It can't happen... It can't happen...It can't happen... It just happened.
Given the US holiday, markets are likely to be thin today but there are some big news stories floating around at the moment. If the fast and furious events from the past few days in a revolutionary Egypt bear a striking resemblance to what happened in the spring of 2011, it is because they are strikingly comparable. Only this time, following the ouster of yet another US-supported "leader" by the US-supported military, the country's CDS has normalized at a level that is roughly double where it was two years ago as the implicit backing of the US looks increasingly shaky, following what was yet another bungled foreign policy venture by the Obama administration. But for now, the people are celebrating, just as they did in 2011. One wonders what happens between now and the next coup, somewhere two years (or less) hence. For now focus merely on who controls the Suez - after all that is really all that matters for the US. The other major story of yesterday, Portugal, continues to be in limbo,
The volatility of recent weeks is but a mere small taste of the volatility in store for all markets in the coming months and years. The global debt crisis is likely to continue for the rest of the decade as politicians and central bankers have merely delayed the day of reckoning. They have ensured that when the day of reckoning comes it will be even more painful and costly then it would have been previously.
There is plenty of discussion of outflows but we though the following chart was perhaps the most insightful at why this drop is different from the last few year's BTFD corrections. As we noted here, corporate bond managers have desperately avoided selling down their cash holdings (since they know dealer liquidity cannot support broad-based selling and its an over-crowded trade) and bid for hedges in CDS markets. But it seems, given the utter collapse in the advance-decline lines for high-yield and investment-grade bonds that the liquidations have begun. While the selling in high-yield bonds is on par with the Lehman liquidationlevels, it is the collapse in investment grade bond demand that is dramatic (and worse than Lehman). It's not like we couldn't see it coming at some point (here) and as we warned here, What Happens Next? Simply put, stocks cannot rally in a world of surging debt finance costs.
Where's the buy-the-dip mentality? Yesterday's collapse triggered yet another Hindenburg Omen - the 7th in the last month) and it appears it is the equity market's turn for some pain as Treasuries (which initially weak) have stabilized 2-3bps higher in yield. The Dow has lost 15,000 and is down over 200 points today; the S&P 500 is testing back to its 1,600 level; but homebuilders are being battered (as clearly good is now officially bad). The S&P 500 is now the furthest below its 50DMA in 2013 - this is key as it has been critical support all the way up. Gold and Silver have been crushed (and copper and oil are following) this week so far and the USD is up 1.75% so far. Credit markets are being destroyed - investment grade spreads are 10bps wider to 90bps from FOMC.
There is no way the pensions and benefits promised in an era of financialized abundance can be paid once the wheels of financialization fall off. During the past 30 years of financialized abundance, the benefits and pensions promised to public employees were increased substantially. Public unions are a powerful political force in many states, and in eras of rising tax revenues, it's an easy political decision to increase public employee benefits and pension payouts. The rising stock and bond markets generated huge profits for the public-employee pension funds, enabling them to grow without taxpayer contributions. Alas, the 8+% annual growth rate of the boom era is now structurally unrealistic. The New Normal is bond yields of 2% or 3% at best, and equities markets that are increasingly at risk of significant sell-offs. The endgame of promises made in an era of illusory, financialized abundance will be hurried along by a collapse in the equities and bond markets.
The Fed’s zero lower bound policies have dislodged credit risk as the primary concern for investors, only to replace it with a major technical headache: interest rate risk. If rates remain too low for too long, financial stability suffers as investors reach for yield, companies lever up, and lending standards decline. The greatest of financial stability risks is probably the least discussed among those that matter at the Fed: the deterioration in trading volumes. As such, we suspect that the longer low rates persist, the worse the unwind of QE may be. And it may, in fact, already be too late. As events in the past two weeks have shown, credit markets also appear vulnerable to a rise in rates that occurs too quickly or in a chaotic fashion. Moreover, to the extent that issuers sense demand may be waning for bonds, there’s a distinct possibility the pace of supply increases precisely at the same time that demand decreases. Invariably, it’s this sort of dynamic that ends in tears.
