Hungary

All eyes were on Germany this morning, where up to €5 billion in new 10 Year Bunds would hit the market, with many dreading a repeat of November's failed auction. As it turns out, the auction was a success in relative terms, with the government getting bids of €5.14 billion or more than the desired maximum - something it could not do two months ago. At the end of the day, Germany sold €4.06 billion and the resulting bid/cover ratio of 1.3 was well higher than the failed auction of November which came at  1.1, when a large amount of paper was retained and bids were not enough to cover the amount of paper on offer. Wednesday's auction is still below the average of 1.54 seen at 10-year sales in 2011 and a 19 percent retention rate is also above the 2011 average. In other words, as we suggested, the November failure has nothing to do with the Buba pushing the ECB into auction and everything to do with prevailing rates: the average yield dropped to 1.93 percent from 1.98 percent but the dwindling returns on offer due to the sharp rally in safe-haven assets as the euro zone debt crisis has intensified have led to lower than average demand at recent German auctions. And while the auction was better than expected it was still quite weak, which explains why the EURUSD is trading at overnight lows, back at around 1.2980. Not helping things is Hungary, which had a failed bond auction last week, and whose IMF rescue package is now in tatters. As a result the CDS on the country just hit an all time record 688 bps and moving much wider, while the forint dropped to record lows. As everyone knows if Hungary falls, which is now operating in a bailoutless vacuum, Austria will tumble promptly next. Next, leading to a blow out in Spanish-Bund spreads is a report in Spanish Expansion which said that Spain may request EU, IMF loans to help banks. In other words - this morning's news shows a potential risk reflaring in the European core, periphery and deep periphery which was immune until now. And finally, a UniCredit €7.5 billion new stock issue pricing at a whopping 43% discount to market price shows that fair value of actual demand for European banks is about half of where the artificially propped up price is (recall Europe still has a short selling ban)

On November 25, Moody's cut Hungary to junk. Now it is S&P's turn: "The downgrade reflects our opinion that the predictability and credibility of Hungary's policy framework continues to weaken. We believe this weakening is due, in part, to official actions that, in our opinion, raise questions about the independence of oversight institutions and complicate the operating environment for investors. In our view, this is likely to have a negative impact on investment and fiscal planning, which we believe will continue to weigh on Hungary's medium-term growth prospects. Moreover, in our opinion, the downside risks to Hungary's creditworthiness have also increased as the global and domestic economic environments have weakened."

Citing uncertainty over the country's ability to meet 'austerity' targets and its rising susceptibility to external shocks - given its heavy reliance on external investors - Moody's just downgraded Hungary to Junk Ba1 (with a negative outlook). With its 10Y yield currently at 9%, only 190bps wider than Italy, we thought it somewhat ironic that Hungary's average 10Y yield from SEP09 to SEP11 was 7.2% - almost exactly where Italy finds itself trading currently.

Earlier today it was Fitch; now, way after the close, it is S&P's turn: the rating agency just put Hungary on junk bond watch, due an "unpredictable policy framework", and better yet, advised readers that the almost certain downgrade from Investment Grade would happen this month. Naturally, if Hungary, AAAustria is next. Then all of Eastern Europe follows quickly and Germany finds itself in a war with contagion on every single front.

As America continues to keep its head firmly planted in the sand, if not somewhere much worse, Europe is falling apart. Hungary was just downgraded by Fitch to BBB-, and still kept its rating outlook negative, meaning the country is about to enter junk territory. And what is sure not helping is the record strength of the CHF, which is making life for borrowers in Hungary a living hell, whose debt is denominated primarily in Swiss Francs. And as US stocks hit 2010 highs, so does the SovX index of sovereign spreads. In other words, equities and sovereign bankruptcy risk are now positively correlated with an R2 that would make 1.000 almost blush.

In an attempt to take the sting out of austerity, the Hungarian parliament late Monday approved the government's much-questioned bill that will reverse a 1997 pension system reform and in effect nationalize mandatory private pension-fund assets. Is this the start of a disturbing trend?

Moody's Investors Service has today downgraded Hungary's foreign- and local-currency government bond ratings by two notches to Baa3 from Baa1. The key drivers for the downgrades are: 1. Increased concerns about the country's medium- to long-term fiscal sustainability; and 2. Higher external vulnerabilities than most of Hungary's rated peers. "Today's downgrade is primarily driven by the Hungarian government's gradual but significant loss of financial strength, as the government's strategy largely relies on temporary measures rather than sustainable fiscal consolidation policies," says Dietmar Hornung, a Moody's Vice President -- Senior Credit Officer and lead analyst for Hungary. "As a consequence, the country's structural budget deficit is set to deteriorate." Next up: Austria

If the recent Hungarian "appropriation" of pension funds, and today's laughable Irish bailout courtesy of domestic pension funds sourcing 20% of the "new" money was not enough to convince the world just how bankrupt the entire European experiment has become, enter France. Financial News explains how France has "seized" €36 billion worth of pension assets: "Asset managers will have the chance to get billions of euros in mandates in the next few months for the €36bn Fonds de Réserve pour les Retraites (FRR), the French reserve pension fund, after the French parliament last week passed a law to use its assets to pay off the debts of France’s welfare system. The assets have been transferred into the state’s social debt sinking fund Cades. The FRR will continue to control the assets, but as a third-party manager on behalf of Cades." FN condemns the action as follows: "The move reflects a willingness by governments to use long-term assets to fill short-term deficits, including Ireland’s announcement last week that it would use the country’s €24bn National Pensions  Reserve Fund “to support the exchequer’s funding programme” and Hungary’s bid to claw $15bn of private pension funds back to the state system." In other words, with the ECB still unwilling to go into full fiat printing overdrive mode, insolvent governments, France most certainly included, are resorting to whatever piggybanks they can find. Hopefully this is not a harbinger of what Tim Geithner plans to do with the trillions in various 401(k) funds on this side of the Atlantic.

