And so the latest inevitable outcome of the French downgrade from AAA has arrived, after the S&P just downgraded the EFSF, that pillar of European stability, from AAA to AA+. S&P adds: "if we were to conclude that sufficient offsetting credit enhancements are, in our opinion, not likely to be forthcoming, we would likely change the outlook to negative to mirror the negative outlooks of France and Austria. Under those circumstances we would expect to lower the ratings on the EFSF if we lowered the long-term sovereign credit ratings on the EFSF's 'AAA' or 'AA+' rated members to below 'AA+'." In other words, as everyone but Europe apparently knew, the EFSF is only as strong as the rating of its weakest member. And now the rhetoric on how AAA is not really necessary for the EFSF, begins, to be followed by AA, next A, then BBB and finally how as long as the EFSF is not D-rated all is well.
Despite disappointing auction results in France, the downgrade hangovers (sell the rumor, buy the news?), and increasingly likely Greek PSI talk epic-fail, most European sovereigns are rallying modestly on the day. Given the expected shift in the AAA benchmark used for margining (dropping higher yielding France 'AAA's as they are downgraded will lower AAA benchmark significantly and implicitly widen the yield differential for other sovereigns), it is perhaps no surprise that TPTB are active in BTPs (Italian bonds) but it appears that Portugal (admittedly illiquid) has been left to its own devices. Portuguese 10Y bond spreads to bunds just broke 1250bps, +180bps on the day and at record wides. Given the subordination concerns as ESM is accelerated, it is perhaps no surprise that the ECB's SMP has seemingly decided that Portugal has crossed the Rubicon into Greece territory.
The Rise Of Activist Sovereign Hedge Funds, The "Subordination" Spectre, And The Real "Coercive" Restructuring ThreatSubmitted by Tyler Durden on 01/16/2012 09:52 -0500
When Zero Hedge correctly predicted the imminent rise of the "activist sovereign hedge fund" phenomenon first back in June 2011 (also predicting that the "the drama is about to get very, very real") few listened... except of course the hedge funds, such as Saba, York, Marathon, and others, which realized the unprecedented upside potential in such "nuisance value", long known to all distressed debt investors who procure hold out stakes, and quietly built up blocking positions in European sovereign bonds at sub-liquidation prices. Based on a just released IFRE report, the bulk of this buying occurred in Q4, when banks were dumping positions, promptly vacuumed up by hedge funds. More importantly, we learn from IFRE's post mortem of what is only now being comprehended by the market as having happened, is the realization that the terms "voluntary" and "collective action clauses" end up having the same impact as a retailer (Sears) warning about liquidity (and the result being the start of the death clock, with such catalysts as CIT pulling vendor financing only reinforcing this) to get the vultures circling and picking up the pieces that nobody else desires. As a reminder, it was again back in June we predicted that "the key phrase (or two) in the proposed package: "Voluntary" and "Collective Action Clauses"." Why? Because what this does is unleash the prospect of yet another word, which is about to become one of the most overused in the dilettante financial journalist's lingo: "subordination" or the tranching of an existing equal class of bonds (pari passu) into two distinct subsets, trading at different prices, and possessing different investor protections (we use the term very loosely) with the result being an even greater demand destruction for sovereign paper.
After the fairly muted Wellington open, the reaction of the European bond markets to the S&P downgrade will be the next focus of attention. One benefit of the S&P ratings action is that it takes away one source of uncertainty. Given a French downgrade wasn't widely anticipated, market focus on this issue may well be short lived. Related to the European downgrades is the rating of the EFSF, which was also put on credit watch in early December. S&P have commented that they are in the process of evaluating the impact of the sovereign downgrades on the EFSF rating. For the AAA rating to be maintained it would require further commitments from European governments. Remaining in Europe, newswires report that Greek debt talks will resume Wednesday, thus the Greek PSI is likely to remain a focus all week.
It has been a busy weekend for Wall Street, which has been doing all it can to spin the S&P downgrade in the best favorable light, although judging by the initial EURUSD and EURJPY reaction, so far not succeeding. Below we present a quick report written by Goldman's Lasse Nielsen on why in Goldman's view the downgrade's "impact is likely to be limited" and also the quick notes from an impromptu call MS organized for institutional clients (which had just two questions in the Q&A section, of which only one was answered - it appears virtually noboby believes that global moral hazard will allow anyone to fail at this point, so why bother even going out of bed).
