Sovereign Debt

It seemed the 'but but but we're oversold' argument was holding up in early trading in Europe as EURUSD, sovereign bonds, corporate and financial credit, and stocks rallied out of the gate. It didn't take long however for the technicals from CDS-Cash traders to wear off and Spain and Italy sovereign debt started to leak back wider. This accelerated pushing everything off the edge as European stocks and financials & investment grade credit fell to recent lows. Interestingly high-yield credit (XOVER) remains an outperformer. By the close, credit markets were pretty much unchanged from last night's close having given back all the knee-jerk improvements on the day but equities remained lower - with a late day surge saving them from total chaos. EURUSD gave back all of its early gains to end the European day lower once again - though off its lows - even as Germany 2Y trades with 0.2bps of negative and Swiss 2Y rates plunge below -25bps. For the month, EMEA stocks were a disaster - Italy and Spain down 12 and 13% and the broad Euro-Stoxx -8.3% (-8.7% YTD).

There is little doubt what the world's pivot security is for now - Spanish sovereign debt. 5Y Spanish CDS just broke above 600bps for the first time ever and S&P 500 e-mini futures reacted by breaking below 1300. Lots of moving parts in Europe's sovereign markets - Spanish bonds were modestly bid today even as CDS was gapping wider - but if one steps back and looks at the basis (the spread between bonds and CDS) this makes sense as it had reached almost 100bps offering basis traders the opportunity to buy bonds and buy protection. We suspect few are outright shorting Spanish bonds here now and the marginal offer is a long-seller but with basis traders still active, do not focus entirely on bonds as evidence of anything until the basis contracts.

So the EC wants the ECB to bypass the EFSF and use the ESM to recap EU banks?  That was the rumor that shifted global stock markets by 1% in a matter of minutes? It has been awhile see we looked at the EFSF Flowchart or had a detailed look at the EFSF Guidelines but it looks like it is time to dig a bit deeper into what is possible and what is not. The ESM is not yet up and running.  There was talk that it would be done by June or July of this year, but in typical EU fashion I don’t think much progress has been made towards that promise.  So right now the EU is stuck with EFSF and the potential to set up the ESM. The market got carried away with the promise of LTRO as a sovereign debt savior, instead it created a potential death spiral. Spanish and Italian bonds are definitely getting crushed today, but with Spanish 10 years above 6.5% and Italian 10 year bonds nearing 6%, the potential for intervention rises.  The secondary market is affecting the primary market, which is driving up the cost of funds, creating more pressure on the budget deficits.  The countries are painfully aware of that, as is the ECB. 

Moving away from baseless (or is that faceless?) European bailout rumors, and moving into cold hard math territory, we hear from JPM's David Mackie that "If a Spanish EU/IMF bailout package covered the government’s gross funding needs through the end of 2014, and included €75bn for bank recapitalisation, then it would amount to around €350bn." This may be a problem since as pointed out on Tuesday, the Spanish Fund for Orderly Bank Restructuring (FROB) is down to... €5.3 billion.

All you need to read

There’s a rather peculiar tribe of people in northern Uganda known as the Ik that has completely mystified anthropologists for decades. You see, the Ik are unlike just about any other people on the planet in that they shun cooperation, community, and even family. Due to the constant disruption of national boundaries in Africa coupled with terminal drought and famine conditions, the Ik have a very limited means of survival. As such, their culture epitomizes the ‘every man for himself’ mentality. Family means nothing. One brother could be starving to death, and the other brother with a belly full of food, and neither would have the slightest thought of sharing. It simply does not register with them. Each member of the tribe typically spends long periods in isolation searching for food and water. Their only reason for marriage is simply that it’s more convenient to build homes in pairs. Nothing else is shared… and most of the time, an Ik husband and wife will seldom be home at the same time. Children are occasionally produced from conjugal relationships, generally because they scare off birds and pests from the agricultural fields. By the age of 3, Ik children are kicked out of the home and left to fend for themselves. And they’re not weaned off, either, it’s sink or swim. All of this sounds shocking to westerners.

