Sovereigns

European Stress Getting Progressively Worse As LTRO Boost A Distant Memory

The sad reality of an austerity induced slowdown in Europe and an ESFS/ESM as useful as a chocolate fire-guard seems to be creeping into risk asset premia across Europe (and implicitly the US). GGB2s are all trading back under EUR20 (that is 20% of par), Sovereign yields and spreads are leaking wider despite the best efforts of their respective banks to back-up-the-truck in the 'ultimate all-in trade' and the LTRO Stigma has reached record levels as LTRO-encumbered banks' credit spreads are the worst in over two months. Spanish sovereign spreads are back at early January levels and with Italian yields comfortably back over 5% and the bonds starting to reality-check back towards the much less sanguine CDS market. It seems apparent that much of the liquidity-fixing LTRO benefits are now being washed away as investors realize nothing has changed and in fact things are considerably worse now given encumbrance and subordination concerns and the increased contagion risk that the LTRO and the Sarkozy trade has created.

Overnight Sentiment: Lower

After two months of quiet from the old world, Europe is again on the radar, pushing futures in the red, and the EURUSD lower, following a miss in March European Economic and Consumer confidence, printing at 94.4 and -19.1, on expectations of 94.5 and -19.0, as well as an Italian 5 and 10 Year auction which seemingly was weaker than the market had expected, especially at the 10 Year side, confirming the Italian long-end will be a major difficulty as noted here before, and pushing Italian yields higher (more on the market reaction below). The primary driver of bearish European sentiment continues to be a negative Willem Buiter note on Spain, as well as S&P's Kramer saying Greece will need a new restructuring. Lastly, the OECD published its G-7 report and reminded markets that Italian and likely UK GDP will shrink in the short-term. This was offset by better than expected German unemployment data but this is largely being ignored by a prevailing risk off sentiment. In other words, absolutely nothing new, but merely a smokescreen narrative to justify stock declines, which further leads us to believe that next week's NFP will be worse than expected as discussed last night.

Phoenix Capital Research's picture

Because of its interventions and bond purchases, ¼ of the ECB’s balance sheet is now PIIGS debt AKA totally worthless junk. And the ECB claims it isn’t going to take any losses on these holdings either. No, instead it’s going to roll the losses back onto the shoulders of the individual national Central Banks. How is that going to work out? The ECB steps in to save the day and stop the bond market from imploding… but the minute it’s clear that losses are coming, it’s going to roll its holdings back onto the specific sovereigns’ balance sheets?

Europe Drops Most In 3 Weeks As LTRO Stigma Hits New Highs

With Chinese and European data disappointing and Weidmann commenting on the futility of the 'firewalls' (as we discussed earlier) ahead of the discussions later this week, European equities dropped their most in almost three weeks over the last two days closing right at their 50DMA (the closest to a cross since 12/20). Credit markets (dominated by financial weakness) continue to slide as the LTRO euphoria wears off. The LTRO Stigma, the spread between LTRO-encumbered and non-LTRO-encumbered banks, has exploded to over 107bps (from under 50bps at its best in mid Feb when we first highlighted it) and is now up over 75% since the CDS roll as only non-LTRO banks have seen any improvement in the last week. Aside from Portugal, whose bonds seem to be improving dramatically on the back of significant Cash-CDS basis compression as opposed to real-money flows as the spread between Bonds and CDS has compressed from 500bps to 250bps on the back of renewed confidence in CDS triggering, sovereign bond spreads are leaking wider all week with Italy and Spain worst.

Goldman On Europe: "Risk Of 'Financial Fires' Is Spreading"

Germany's recent 'agreement' to expand Europe's fire department (as Goldman euphemestically describes the EFSF/ESM firewall) seems to confirm the prevailing policy view that bigger 'firewalls' would encourage investors to buy European sovereign debt - since the funding backstop will prevent credit shocks spreading contagiously. However, as Francesco Garzarelli notes today, given the Euro-area's closed nature (more than 85% of EU sovereign debt is held by its residents) and the increased 'interconnectedness' of sovereigns and financials (most debt is now held by the MFIs), the risk of 'financial fires' spreading remains high. Due to size limitations (EFSF/ESM totals would not be suggicient to cover the larger markets of Italy and Spain let alone any others), Seniority constraints (as with Greece, the EFSF/ESM will hugely subordinate existing bondholders should action be required, exacerbating rather than mitigating the crisis), and Governance limitations (the existing infrastructure cannot act pre-emptively and so timing - and admission of crisis - could become a limiting factor), it is unlikely that a more sustained realignment of rate differentials (with their macro underpinnings) can occur (especially at the longer-end of the curve). The re-appearance of the Redemption Fund idea (akin to Euro-bonds but without the paperwork) is likely the next step in countering reality.

