A massive arbitrage has developed in European sovereign CDS, where the differential between local and foreign-denominated (euro and dollar most typically) CDS has jumped to record spreads. Case in point Germany, where €-denom CDS trade at 30 bps, while the $ equivalent is 43 bps, a 30% spread differential. The reason for this is obvious: as concerns of pan-european defaults have hit the euro, getting paid off on euro-denominated default protection seems increasingly less attractive. Should, say, Germany default, €10MM worth of protection on a German credit event would be worth much less at default which would certainly be accompanied by an almost full devaluation of the euro, resulting in a huge hit to the "at converted" currency, presumably dollars (as the euro would no longer exist). This has led to a major drop in demand for EUR-denom German (and other European) protection, with the differential hitting the abovementioned 30% margin. As Fitch discloses, this spread was just 7% in January. As this is a second derivative play on both currency devaluation/vol and increasing default risk, arguably the most profitable way to bet on a the confluence of factors that impact the eurozone could be a simple quanto swap trade, which could reap massive rewards should peripheral or core European weakness persist.
Playing The Contagion II: Goldman Recommends Betting On Contagion Risk In Portuguese, Spanish And Italian BanksSubmitted by Tyler Durden on 04/23/2010 11:43 -0500
Earlier we pointed out the surge in CDS on a variety of PIIGS banks, mostly in Portugal and Spain. Now we know why: Goldman's Charles Himmelberg has just reiterrated his call for Long CDS on local banks in Portugal, Spain and Italy, hedged by selling Main (iTraxx) protection. It is our view that as accounts plough into this trade and as bank spreads blow out, it will only accelerate the funding complexities, the bank runs and the inevitable collapse of the financial systems in all of the other imparied peripheral countries, ultimately leading to the collapse of the EMU. Will Goldman be accused next of destroying Europe? Stay tuned.
These are the news items from the Easter weekend that those who're asleep at the wheel probably missed. Yes, of course they're important and deserving of your attention, that's why they were buried into the Easter weekend!
No need to fret, I condensed them and supplied supplementary analysis to show my love:-)
This is the skinny on the EU's Greek rescue package. The (empirical) truth, the whole truth, and nothing but the whole (empirical) truth! Moral hazard, be damned...
More Than Meets The Bottom Line: Are Banks Getting Crushed Due To Negative Swap Spreads And The $154 Trillion IR-Derivative Market?Submitted by Tyler Durden on 03/26/2010 14:46 -0500
Lots of confused chatter in the bond community as to why the negative swap spread story (anywhere between 7Y and 30Y) is being largely ignored by the media. After all, the associated market, which according to the BIS was roughly $154 TRillion in June 30 makes the Greek bond debacle and various sovereign CDS discussions in the media pale in comparison. As several bond traders pointed out, the likelihood of negative spreads having been modelled out by the TBTFs is very low, if any, meaning that unhedged bank IR-swap exposure is suffering massively, and is likely to surpass all record past prop desk losses. In fact, rumors abound that a few of the desks having placed leveraged bets on spread divergence over the past months and years are currently in critical condition, yet nobody is discussing this for fear of another round of bank run concerns among the TBTF banks. What is odd, is that the Primary Credit borrowings are now at almost financial crisis lows of just under $9 billion, leading many to speculate that banks now satisfy all of their short-term funding needs via the fungibility of excess reserves (and indicating once again that the Fed's discount rate hike was the most irrelevant action in a history of irrelevant actions). And just in case there is still confusion as to what negative swap spreads mean, here is a useful primer.
Some weeks ago we presented evidence that the sovereign CDS market pales in comparison with cash notionals outstanding, and furthermore, we demonstrated that sovereign spreads have been led by cash selling, which has been followed only subsequently by CDS moves, not the other way around. The fact, however, did not stop the bashers. Today, ISDA, the International Swaps and Derivatives Association, has issued the following statement, which along the lines of our observations, refutes claims that CDS speculators are to blame for widening (but not, shockingly, tightening) in sovereign spread moves.
European Commission To Back CDS Trading Ban As Second Round Of Strikes Cripples Greece; Greek GDP Now Expected To Miss Worst Case ScenarioSubmitted by Tyler Durden on 03/10/2010 22:35 -0500
The Washington Post reports that the next "Lehman-sized" event may be just around the corner, as the European Commission is now supporting a ban on trading sovereign CDS. While we are in process of tracking down whether this is actual news or just some exaggeration based on semantics, we will caution, once again, that the consequences of a CDS trading ban will be severe and very likely result in the opposite of what the EC intends on achieving. Keep in mind that everyone expected the Lehman bankruptcy to be contained as it was at best a fringe cog in the financial system. The result was a systemic collapse as one interlinked component of the financial fabric imploded after another. The rush to unwind CDS positions ahead of a ban will be massive and have unpredictable consequences. But the biggest threat is what happens to bond prices, which once basis trades are made impossible, will be promptly unwound, leading to pervasive selling of the cash leg not by speculators but by plain vanilla mutual fund idiot money. What scapegoaters seem to forget is that the vast majority of existing sovereign CDS notional is tied into perfectly boring insurance "basis" trades, in which the bond is held in combination with associated CDS. Once there is an inability to have hedged cash sovereign exposure, the demand for European sovereign paper will plummet, achieving precisely the opposite of what the CDS ban is attempting to accomplish.
