Although the supply and demand factors do not seem to support the current price levels, there are plenty of other events to sustain and add premium.
By now it should be painfully clear to involved that the Greek economy is nothing but a zombie, whose funding shortfalls and other deficit needs are sustained each month only courtesy of constantly new and improved "financial engineering" ponzi creations out of the ECB, the ELA, and other interlinked funding mechanisms which are merely a transfer of German cash into empty peripheral coffers. And while the attention of the world has moved on, at least for the time being, from the small country which has been left for dead with the assumption that Europe will do the bare minimum to keep it alive, but not more, Greece once again reminds us that not only does it still pretend to be alive, but that the zombie is getting hungry, and want to eat.
For months everyone was confused, like lost lambs in a sea of noise and 500x leverage, not knowing how to navigate the stormy, choppy FX seas. Now we know. For that beacon of anti-precision, the man, the myth, the legend who bats 0.000 and thus is the most certain contrarian bet in history, Goldman's Tom Stolper has spoken: "We would now recommend going long EUR/$ at current levels with a one-day stop on a close below 1.18 for an initial target of 1.30." Start your selling.
Summary of what has been said so far: Nothing, just as we said last week. Draghi basically repeated the June 29 summit bottom line that the EFSF should buy PIIGS bonds, the ECB "May" act, which means Germany is still not on board, and that after talking markets up by 5%, he has delivered nothing but a delay. This is a huge blow to his and the ECB's credibility.
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With speculation ripe out of everyone from Reuters to the FT about what Draghi may or may not say, with or without Germany's blessing, the best at this point is just to hand over the microphone to the former Goldmanite. Here is the live webcast of Draghi's press conference. Pay attention as a word out of place will send the EURUSD plunging by 200 pips. Or soaring.
Want to buy stocks on anything than a greater fool theory, or hope and prayer that someone with "other people's money" will bail you out of a losing position when the market goes bidless? That may change after reading the latest monthly letter from Pimco's Bill Gross whose crusade against risk hits a crescendo. Yes, he is talking his book (and talking down his equity asset allocation), but his reasons are all too valid: "The cult of equity is dying. Like a once bright green aspen turning to subtle shades of yellow then red in the Colorado fall, investors’ impressions of “stocks for the long run” or any run have mellowed as well. I “tweeted” last month that the souring attitude might be a generational thing: “Boomers can’t take risk. Gen X and Y believe in Facebook but not its stock. Gen Z has no money.”.... So what is a cult chasing figure supposed to do? Well, the cult of equities may be over. But the cult of reflating inflation is just beginning: "The primary magic potion that policymakers have always applied in such a predicament is to inflate their way out of the corner. The easiest way to produce 7–8% yields for bonds over the next 30 years is to inflate them as quickly as possible to 7–8%! Woe to the holder of long-term bonds in the process!... Unfair though it may be, an investor should continue to expect an attempted inflationary solution in almost all developed economies over the next few years and even decades. Financial repression, QEs of all sorts and sizes, and even negative nominal interest rates now experienced in Switzerland and five other Euroland countries may dominate the timescape. The cult of equity may be dying, but the cult of inflation may only have just begun."
It's all about the central banks this week.
We discussed the use of Game Theory as a useful tool for analyzing Europe's predicament in February and noted that it was far from optimal for any (peripheral or core) sovereign to pre-emptively 'agree' to austerity or Eurobonds respectively (even though that would make both better off). This Prisoner's Dilemma left the ugly Nash-Equilibrium game swinging from a catastrophic break-up to a long, painful (and volatile) continuation of the crisis. Recent work by BofAML's FX team takes this a step further and in assigning incentives and from a 'do-not-cooperate' Nash-equilibrium between Greece and Germany (no Greek austerity and no Eurobonds) they extend the single-period game across the entire group of European nations - with an ugly outcome. Analyzing the costs and benefits of a voluntary exit from the euro-area for the core and periphery countries, the admittedly over-simplified results are worrying. Italy and Ireland (not Greece) are expected to exit first (with Italy having a decent chance of an orderly exit) and while Germany is the most likely to achieve an orderly exit, it has the lowest incentive to exit the euro-zone - since growth, borrowing costs, and a weakening balance sheet would cause more pain. Ultimately, they play the game out and find while Germany could 'bribe' Italy to stay, they will not accept and Italy will optimally exit first - suggesting a very dark future ahead for the Eurozone and with EUR tail-risk so cheap, it seems an optimal trade - as only a weaker EUR can save the Euro.