Bill Gross: "The Game As We All Have Known It Appears To Be Over"

First it was Bob Janjuah throwing in the towel in the face of central planning, now we get the same sense from Bill Gross who in his latest letter once again laments the forced transfer of risk from the private to the public sector: "The game as we all have known it appears to be over... moving for the moment from private to public balance sheets, but even there facing investor and political limits. Actually global financial markets are only selectively delevering. What delevering there is, is most visible with household balance sheets in the U.S. and Euroland peripheral sovereigns like Greece." Gross' long-term view is well-known - inflation is coming: "The total amount of debt however is daunting and continued credit expansion will produce accelerating global inflation and slower growth in PIMCO’s most likely outcome." The primary reason for Pimco's pessimism, which is nothing new, is that in a world of deleveraging there will be no packets of leverage within the primary traditional source of cheap credit-money growth: financial firms. So what is a fund manager to do? Why find their own Steve McQueen'ian Great Escape from Financial Repression of course. " it is your duty to try to escape today’s repression. Your living conditions are OK for now – the food and in this case the returns are good – but they aren’t enough to get you what you need to cover liabilities. You need to think of an escape route that gets you back home yet at the same time doesn’t get you killed in the process. You need a Great Escape to deliver in this financial repressive world." In the meantime Gross advises readers to do just what we have been saying for years: buy commodities and real (non-dilutable) assets: "Commodities and real assets become ascendant, certainly in relative terms, as we by necessity delever or lever less." As for the endgame: "Is a systemic implosion still possible in 2012 as opposed to 2008? It is, but we will likely face much more monetary and credit inflation before the balloon pops. Until then, you should budget for “safe carry” to help pay your bills. The bunker portfolio lies further ahead."

3 Charts On Why Eurosis Never Really Went Away

Somehow the investing public managed to convince itself that a massive liquidity flood designed to 'help' banks (implicitly buy sovereign debt) with their government reacharounds actually 'fixed' the European economic imbalance problem because yields fell and reflexively this means all-is-well. Just ask Eastman Kodak shareholders how good it felt to rally over 100% the week before bankruptcy? Morgan Stanley has the mother-of-all-chartdecks on the European situation but 3 charts standout in our view by summarising the problems Europe faces. The last few days have seen Eurosis return - but away from the momentum and liquidity - did it ever really go away? This time is no different except LTRO 3 is becoming harder and harder as quality unencumbered collateralizable assets are few and far between - and with the recent weakness in Spain, how long before ECB margin calls start to ramp up?

LTRO Stigma Spikes As Sovereigns Slump

As we approach the US day session open, Europe is on a similar trend to yesterday with broad market weakness. European sovereigns, most notably the fulcrum securities in Italy and Spain - but also France, are at their worst levels in three weeks with Italian 10Y back over 5% yield and Spanish 10Y back over 5.5% (near its worst level since mid January). The LTRO Stigma (the spread between LTRO-encumbered banks and non-LTRO-encumbered banks) has jumped again and is near its worst levels since the initial LTRO at over a 90bps differential. Corporate credit and stocks are also notably weaker as credit decompresses to catch up with stocks weakness as CDS roll technicals unwind.

Those Catchy Spanish (Yield) Curves

With ZIRP and LTRO it is hard to get a good read on the Spanish yield curve and what anything means.  Spanish 10 year yields have risen 9 days in a row, 5 year yields have moved higher 8 out of 9 days, and the 2 year has been much more mixed, until recently. The 2 year yield is out 19 bps in those 9 days, but 18 bps of that move has occurred the last 2 days.  The 2 year bond fits the sweet spot of LTRO, is likely to be held by banks in non mark to market accounts, so it has been stable, but it has even started to leak a little.  The move is small, almost trivial, yet with all the things working to support 2 year bonds, it is curious that it is able to widen at all, let alone 18 bps in 2 days.

