on a day when the problems of Greece are now apparently behind us and Dow 13,000 means that retail will come storming back. High yield credit underperformed (and investment grade outperformed) as stocks drifted to Friday's lows suggesting some up-in-quality rotation (though HYG - the high-yield bond ETF - was strong most of the day). Financials ended the day red with the majors losing significant ground off intraday highs (and CDS widening still further) but the bigger story of the day was the rise in commodities with Copper (RRR cut?) and Silver outperforming (up 3.3% since Friday's close already), WTI managing $106 intraday and Gold touching $1760 (both up over 2% from Friday). What was surprising was the dramatic outperformance with the USD which weakened by 0.44% from Friday as EUR is up 0.75% from Friday alone (while Cable, JPY, and most notably for risk AUD are all weaker against the USD). Treasuries sold off through European hours today and then recovered about half the loss only to ebb quietly into the close with 30Y +6.5bps from Friday (another divergence with stocks) and steeper curve. All-in-all, it seems confusion reigned on Europe but the bias in credit (and financials) seemed more concerned than equities (even with HD and WMT) and FX as real assets were bought aggressively.

Following the recent downgrades of many of the major European banks and insurers and last year's comments by Fitch on insurers' inability to pass on losses to policyholders, the hot-topic of ASSGEN, ALZ, and the rest of the capital-impaired forced-soakers-up-of-new-issue-demand in the European insurance market are under new pressure as The WSJ points out today that new 'rightly punitive' capital rules have been watered down. The 2014 introduction of 'Solvency II' - the insurers' equivalent to banks' Basel III capital rules - did indeed attempt to create risk-weighted capital requirements and better balance assets and liabilities within these firms. However, as Hester Plumridge notes, regulators bowed to industry pressure (again) adding the ability to shift discount rates to get around low-rate-implied valuations for their annuity streams and the introduction of a 'countercyclical premium' to avoid the growing (and negative) spread between distressed assets and rising liabilities. As Plumridge concludes, "a solvency regime that ignores all European sovereign credit risk looks increasingly unrealistic. Investors could end up none the wiser." After some systemic compression, the last week or so has seen insurers start to deteriorate as perhaps the market will enforce its own capital expectations even if regulators are unwilling to.

In spite of the fact that the Greek story has been out there for almost 2 years now, it still drives the market. Virtually all of the big moves this week came on the back of Greek headlines so it is impossible to argue that it is “priced in”. My best guess is that a resolution (which the market believes is most likely) sparks a 2%-4% rally. A default (which I think is most likely) sparks a 5%-10% decline. So at these levels I will be short as I think the most likely move is lower, and the move lower is likely to be bigger. With the market being choppy, being nimble remains a key....The market has a tendency to do well after the credit guys leave on holiday shortened trading days. So with the desire to believe that Europe will not let Greece default (in spite of evidence to the contrary) the markets may remain in rally mode for the day because no one wants to miss the imminent resolution of the crisis. I am far more convinced that we will get some very disappointing headlines because the situation really doesn’t work, and the tone of Europe has switched from “No Default” to “No Disorderly Default”.

Europe has moved into the “pound of flesh” stage of negotiations. Everyone just wants to make their point and the probability of a deal is dropping by the day. Europe is running out of time, and is just clueless. Yesterday has to confirm that even for the most optimistic person out there. They decided they should wait until the elections. Then they realized they had to deal with the March 20th bonds. Then they came up with a “bridge loan”. Clearly they didn’t bother to look up the definition of a bridge loan. A bridge loan is a loan that is meant to be temporary and has such punitive rates over time that the borrower is heavily encouraged to pay it back with new debt. This is just a “small” loan but one that is permanent and probably never getting paid back. I’m not sure if they asked the contributors whether they wanted to put up €16 billion which is somehow now “small”. Then noise came out that maybe Greece just shouldn’t have elections. The Troika and Greece have been negotiating all this time and no effort was spent on figuring out a plan in the event of default. They are scrambling to come up with one. I remain convinced that Greece could do well in default if it is managed properly, but the chances of them doing anything properly is low.