Ongoing monetary stimulus is leading to heightened volatility, and the bull market which has been in place since 2009 is becoming overextended. The recent string of surprise downside moves in markets may be the canary in the coal mine for global investors. This is where we are today. The tide is rising for U.S. and Japanese markets and asset prices will ultimately move higher. The size and violence of each wave that advances or recedes will continue to increase due to the surge of liquidity from central banks. These tides of liquidity are strong, as are the currents underneath. We must guard ourselves from the risk of being pulled under.
Something is afoot in the land of credit markets. As we have been warning for a few weeks, credit appears to have 'turned' in the cycle suggesting equity should not be too far behind; but today's price action is rather stunning. Not only is investment grade credit spreads trading at their widest since the first day of the year, the high-to-low range of the day is huge. Aside from the extreme jump on the opening day of 2013, this is the biggest range in IG credit since Nov 2011. The last time we were at these levels was early 2011 and the rise in range then signaled the start of an extreme correction (from 80bps to over 150bps). Today's over 6bps range (from 76.9bps to 83.3bps) is extreme by any measure. Perhaps it is delta-hedging - since the low spread vol has driven many to the CDS options market for juice but whatever way one looks at it - something significant is changing (for the worse) in credit.
With JPY losing 100 and the Nikkei futures trading down to a 19.25% loss from the highs (12815 the dreaded bear-market 20% drop level), a combination of a desperate Japanese 2015 plan for the pension fund to buy moar stocks, bad-is-good economic data, and front-running of the now-ubiquitous Tuesday rally provided the ammo for a rally in equities - recovering almost 50% of their post Friday drop losses. Risk-assets in general correlated extremely closely on the day and while volume was well above average, this was driven by the surge to the downside (not the upswing). Treasuries ended the day unchanged (amid a 12bps range on the day) ending near the low yields (moar QE). VIX snapped above 17.5% (its highest in 6 weeks) before fading back in the ramp to unchanged at 16.25%. Credit tracked stocks closely but was less exuberant in the late-day ramp. USD weakness (JPY and EUR strength) supported commodities, with gold and silver outperforming on the day (up 1.65% and 2.2% respectively).
At the moment, it seems like the US is that naïve kid sitting in front of the Chinese magician watching China pull economic growth out from behind their ears and rabbits to chase after (that disappear down holes usually). But while their attention is focused on the Chinese magician, they are missing the assistant! She’s doing far more than they could ever imagine. And, nobody is taking the blindest bit of notice. The Philippines! You’d better watch out! She’s behind you!
Preview of tomorrow's Bernanke testimony and FOMC minutes.
Those hoping for a slew of negative news to push stocks much higher today will be disappointed in this largely catalyst-free day. So far today we have gotten only the ECB's weekly 3y LTRO announcement whereby seven banks will repay a total of €1.1 billion from both LTRO issues, as repayments slow to a trickle because the last thing the ECB, which was rumored to be inquiring banks if they can handle negative deposit rates earlier in the session, needs is even more balance sheet contraction. The biggest economic European economic data point was the EU construction output which contracted for a fifth consecutive month, dropping -1.7% compared to -0.3% previously, and tumbled 7.9% from a year before. Elsewhere, Spain announced trade data for March, which printed at yet another surplus of €0.63 billion, prompted not so much by soaring exports which rose a tiny 2% from a year ago to €20.3 billion but due to a collapse in imports of 15% to €19.7 billion - a further sign that the Spanish economy is truly contracting even if the ultimate accounting entry will be GDP positive. More importantly for Spain, the country reported a March bad loan ratio - which has been persistently underreproted - at 10.5% up from 10.4% in February. We will have more to say on why this is the latest and greatest ticking timebomb for the Eurozone shortly.
Another day, another US city on the brink of insolvency. This time it's Detroit, whose recently appointed emergency financial manager Kevyn Orr said may run out of cash next month and must cut costs such as long-term debt and retiree obligations. According to Bloomberg, "Orr’s report says the cost of $9.4 billion in bond, pension and other long-term liabilities is sapping the ability to provide such basic services as public safety and transportation. He listed cutting debt principal, retiree benefits and jobs among options he may take. “No one should underestimate the severity of the financial crisis,” He called his report "a sobering wake-up call about the dire financial straits the city of Detroit faces."
More thoughts on the ECB's balance sheet and why a negative deposit rate is unlikely.