Back in February, as part of the latest Greek bailout of European banks, we noted that the most subversive part of the German-led proposal was nothing short of a gold confiscation scheme. Today, courtesy of The Telegraph, we learn that Germany is quietly reminding the world that the stealthy, but voluntary, accumulation of gold is what it is all about. As part of a newed push for quasi-Federalism, whereby Germany would fund a "European Redemption Pact", in which Berlin would, in the form of Germany-backed joint bonds, be responsible for any sovereign debt over the 60% Maastrtich limit, but with a big catch. The catch is that "a key motive is to relieve the European Central Bank of its duties as chief fire-fighter. "We have got to get the ECB out of the game of distributing money, and separate fiscal and monetary policy. Germany has only two votes on the ECB Council and has no way to control consolidation," he said. Germany would have a lockhold over the fund, able to enforce discipline. Each state would have to pledge 20pc of their debt as collateral. "The assets could be taken from the country’s currency and gold reserves. The collateral nominated would only be used in the event that a country does not meet its payment obligations," said the proposal. In other words: a perfectly legitimate, and fully voluntary scheme in which sovereign gold is pledged to a German "pawn broker" until such time as the joint bonds are extinguished, and if for some "unpredictable" reason, a country fails to meet its obligations, read defaults, all the pledged gold goes to Germany!

But why Gold? Why not spam. After all gold is selling off, spam is stable, and the dollar is soaring. Couldn't Germany merely demand that broke countries simply pledge all their USD reserves, and keep their worthless, stinking yellow metal? Apparently not.

Slowly, surely the largest investors in the world are no longer buying the debt of Europe. Recently the Chinese sovereign wealth fund, China Investment Corp., said that they were done and would no longer be buying European debt. The risks are just too great and the way Europe does business is also having a serious effect. You see, Europe does not count any contingent liabilities, sovereign guaranteed debt, derivatives, bank guaranteed debt, regional guaranteed debt or promises to pay for various entities as part of their calculation for their debt to GDP ratios. What can clearly be said then is that the numbers we are given, the data that is flouted day in and day out as accurate is nothing short of a con game built on a Ponzi scheme that rests on the back of a financial system that has been purposefully designed to distort the truth. Regardless of your opinion about all of this there are consequences to this type of manipulation that are in the process of becoming realized. Eventually, when hopes and prayers give way to reality, losses are taken and I submit that we are just at the beginning, just at the start, of seeing realized losses begin to hit balance sheets. The European nations and banks have performed a neat new trick, nailing themselves to the Cross, and it is now only for Pontius Pilate to pick up the spear and begin.

All you need to read and some more.

At François Hollande’s “growth” policies, Greece, the ECB, the Fed, Paul Krugman....

We present the following postcard we just got from Sweden. We can only hope this is a very isolated incident of people enjoying to wait in line for a few pieces of paper, completely devoid of any contextual reference. That, or they are all suddenly applying for a mortgage, or in the best case, merely enjoying the wonderful weather, just incidentally next to a branch of one of Sweden's largest banks.

A "failed state" — but Germany is still trying to save the euro, up to a point....

Today's most exciting piece of financial analysis and debate has been conveniently saved until early evening, when courtesy of BNN's "Munk Debates" we will get a great discussion on the number one topic of the times: whether the European experiment has failed. Arguing for the argument will be famed historian Niall Ferguson as well as Josef Joffe, while the contra side will be defended by Daniel Cohn-Bendit and Peter Mandelson. Courtesy of BNN: "In the sweep of human history, the European Union stands out as one of humankind's most ambitious endeavors. It encompasses half a billion people, twenty-seven member states, twenty-three languages and an economy valued at over $15 trillion. Modern Europe's stunning achievements aside, its sovereign debt crisis has shaken the world's largest political and economic union to its core. Can the federal institutions and shared values of Europeans meet the challenges of debt crisis that are as much political as economic? Or, are Europe's current woes indicative of a series of deep structural faults that will doom the European Union to breakup and failure?"

Newedge: "Last thing I asked before I went traveling was "try not to break anything" while I’m away. I get back this morning and it looks like a bunch of teenagers have had a particularly messy drug-fuelled rave in the market’s front room. The day-on-day charts hide the roller-coaster ride we've seen on the back of the Euro. Bond markets are in lock-down awaiting what-ever-next “liquidity bomb” the authorities can find to drop. Aside from some minor bond crosses, there has been zip activity outside zero-coupon bunds, gilts and treasuries. There is more liquidity in the Atacama desert."

Bank Regulatory Capital has been in the news a lot recently - between the $1+ trillion Basel 3 shortfall, the Spanish banks with seemingly their own set of capital issues, or JPM's snafu.  There has been a lot of discussion about Too Big To Fail (“TBTF”) in the U.S. with regulators demanding more and banks fighting it.  After JPM's surprise loss this month, the debate over the proper regulatory framework and capital requirements will reach a fever pitch.  That is great, but maybe it is also time to step back and think about what capital is supposed to do, and with that as a guideline, think of rules that make sense. Specifically, regulatory capital, or capital adequacy, or just plain capital needs to address the worst of eventual loss and potential mark to market loss. Hedges are once again front and center.  The only "perfect" hedge is selling an asset. This "hedge" is also a trade.  The risk profile looks very different than having sold the loan and the capital should reflect that.