Sorry, Merkel, Papanderou et al. BaFin finds that there is no sign that CDS speculation is involved when it comes to Greek government bonds, even as the volume in cash bonds has spiked. As a reminder - selling bonds has the same effect as buying CDS. And guess what: the real Greek cash-CDS basis is negative 112 bps (for "experts" this is swap-clean basis, i.e., Greek CDS minus German CDS compared to GGB minus Bunds). This means that cash bonds are far and ahead a leading indicator, and much more dominant when it comes to determining actual price/yield levels. So does this mean that GGB sellers will now be demonized with the same ferocity as those meddling CDS traders? Hopefully, this will finally be the end of the CDS as satan's spawn topic.
While we are not sure how Betty Liu feels about Rogers' invitation to come eat some Wienerschnitzel, what is certain is that Greek PM Papandreou is not too happy with the commodities pundit right about now. When asked should Europe bail out Greece, Jim says: "No, of course not, they should let Greece go bankrupt. It would be good for the euro, it would be good for Greece, it would be good for everybody." Alas, more true words have rarely been spoken. And with every financial professional already on the same side of the boat as Rogers, politicians are now left on their own to do what they know best: i.e., the wrong thing...and over and over again, and if someone can be blamed (evil, evil CDS speculators come to mind), so much the better. Also, should anyone wish to take a brave foray into the political arena (which appears is now the best paying job in the world, incidentally, just after Goldman CDS traders, hehe) on the crest of the anti CDS bashing, now is the time. It appears quite a few have risen to the challenge.
“We must succeed at putting a stop to the speculators’ game with sovereign states. We can’t allow speculators to be the profiteers of Greece’s difficult situation. Derivatives must be curbed.” - Angela Merkel
As the Fed is ever-so-gradually shifting toward a tightening posture, many have wondered what will Bernanke's actions mean for the bond curve. With various liquidity facilities set to expire this month, and the recent discount rate hike already having been priced in, there has so far not been a muted response by the bond market, although over the past few days we have seen an odd tendency, albeit minor, for curve tightening. We say odd, because as Morgan Stanley points out, the Fed's actions, coupled with an unwillingness to actually hike rates, should be one benefiting ongoing steepening. Then again, the problem with that logic is that at this point going steep is like buying Greek CDS today: it pretty much means sloppy hundreds, with very few greater fools left over (and without the opportunity to arb a naked-short position via another nearly busted GGB auction). The silver lining is that at least the government will not go after you with an arrest warrant: after all the government wants nothing else more than a vertical yield curve. A brief analysis by MS details the argument for why steepening makes all the sense in the current environment where the long-end is looking increasingly shaky courtesy of marginal liquidity contraction, all the while risk-flaring episodes such as those in Dubai and Greece will likely keep the short-end well bid for months, if not years, to come.
PIIGS Come To Market: Greece With €5 Billion In Ten Year Notes, Spain With €4.5 Billion Five Year BondSubmitted by Tyler Durden on 03/04/2010 07:07 -0500
Greece has finally come to market with a 10 year bond, catching the very end of the offering window, through a €5 billion bond issue, which according to Petros Christodoulou-spread rumors, is nearly 3 times oversubscribed. Underwriters Barclays, HSBC, NBG, Nomura and Piraeus Bank are alleged to have collected nearly €14.5 billion in bids. We wonder how much of that is merely basis trades being fillled on the cash side. "We are very happy with the bid because the re-entry into the market is always challenging. It went very well," Petros told Dow Jones Newswires. Greece has cut price guidance on the bond from 310 bps over mid-swaps to 300 bps, with books closing at 11am GMT. Pricing is expected later today. Assuming this bond offering closes successfully, Greece will have enough money to last it for at least 30 days, joining such other illustrious countries as the United States, in living bond auction to bond auction.
An early glimpse at the detailed "Volcker Rule", which is expected to be released this afternoon, indicates that not just bank holding companies are going to be targeted by the prop trading ban. The WSJ reports that "the White House's push to limit, or in some cases ban, certain risky trading activities at financial companies also would affect companies that don't own bank subsidiaries, according to a summary of proposed legislative language prepared by the administration." This probably means that life for those pesky hedge fund scapegoatees is about to get even more unpleasant. And as for trading sovereign CDS, we suggest you novate all positions promptly.
- China's hidden debt to reach 96% of GDP, compared to the IMF's estimate of 22% (Bloomberg)
- Here come the idiots - Banks summoned to EU to discuss sovereign CDS market (Bloomberg)
- Upwardly biased ADP continues longstanding tradition of prior downward revisions (Bloomberg)
- US said to tell hedge funds to save euro records (Bloomberg, first reported on Zero Hedge)
- SEC supervisor surfed tranny porn to cope with stress [and self-loathing from working for an incompetent bureaucracy] (Dealbreaker, h/t plastic man)
- Europe's original sin (WSJ)
- Rumors of Ukraine's default to become certainty: Tymoshenko loses Ukraine vote, moves into opposition (Bloomberg)
- Greece in no rush to sell bonds, debt chief says (Bloomberg)
- Greece puts bond sale on hold as it hopes bail out will let it borrow at sub-7% (Guardian)
- Banks raise pay as U.K. efforts to cut bonuses fail (Bloomberg)
- John Crudele: Hey Washington! Economy has us very worried (Post)
- Hedge funds move to euro after Greek CDS trading is the now the "old trade" (Reuters)
- Sovereign CDS trading to be probed by EU (Bloomberg) as shorting euro is now borderline illegal