Spain is not Uganda: this morning Spain is increasingly looking like the 10th circle of bondholder vigilante hell with its 10 Year trading at 7.59% after hitting a record 7.607% moment prior. The short end has blown out even wider and the 2 Year very appropriately at 6.66% and rising. Italy has also joined the party blowing out to just why of 6.5% and Italy's banks about to be halted across the board despite the short-selling ban. Next up: selling anything forbidden. Finally, the scramble for safety into Swiss 2 year notes accelerates as these touch a mindboggling -0.44%. There was no specific catalyst to lead to today's ongoing meltdown, but the fact that Spain just paid a record price for 3 and 6 month Bills is not helping: the average yield was 2.434 percent for the three-month bills compared with 2.362 percent in June and 3.691 percent for six-month paper compared with 3.237 percent. With each passing day, the selling crew is demanding the ECB get involved and stop the carnage. For now Draghi is nowhere to be seen as Germany continues to have the upper hand. After all recall just who it is that benefits from keeping the periphery on the razor's edge and the EURUSD sliding.
With Valencia bust, Spanish bonds at all-time record spreads to bunds, and yields at euro-era record highs, Spain's access to public markets for more debt is as good as closed. What is most concerning however, as FAZ reports, is that "the money will last [only] until September", and "Spain has no 'Plan B". Yesterday's market meltdown - especially at the front-end of the Spanish curve - is now being dubbed 'Black Friday' and the desperation is clear among the Spanish elite. Jose Manuel Garcia-Margallo (JMGM) attacked the ECB for their inaction in the SMP (bond-buying program) as they do "nothing to stop the fire of the [Spanish] government debt" and when asked how he saw the future of the European Union, he replied that it could "not go on much longer." The riots protest rallies continue to gather pace as Black Friday saw the gravely concerned union-leaders (facing worrying austerity) calling for a second general strike (yeah - that will help) as they warn of a 'hot autumn'. It appears Spain has skipped 'worse' and gone from bad to worst as they work "to ensure that financial liabilities do not poison the national debt" - a little late we hesitate to point out.
A generation of market participants has grown up knowing only the era of central bankers and the 'Great Moderation' of (most of) the last two decades elevated their status significantly. While central bankers are generally very well aware of the limits of their own power, financial markets seem inclined to overstress the direct scope of monetary policy in the real world.
If markets fall, investors need only to run to central bankers, and Ben Bernanke and his ilk will put on a sticking plaster and offer a liquidity lollipop to the investment community for being such brave little soldiers in the face of adversity
Monetary policy impacts the real economy because it is transmitted to the real economy through the money transmission mechanism. This has become particularly important in the current environment, where, as UBS' Paul Donovan notes, some aspects of that transmission mechanism have become damaged in some economies. Simplifying the monetary transmission mechanism into four very broad categories: the cost of capital; the willingness to lend; the willingness to save; and the foreign exchange rate; UBS finds strains in each that negate some or all of a central bank's stimulus efforts. In the current climate, it may well be that the state of the monetary transmission mechanism is even more important than monetary policy decisions themselves. Some monetary policy makers may be at the limits of their influence.
With everyone scrambling to buy into the bathsalts rally, and shorts rushing to cover with a panic bordering on a QE-announcement, it is somewhat ironic that today's voice of muted reason comes from none other than Liebor expert extraordinaire: Barclays, whose suggestion is simple: lock your profits: "We remain bearish on EURUSD, expecting it to grind slowly down to 1.15 over the next 12 months. We therefore suggest investors look to fade this morning's European currency strength versus the USD and non European commodity currencies such as the AUD and CAD." Why? They have their listed reasons. The unlisted ones are the same that every other bank has for becoming bearish recently (we have recently listed Citi, Goldman, SocGen and DB to name but a few): for a real fiscal and monetary policy intervention to take place (i.e., a rescue package that lasts at least a few months, as opposed to today's several day max rally): the market has to be tumbling. That, as we have explained repeatedly, is the only way to get a powerful response. Everything else is (quarter end) window dressing.
