Sovereign CDS

US-Europe Decoupling At All Time Record As SovX - Implied Correlation Spread Indicates Historic Domestic Complacency

In last night daily report by BofA's Jeffrey Rosenberg, one chart stands out: the spread between the 12 month S&P 500 top 50 Implied Correlation (generically a proxy of broad US equity risk) and the Sov X, or the blended sovereign risk as indicated by CDS, which recently hit an all time high. In a nutshell: the spread has never been bigger, confirming that US domestic complacency over all things European (and the continuing levitation in stocks) has reached unprecedented levels, as absolutely no fundamentals can stand in the path of the hedge fund levered beta year end rally. In other words the China-US fatally flawed "decoupling" of 2007 has been replaced with a decoupling between the US and Europe. This will also end in tears. And this is happening even as European markets are unraveling, and as the EURUSD is tumbling, guaranteeing a drop in both US exports and the top line for US MNCs. But why worry: as 58 year old Valerie Whelan yesterday summarized it best: "It's capitalism gone mad." Every move in risk assets higher is merely a bet that central bankers can kick the can down the road for one more day. Nothing else. That it is unsustainable is guaranteed. Willem Buiter makes the case all too clearly that Europe will go bankrupt soon. We expect someone to make the same argument about the US very soon, especially if China does in fact commence tightening, leaving the chairman no other choice than to open the liquidity floodgates in one last attempt to preserve the dying economic system, however, this time without the benefit of being able to export inflation to China.

Reggie Middleton's picture

Any readers who read the back and forth between Tyler and TRS should ask themselves, "But why didn't the Fund answer these important questions?". Hey, they may not be in a death spiral, but when you make what looks like desperate moves and your returns are spiraling at the same time your liabilities are soaring, all the while your risk is flying through the roof... One should expect a blogger or two to take notice, particularly those bloggers who can count.

Irish Nationwide Now Engaged In "Micro-Quantitative Easing" As It Issues Bonds To Itself To Repay Interest

A new report in the Irish Times discusses how Irish Nationwide, where incidentally sovereign CDS spreads just hit a fresh all time wide record north of 400 bps, discusses how the insolvent bank, in a supreme example of just how prevalent ponziness has become in the current Central Bank subsidized environment, is now issuing bonds... to itself. In a circular issuance scheme that would make the Greek finance minister blush with envy, "Irish Nationwide has issued €4 billion of Government-guaranteed bonds effectively to itself. It can use the bonds to draw €4 billion in funding from the European Central to help tide it over a key refinancing period later this month." At its core, the scheme is nothing new, having been used repeatedly by Europe's most bankrupt countries, although the small scale in this case, and the blatant inability to even cover up the circularity has many worried that if the ECB needs to step in for such "modest" amounts to preserve bank solvency, it is all pretty much just a matter of time before it is game over for Ireland's banks. And elsewhere, confirming that defaults are imminent, the CFO of Anglo-Irish has just said it would be a disaster to default on its bonds. He is, of course, absolutely correct.

Daily Credit Summary: August 23 - Low Volume, Low Range, Low Growth

Spreads closed marginally wider, at the worst levels of the day, after an anemic volume day that only picked up in activity when we weakened. Overnight angst from Australia combined with some weakness in EU data was marginally trumped early on by M&A chatter and headline spin on US ECO data but further evidence of a deflationary view of the world (NSC 100Y issue) seemed to provide some downward pressure and despite valiant attempts to steepen the curve or drive AUDJPY up, stocks ended at their lows of the day as did spreads at their wides.

We have had a number of clients asking about our views on the forthcoming GM IPO. Suffice it to say, and in the interests of brevity, we are not overly impressed and worry about this on many fronts as anything but a flipper's fantasy (drop us a line for somewhat more coherent thoughts). Most notably we have noticed something rather fascinating in the Auto sector. The relationship between GM's 2016 bonds and the Ford Equity price has been amazingly (and we mean incredibly) consistent for many months now - a simple arb at around 2.5x Ford's stock price explains huge amounts of variance in the GM bond price and we suggest tracking this going into the IPO for any signs of a preference. One we would expect is selling of Ford to buy into the GM IPO in hopes of flipping soon after and still leaving the manager equally exposed to the Auto sector - this would also be interesting as the GM bonds have residual ownership in the new GM and may be a decent hedge here should the deal be 'better' than many expected. Just thinking out loud on this but we will keep an eye on it.

Upcoming Weekly Calendar

A look at the key economic events in the relatively quiet week ahead from the perspective (and benchmarks) of Goldman Sachs.