European (like US) stocks remain in a narrow range just above the cliff of the unbelievably good NFP print of 2/3. US and European credit markets have lost significant ground since then and it seems equity investors just want to ignore this 'uglier' reality for now. The BE500 (Bloomberg's broad European equity index) is unchanged from immediately after the NFP 'jump', investment grade credit is +10bps from its post-NFP tights, crossover (or high yield) credit is around 50bps wider, Subordinated financial credit is +50bps off its post-NFP wides at 382bps, and senior financial credit is an incredible 36bps wider at 225bps (by far the largest on a beta adjusted basis). The divergence is very large, increasing, and a week old now and perhaps most importantly as we look forward to LTRO Part Deux, LTRO-ridden banks have underperformed dramatically (40bps wider since 2/7 as opposed to non-LTRO banks which are only 10bps wider) - how's that for a Stigma? Some 'banks' have suggested the underperformance of credit is due to 'technicals' from profit-taking in the CDS market - perhaps they should reflect on why there is profit-taking as opposed to relying on recency bias to maintain their bullish and self-interest positioning as the clear message across all of the credit asset class is - all is not well.

UPDATE: EURUSD back over 1.32 and TSYs +2bps on Greek loan plan news.

Credit (and vol) continue to lead the way as smart deriskers as ES (the e-mini S&P 500 futures contract) ends down only 0.5% - which sadly is the biggest drop since 12/28. The late day surge in ES, which was not supported by IG or HY credit (and very clearly not HYG - the HY bond ETF - which closed at its lows and saw its biggest single-day loss since Thanksgiving), saw heavier volumes and large average trade size which suggest professionals willing to cover longs or add shorts above in order to get filled. Materials stocks underperformed but the major financials had a tough day as their CDS deteriorated to one-week wides. VIX (and its many derivative ETFs) had a very bumpy ride today. VXX (the vol ETF) rose over 14% (most in 3 months) at one point before it pulled back (coming back to settle perfectly at its VWAP so not too worrisome). After the European close, FX markets largely went sideways with the USD inching higher (EUR weaker) as JPY strength reflected on FX carry pair weakness and held stocks down. Treasuries extended their gains from yesterday's peak of the week yields as 7s to 30s rallied around 6bps leaving the 30Y best performer on the week at around unchanged. Commodities generally tracked lower on USD strength with Oil the exception as WTI pushed back up to $99 into the close (ending the week +1.1% and Copper -1.1%). Gold and Silver ended the week down almost in line with USD's gains at around 0.25-0.5%. Broadly speaking risk has been off since around the European close yesterday and ES and CONTEXT have reconverged on a medium-term basis this afternoon (to around NFP-spike levels) as traders await the potential for event risk emerging from Europe.

Credit markets are continuing the trend of the last couple of days with this afternoon seeing their underperformance accelerating. Major underperformance this week in investment grade and high yield credit markets relative to stocks (and as we noted this morning, we are also seeing financial credit in Europe notably underperforming) as Maiden Lane II assets are sold and high yield issuance peaks (and liquidity dries up). Adding to the concerns, VIX futures saw their biggest 2-day jump in over two months despite equity's modest rally. On a day when Pisani tells us there was much to rejoice about, stocks managed only negligible gains (even with broad risk assets in risk-on mode, TSY yields up, FX carry up, Oil up) and while stocks are limping higher now (aside from AAPL of course) with financials underperforming, perhaps this week of notably higher average trade size in equity futures is the calm before the real storm gets going - as credit and vol seems to be hinting at.