The Real Dark Horse - S&P's Mass Downgrade FAQ May Have Just Hobbled The European Sovereign Debt MarketSubmitted by Tyler Durden on 01/13/2012 18:55 -0500
All your questions about the historic European downgrade should be answered after reading the following FAQ. Or so S&P believes. Ironically, it does an admirable job, because the following presentation successfully manages to negate years of endless lies and propaganda by Europe's incompetent and corrupt klepocrarts, and lays out the true terrifying perspective currently splayed out before the eurozone better than most analyses we have seen to date. Namely that the failed experiment is coming to an end. And since the Eurozone's idiotic foundation was laid out by the same breed of central planning academic wizards who thought that Keynesianism was a great idea (and continue to determine the fate of the world out of their small corner office in the Marriner Eccles building), the imminent downfall of Europe will only precipitate the final unraveling of the shaman "economic" religion that has taken the world to the brink of utter financial collapse and, gradually, world war.
Today's worst kept secret just hit the wires, as S&P announces that it has officially downgraded France
- FRANCE CUT TO AA+ FROM AAA BY S&P, OUTLOOK NEGATIVE
- "we believe that there is at least a one-in-three chance that we could lower the rating further in 2012 or 2013"
- "we believe that a reform process based on a pillar of fiscal austerity alone risks becoming self-defeating,"
One notch, but the negative outlook means a future downgrade is likely.
The moment BTPs broke above 500bps over Bunds this morning, it was clear that the ECB was in buying (and confirmed by desk chatter). Early in the day, European corporate, financial, and sovereign credit markets were in quite positive territory with the former at highs of the year. As downgrade rumors broke, and then were exacerbated by the increasing realization that Greek PSI is not going to happen, sovereigns broke wider rapidly and corporates and financials fell off a cliff (their biggest drop of the year so far) with XOver (the European high-yield credit index) widening 30bps almost instantly. EURUSD took out recent lows trading back to 1.2624, its lowest since August 2010 and EFSF (the much-heralded firewall) widened 9bps off its tights. The last hour or so of trading was dominated by improvements in BTPs and OATs as the SMP went to work and this provided some relief across all assets leaving European stocks at day's highs and modestly lower (after nearing the lows of the year so far earlier), non-sovereign credit marginally wider but sovereigns (Belgium, Spain, and Austria worst) still decently wider. While the impact of the downgrades on EFSF's structure and Germany's willingness to shoulder even more implicit guarantees is critical, we wonder if the PSI talks breakdown is the more important driver as investors face yet another a-ha moment and just as when the USA was downgraded, that the impossible may actually be possible (disorderly Greek default). In the US, ES (the e-mini S&P 500 futures contract) has also rallied nicely off the earlier lows but is holding at VWAP (and is in line with broad risk drivers for now).
Almost six months ago we discussed the dramatic shifts that were about to occur (and indeed did occur) the last time the New York Fed tried to unwind the toxic AIG sludge that is more prosaically known as Maiden Lane II. At the time, the failure of a previous auction as dealers were unwilling to take up even modest sizes of the morose mortgage portfolio was the green light for a realization that even a small unwind of the Fed's bloated balance sheet would not be tolerated by a deleveraging and unwilling-to-bear-risk-at-anything-like-a-supposed-market-rate trading community. Today, we saw the first glimmerings of the same concerns as chatter of Goldman's (and others) interest in some of the lurid loans sent credit reeling. As the WSJ reports, this meant the Fed had to quietly seek confirming bids (BWICs) from other market participants to judge whether Goldman's bid offered value. The discreteness of the enquiries sent ABX and CMBX (the credit derivative indices used to hedge many of these mortgage-backed securities) tumbling with ABX having its first down day since before Christmas and its largest drop in almost two months. The knock-on effect of the potential off-market (or perhaps more reality-based) pricing that Goldman is bidding this time can have (just as it did last time when the Fed halted the auction process as the market could not stand the supply) dramatic impacts as dealers seek efficient (and critically liquid) hedges for their worrisome inventories of junk. The underperformance (and heavy volume) in HYG (the high-yield bond ETF we spend so much time discussing) since the new-year suggests one such hedging program (well timed and hidden by record start-of-year fund inflows from a clueless public which one would have thought would raise prices of the increasingly important bond ETF) as the market's ramp of late is very reminiscent of the pre-auction-fail-and-crash we saw in late June, early July last year as credit markets awoke to the reality of their own balance sheet holes once again.