Goldman's EURUSD Forecast Is Now Most Erratic Ever

One of the classic comedy themes of the year has been Goldman's series of failed recommendations on the EURUSD, where the hedge fund has had about a 1 out of 10 "success" rating (for its clients). Today, the Markets Strategist Mark Tan recaps the firm's 3, 6 and 12 month forecast on the EURUSD, which are, conveniently, 1.22, 1.35 and 1.38. That's like saying the S&P will be in a range of 950 to 1500. At least the firm is sure to "hit" its projected range.... And be sure to watch that major inflection point some time in December which send the dollar sharply lower: is Goldman implicitly saying the "real deal" QE will now come around New Year's, just after the elections and just before the government has to raise the debt ceiling regardless? One thing we agree with, as we have long claimed: look for strikes and other expressions of non-appreciation to spike once everyone is back from vacation. As Goldman says: "One of the main reasons we incorporated downside risks to our EUR/$ forecast (1.22 in 3-months) is to reflect the potential for rising political tension again. This could potentially occur as Europe returns from its summer lull and is confronted with the reality of unpopular austerity measures." What are the InTrade odds on CNBC broadcasting the next storming of the Greek parliament?

Arbing Moody's Sovereign Ratings Via CDS Pair Trades

Now that sovereign CDS (and ratings) are back in vogue with everyone finally expecting the world to relapse into a double dip, Zero Hedge has compiled Moody's sovereign ratings and spread these alongside the CDS levels in any given bucket to propose several trade ideas taking advantage of Moody's market lagging inefficiency.

Berlin Pushing For European Bankruptcy Framework With Provision For State Sovereignty Give Up

The big news out of Europe this morning, and the reason for the drag on the euro is an article in Der Spiegel, "Merkel's rules for bankruptcy" according to which Germany is now actively (and very secretly) pushing for a plan outlining a set of insolvency rules, which would require that private investors bear a portion of the rescue burden, and much more importantly, would see at least a partial give up in state sovereignty, where a new insolvency trustee (the "Berlin Club", which we fail to see at least for now, how it differs from the Paris Club) would take implicit control over and override a default nation's treasury, in essence pushing the bankrupt country into a form of Feudal vassal state-cum-reparations subservience. Welcome to financial warfare in the post-globalization period.

Housekeeping - We Are Back

Update: ok, the 10,000 people that just hit the server didn't help.

We apologize for the extended downtime. European server hosts responsible for the crash will be promptly punished when their sovereign CDS shortly catch up with BP's defaults risk (+108 now to 368bps, 27% implied default probability for 5 Y). We are comforted by the fact that Ben Bernanke sees no future crash for Zero Hedge servers, ever again.

UK And US Among Top 5 Weekly Sovereign Deriskers

The week's biggest (sovereign) CDS movers have been released, and we have some new entrants in the most endangered species list. While by now nobody will be surprised that the UK is a consistent top 2 player (coming in this week with $319 million in net notional derisking, this making it the 8th week or so the country has made the top 3), only behind Italy and its $452 million in net notional, and just in front of last week's #1 Brazil, the presence of the United States at #4 should be a little unsettling. It has been months since the US appeared in the top 5. And just like in the long gold case, the same types of existential questions once again arise when the interest in US CDS picks up: who gets to pay off your contracts in the case of an event of default? Elsewhere, the presence of Korea and Turkey (or Australia) in the top 10 should not come as too surprising. On the other end, short covering was violent in CDS of Spain, Hungary and Portugal - Europe's newest lepers. Is the CDS community concerned the EU can actually pull out a rabbit out of the hat that actually works for once? Hardly. The top 10 reriskers also saw the inclusion of France and long-forgotten insolvent Greece.

UK Continues To Be A Top Sovereign CDS Derisker

After taking a brief break last week, the UK is once again firmly in the top sovereign deriskers: a place it has held with pride for almost two months now. Summing up cumulative net notional exposure on the UK based on just the last several weeks results in a net short exposure of well over $3 billion. Someone has now amassed a huge short on the British Isles. Curiously, the country that was actually the top derisker in the past week, with $420 million in net notional change, was Brazil, the same Brazil which today decided to not lift any offers in its 2021 Fixed Coupon Bond auction. Is this the next hotbed of instability? Look for at least one more week of aggressive derisking before confirming this trend. Turkey completes the trio of top deriskers, with $172 billion in CDS. Surely with the prior week ending on May 28, there is no way anyone could have hedged for an Israeli incursion of Turkish ships ahead of time. On the other end, some of the names that have been making the news recently, have seen some material rerisking, probably based on short positional unwinds: the top five were the US, Japan, Austria, France and China. After tonight's news out of Tokyo, look for Japan to take its rightful place at the top of this table.

Global Macro Update

Certainly the market was eager after a long weekend! I am not too sure what prompted EURUSD and the Dax to take off vertically at 9.30AM for US equities' open: was it the excitement about the German president's resignation, a 50bps widening in Italy's sovereign CDS in early trading, follow through rejoicing at Spain's latest downgrade Friday afternoon, or the excellent news out of the Middle East on Monday? There was a piece in Barron's this weekend entitled "time to buy" (I am eagerly waiting for the day they will print something entitled "time to sell") so maybe institutionals were waiting for US equities to open to start gunning. It doesn't make much sense in my opinion. The move came out of Europe most certainly given what we observed, but nobody confirmed our suspicion that it was central bank related. - Nic Lenoir