The last few days have seen high-yield credit markets remain remarkably resilient in the face of an equity downdraft. Both HYG (the high-yield bond ETF) and HY18 (the credit derivative spread index) have remained notably stable even as stocks have lost over 3% - and in fact intrinsics and the underlying bonds have improved in value modestly. HY bonds are much less sensitive to interest rate movements (especially at these spread levels) and so, in general, this divergence in performance is aberrant (especially with equity volatility also pushing higher in sync with stocks and not with credit). So why is high-yield credit not so weak? The answer is surprisingly simple. As we argue for weeks from the end of LTRO2, credit markets were far less sanguine than stocks and have leaked lower ever since. This 'relative' outperformance of high-yield credit over stocks appears to be nothing less than the last of the hope-premium bleeding out of stocks and re-aligning with credit's more sombre 'reality' view of the world. Given the sensitivity of HYG (and HY) to flows, and the weakness in risk assets, we would suspect that outflows will now dag both lower as they resync at these higher aggregate risk premium levels.
In a no-holds-barred interview with Bloomberg TV's Francine Lacqua, the increasingly droopy-faced George Soros remains as sprite-minded as ever in his clarifying thoughts on Europe. His diagnosis is spot on: "Basically there is an interrelated problem of the banking system and the excessive risk premium on sovereign debt - they are Siamese twins, tied together and you have to tackle both" and summarizes the forthcoming Summit 'fiasco' as fatal if the fiscal disagreements are not resolved (and as of this afternoon, we know Germany's constant position on this). His solution is unlikely to prove tenable in the short-term as he notes "Merkel has emerged as a strong leader", but "unfortunately, she has been leading Europe in the wrong direction". His extensive interview covers what Europe needs, the Bund bubble, GRexit, post-summit contagion, and Mario Monti's impotence.
Hours before Spain is expected to present the bank "assessment" from Roland Berger and Oliver Wyman on its comprehensive bank insolvency status, the country sold €2.22 billion of two-, three- and five-year government bonds, in a sale which saw solid demand but yields that are simply laughable and are completely unsustainable, culminating with a record yield on 5 year paper. Per Reuters, the Treasury sold 700 million euros worth of a 2-year bond, 918 million euros worth of a 3-year bond and 602 million euros of a 5-year bond, beating a target to issue up to 2 billion euros of the debt... In a nutshell: big demand for paper that will leave Spain pennyless. Not very surprising, and as Elisabeth Afseth from Investec summarized, "They got it away, it's about the most positive thing you can say about it." Elsewhere the German economy continues to deteriorate from carrying the weight of the PIIGS on its shoulders, with the Mfg PMI and Services PMI both missing estimates of 45.2 and 51.5, and printing at 44.7 and 50.3, respectively. This was a 3 year low for German PMI and now all but confirms that the economy will enter a recession at the next GDP update. But all this pales in comparison with the latest update of the Greek comedy where we learn that the three parties forming Greece's new coalition government have agreed to ask lenders for two more years to meet fiscal targets under an international bailout that is keeping the country from bankruptcy, a party official said on Thursday. This came a few hours after a German parliamentary group officially spoke against a time trade-off for Greece. Which means that beggas will not be choosers after all.
The past week was dominated by the Eurogroup statement over the weekend that Spain will seek financial support for its banks. According to the statement, Spain intends to make a formal request soon, with financial assistance expected to be around EUR100 bn and to come from the EFSF or ESM. Aid will be channeled through the FROB, and will increase the debt burden of the Spanish sovereign. There will be no macro or fiscal conditionality as in the bailouts of Greece, Ireland and Portugal, but only on bank sector restructuring. That said, there will be monitoring of the deficit and structural reforms as part of this bailout, though no conditionality, and the IMF is also invited to monitor progress under the program. Separately, the week also saw lots of commentary out of the Fed, including from Chairman Bernanke and Vice Chair Yellen. Looking to the week ahead, the key question for us is where to harvest excessive risk premia, bearing in mind that the Greek elections are around the corner.. In terms of policy talk and data, for the former Fed chatter ends on Tuesday when the blackout period begins ahead of the FOMC on June 19/20. For the latter, US retail sales and industrial production will be important to watch as we head into the FOMC next week.