UPDATE: EURUSD at highs of day now 1.2790, sovereigns and corps/fins tightening back modestly
The ECB press conference has begun and immediately the headlines are flying and driving EUR weaker (ironically not helped by the dismal US macro data that just printed). European sovereign spreads are leaking wider, stocks are underperforming, treasuries outperforming bunds, and corporate and financial spreads are widening rapidly on his comments, via Bloomberg:
- *DRAGHI SAYS ECONOMIC OUTLOOK FACING SUBSTANTIAL DOWNSIDE RISKS
- *DRAGHI SAYS FISCAL COMPACT MUST HAVE UNAMBIGUOUS WORDING
- *DRAGHI SAYS FISCAL CONSOLIDATIONS ARE UNAVOIDABLE
- *DRAGHI SAYS ECB WILL ACT AS AGENT FOR EFSF
- *DRAGHI SAYS HARD DATA DON'T YET SHOW STABILIZATION
- *DRAGHI SAYS HILDEBRAND WAS `VERY, VERY GOOD' GOVERNOR
- *DRAGHI SAYS ECB DIDN'T DISCUSS CUTTING DEPOSIT, MARGINAL RATES
- *DRAGHI SAYS ONGOING TENSIONS KEEP DAMPING ECONOMIC ACTIVITY
- *DRAGHI SAYS ECB `VERY CONCERNED' ON HUNGARY
- *DRAGHI SAYS ANY WAY TO INCREASE THE 'FIREWALL' FIREPOWER WELCOME
- *DRAGHI: NATIONS SHOULD HAVE HAD CAPITAL READY ON STRESS TESTS
- *DRAGHI SAYS NEW COLLATERAL RULES EXPANDED POTENTIAL RISK
- *DRAGHI SAYS PSI WAS RESPONSE TO `SELFISH' BEHAVIOR
- *DRAGHI SAYS ECB EXPECTS SUBSTANTIAL DEMAND FOR SECOND LTRO
- *DRAGHI SAYS GREEK CASE IS `UNIQUE'
Following yesterday's extravaganza in European credit markets, which saw XOver (European high-yield credit) surge to highs year-to-date (wiping out a week's worth of leaking wider in one fell swoop), today's open suggested some follow-through but as macro data combined with France downgrade rumors (denied rapidly) sovereign and corporate credit markets sold off quite rapidly into the close. Interestingly, financials (senior and sub debt) managed to hold gains from yesterday's close as XOver and Main (Europe's investment grade credit index) along with the broad stock market lost ground to close near their lows (though well off yesterday's open still). EURUSD (holding under 1.27 at the EUR close) weakened fairly consistently after Spanish industrial output and German GDP did nothing to inspire and while sovereign spreads (Spanish and Italian mostly) were outperforming, as the French rumors hit, they sold off rapidly (France and Italy back to unchanged). As usual into the close there was a modest risk rally and sovereign spreads leaked modestly tighter (by around 6-9bps) with France underperforming but we did not see that bounce in corporate credit. The weakness in 'cheap-hedge' investment grade credit suggests risk appetite is not returning and decompression trades are back in vogue after yesterday's snap and perhaps a growing realization that no PSI agreement is looming anytime soon.
It will come as no surprise to anyone (other than Dallara and Venizelos perhaps) that all is not rosy in the Greek Public Sector Involvement (PSI) discussions. Whether it is the Kyle-Bass-Based discussions of the need for non-Troika haircuts to be 100% for any meaningful debt reduction, or the CDS-market-based precedent that is set from chasing after a purely voluntary, non-triggering, agreement, the entire process remains mired in a reality that Greece needs much broader acceptance of this haircut (or debt reduction) than is possible given the diverse audience of bondholders (especially given the sub-25 price on most GGBs now). As Goldman points out in a note today, the current PSI structure does not encourage high participation (due to the considerable 'voluntary' NPV losses), leaves effective debt-relief at a measly EUR30-35bln after bank recaps etc., and as we have pointed out in the past leaves the door open for a meaningful overall reduction in risk exposure to European sovereigns should the CDS market be bypassed entirely (as the second-best protection for risk-averse investors would be an outright reduction in holdings). The GGB Basis (the package of Greek bond plus CDS protection) has been bid up notably in the last month or two suggesting that the banks (who are stuck with this GGB waste on their books) are still willing to sell them as 'cheap' basis packages to hedge funds. This risk transfer only exacerbates the unlikely PSI agreement completion since hedgies who are holding the basis package have no incentive to participate at all.
10Y Italian bonds (BTPs) ended the day at their second-widest closing spread to Bunds ever (at 533bps). Only November 9th saw a wider closing print and of course we saw margin hikes at LCH CC&G. 10Y yields are at 7.16%, their highest since just after Thanksgiving but we do note that 2Y yields have stabilized at around 5.00% yields (having peaked near 8% during thin Thanksgiving trading). It seems apparent that perhaps traders front-running LTRO's impact have compressed the 2s10s term structure but much clearer to us is Mr. Market's obvious desire for more money-printing now as BTPs are pushed to unsustainable levels once again - and the banking-to-sovereign vicious circle transmission of insolvency cranks up.
Peter Tchir submits: "The market is essentially frozen ahead of yet another Merkozy press conference. I have lost count of how many of these press conferences they have had. I haven’t lost count of how many resulted in anything particularly useful – zero is an easy number to remember."