Somehow, once again, we managed to rally EURUSD (to 2 month highs) on the back of Greek deal hopes (even as Merkel stomped her feet, Hollande flexed his muscles, and Dallara/Venizelos had nothing to report) which maintained a modicum of support for equity markets (which also got a little late day push from another record-breaking Consumer-Credit expansion) as cash S&P made it to early July 2011 levels. Unfortunately, with Utilities leading S&P sectors, credit diverging wider in investment grade and high-yield, Copper underperforming (post overnight China reality checks), WTI's exuberance (relative to Brent at least), and implied correlation diverging bearishly from VIX, we can't say this was a wholly supported rally. Broad risk-asset proxy (CONTEXT) did stay in sync with ES (the e-mini S&P 500 futures contract) after the European close as Treasuries held up near the day's high yields and FX carry stabilized. Financials lagged with the majors actually underperforming for a change as we note the late-day surge in ES to new highs saw significant average trade size suggesting more professionals covering longs into strength rather than adding at the top. Volume was above yesterday's dismal performance but remained below the year's average so far. Credit and equity vol are back in line and credit has now been flat and underperforming for the last three days (even as HY issuance has been high).

The Fed is doing everything it can to push people out the risk curve, and in particular is encouraging the hunt for yield in credit products. A lot of people are arguing that “credit” is cheap.  That spreads are high and offer a lot of value.  That may even be true, but the problem is that most retail investors don’t own bonds on a spread basis, they own them on a yield basis. The ETFs are all yield based.  The mutual funds are all yield based.  The argument might be that “corporate credit spreads” are cheap, but people aren’t investing in corporate credit spreads, they are investing in corporate credit yields, and that strikes me as very dangerous. The yields are being held down by operation twist.  The treasury has anchored the short end and continues to shift money to the long end, keeping those yields low, for now.  What happens when that ends? And keep in mind that credit almost always grinds tighter and gaps wider with little to no warning.  When the shift from concern about not getting enough yield to concern about how much notional I can lose always seems to catch the market by surprise.

The real meaning of a treasury bear market may not be a flight out of treasuries into another asset class. Rather it real import could be the lack of liquidity available anywhere for nearly any asset class... Liquidity acts in a financial system like ample water, ambient temperature, and clean air act in an ecosystem. It makes trading strategies proliferate. Further, it makes meaningful intermediation possible, fostering the growth in high yield bonds and marketable loans. Yes, derivatives like vanilla stock options and others too. A financial system without liquidity is like a tropical ecosystem dried into a desert. Without liquidity, it is an open question whether the arbitrage pricing revolution will outlast the antiquated mark-ups of reinsurers. Liquidity makes random processes stationary, which is crucial to make the probabilistic foundations of risk neutral pricing work. Is it intuitively possible to price (and even more buy and sell) credit and interest rate risk without some liquidity in the underlying? How can a bank generate carry when the curve is flat and there is no appreciable differential anywhere that has a minimum tolerance of liquidity?

Equity and credit markets eked out small gains on the day as Treasuries limped a few bps lower in yield (with 30Y the notable underperformer) and the EUR lost some ground to the USD. ES (the e-mini S&P futures contract) saw its lowest volume of the year today at 1.35mm contracts (30% below its 50DMA) as NYSE volumes -10% from yesterday but average for the month. Another small range day in almost every market aside from commodities which saw significant divergence with Silver (best today) and Gold surging (up around 1.15% on the week) while Oil and Copper dived (down 2.6-3% or so on the week) with the former managing to scramble back above $96 into the close. ES and the broad risk proxy CONTEXT maintained their very high correlation as Oil and 2s10s30s compression dragged on ES but AUDJPY and TSYs post-Europe inching higher in yields helped ES. HYG underperformed all day (often a canary but we have killed so many canaries recently). Energy names outperformed on the day (as Brent and WTI diverged notably) but financials did well with the majors now back up to the late October (Greek PSI deal) highs. All-in-all, eerily quiet ahead of NFP but it feels like something is stirring under the covers as European exuberance didn't carry through over here (except in ZNGA and FFN!).