Another ridiculous market reaction following the ADP read today, when the AUDJPY initially dropped, only to see every deranged Japanese housewife, and anyone else with an FX account plough into it taking full advantage of 50x+ leverage to spook remaining weak short hands out. The catalyst: good news is good news, bad news is better news, as, just like Bank of America which just threw in the towel (more in a post momentarily), any incremental economic snapshot now means either more QE by the Fed or more QE by the Fed (and other CBs). We are back to the regime where dollar weakness is good for risk (especially beta>5.0 risk, meaning all the empty chatterboxes whose only strategy is to lever up on beta and pray will be out in full force on CNBC today). Incidentally, just as we expected, and right on cue, the Hungarian central bank said that the surging CHF poses "risks from the aspect of Hungarian economy's growth prospects, and that the weakening HUFCHF is causing higher than expected loan losses in bank sector." Define zero sum.

If you would like to subscribe to Shadow Capitalism Daily Market Commentary (of which this is an excerpt), please email me at naufalsanaullah@gmail.com to be added to the mailing list.

Goldman Sachs has put together a very informative chart, as part of its European chart of the day series, which shows the discrepancy between household accumulation in domestic and foreign denominated debt. While HUF-denominated debt is a mere 12% of GDP, FX-denominated is at almost 50% of GDP. Most of this debt is CHF-based, and with the CHF hitting fresh record highs, the pain for debtors is becoming unsustainable due to the relative FX strength. And while, as Goldman points out, new FX debt accumulation has plunged, the legacy positions will be there for a long time. For this debt to clear out, the Balance of Payments for Hungary and other non-euro countries will enforce a very prudent deleveraging regime, and will require that the economies grow, not contract. The last is something that is very much in question for Hungary, which as we pointed out recently, has decided to go it alone with IMF assistance, and thus without a safety net backstop should things not work out as expected. Either way, the bottom line is that as European countries loaded up on EUR-, and especially CHF-, denominated debt when the currencies were cheap, the current violent swings with a rising bias, will make the pain for the peripheral countries all that much more pronounced.

From S&P: "Discussions with the IMF reportedly concluded July 17, 2010, without a subsequent donor package having been agreed. We understand that the IMF will return to reactivate discussions with the authorities in September 2010. In our view, the likelihood of a new program with the EU and IMF being agreed could be contingent on some amendments by the government of some aspects of specific policy measures such as the temporary financial institutions tax. We believe that without an EU/IMF program to anchor policy, Hungary is likely to face higher and more volatile funding costs, which in our view could weigh on financial sector balance sheets, the public finances, and economic growth."

Yields on Hungary 12 Month Bills surged in the just completed Bill auction, jumping to 5.75%, or by 32 bps, since the last auction two weeks. This is just tight of what Greece would likely have to pay for a comparable maturity. Investors were focused on this deal as it was the first issuance by the troubled country since the breakdown in IMF relations over the weekend, leaving the country in the liquidity cold and without a €25 billion lifeline. Surely, European investors are far more transfixed by backward looking industrial production numbers that served to feed the massive surge in Chinese imports over the past month (not to be repeated for a while), and totally ignoring the continuously deteriorating liquidity situation in their continent (Eur LIBOR just hit a fresh year high). And speaking of China, it was announced by the European Trade Commissioner (proudly at that), that China's SAFE had been accumulating bonds of bankrupt Greece and semi-bankrupt Spain, purchasing several hundred million in ECB-backstopped paper of the two countries. Just like SAFE ran home to its communist parents, asking for rescue capital after its US investments blew up in May, so this too will serve as a preamble to comparable self-punishment.

In the most surprising news of the weekend (so far), the IMF and the EU effectively suspended Hungary's access to the remaining funds in a $25 billion rescue loan package created in 2008 to prevent a financial meltdown of the country. The timing of this development is most extraordinary, as only a month ago Hungary served as ground zero for yet another scare that pushed European sovereign bond spreads to new records. The reason given for this dramatic, and very destabilizing action is that the nation must "take tough action to meet targets for cutting its budget deficit." Ostensibly Greece continuing to lie about its own economic deterioration is a necessary and sufficient condition for escalating IMF lauding. Yet, with Europe set to announce results of its Stress Test kabuki next week, the last thing the continent needs is a real liquidity crisis (or the threat thereof) to counteract the smooth talking bureaucrats dead set into hypnotizing the union into "all is well" submission ("and when I snap my fingers, the debt-to-GDP ratio will be back to 10%"). To quote Portfolio.hu: "Brace yourself for Monday, folks!"

In what is without doubt the statement of the day, the Austrian finance minister has said there is "no danger to Europe from Hungary's debt problems." What he has failed to mention is that just in case he is wrong, his country is next on the chopping block, due to its massive exposure to Hungarian bad debt, and the hockeystick seen in Belgian bonds will seem like a smooth slope compared to what will happen in Vienna. But why discuss the truth: after all the IMF's Strauss-Khan was caught on the tape saying Europe's stress is "probably exaggerated." Probably... If anyone knows of a soap opera with more tragicomedy, manipulation and lying, please advise.