European Sovereign Debt Shows First Weakness In 3 Months

Whether it was the truthiness of Willem Buiter's comments this morning, the sad reality of Spanish housing, or more likely the ugly fact that LTRO3 is not coming (as money-good assets evaporate), today was broadly the worst day of the year for European sovereigns. Spanish 10Y spreads jumped their most since the first day of the year, Italian yields broke back above 5% (and spreads broke back over 300bps), and Belgium, France and Austria all leaked notably wider. Since Friday's close, Italian and Spanish bonds have suffered their largest 2-day losses in over 3 months. Notably the CDS markets rolled their contracts into Monday and perhaps this derisking is real money exiting as they unwound their hedges - or more simply profit-taking on front-run LTRO carry trades but notably the LTRO Stigma has exploded in the last few days back to near its highs. European equity markets are now underperforming credit - having ridden the high-beta wave far above credit markets in the last few months (a picture we have seen in the US in Q2 2011 and HY is signaling risk-aversion rising in the US currently in the same way). Just how will the world react to another risk flare in Europe now that supposedly everything is solved?

Risk-Off As Buiter Reminds World About Europe

The EURUSD, Treasuries, and European sovereign spreads had been leaking in a risk-off direction from around 530amET this morning but European risk assets (followed quickly by US) accelerated shortly after comments by Citi's Willem Buiter, in a scathing Bloomberg Radio interview that pulled no punches with regard to US and European fiscal and monetary policy, noted Spain is 'at greater risk than ever before' of debt restructuring. The EUR reacted quickly and started to drop - now lower on the day - and sovereign spreads (which had been leaking gently wider) accelerated. "Spain is the key country about which I'm most worried", Buiter added, "and it has moved to the wrong wide of the spectrum". Simultaneously the DAX dropped (after stabilizing at slightly positive levels from a higher open) shifting into the red, US Treasuries went bid with the 10Y yields dropping almost 5bps from its overnight highs, and US equity futures fell 4pts back to unch. European corporate credit is still digesting the technicals of the roll and is less reactive so far though broadly speaking equities are underperforming.

Portugal: Another Significant Miss, And Another 140% Debt/GDP Case Study

The next country that could follow Greece out of Valhalla and down to meet Poseidon at Hades gates is Portugal. They trod the path once before but look likely to be headed out on a second journey. The country’s private and household debt are approximately 300% of the total GDP of Portugal and their economy is contracting; around 4.00% by some estimates. While the European Commission estimates a debt to GDP ratio of 111% for this year; the actual data tells another story. Further aggravating a future restructuring are the CDS contracts with a net position of $5.2 billion and a gross amount of $67.30 billion which is about twice the amount of the net exposure for Greece.

Morgan Stanley, Italy, Swaps And Misplaced Outrage

One of the big stories of the week was that Morgan Stanley “reduced” its exposures to Italy by $3.4 billion mostly by unwinding some swaps they had on with Italy. Morgan Stanley booked profit of $600 million on the unwind. The timing couldn’t have been worse coming on the heels of the “Darth Vader” resignation at Goldman Sachs, attracting more attention to profits on derivatives trades was the last thing the investment banks need. Much of the outrage seems misplaced though. In this case, don’t blame Morgan Stanley, blame Italy, and be very afraid of what else Italy has done.

The Fool's Game: Unravelling Europe's Epic Ponzi Pyramid Of Lies

Now in the curious world we live in today; this only came out in public as the answer to a question raised in the German Parliament. Some reflection on the nature of these guarantees, that the European Union had decided not to tell us about, causes me to think of them as “Ponzi Bonds.” These are the seeds of a great scheme that has been foisted upon us. Bonds of a feather that have flocked together and arrived with the black swans one quiet Wednesday afternoon. The quoted and much ballyhooed sovereign debt numbers are now known to be no longer accurate and hence the lack of credibility of the debt to GDP data for the European nations. Stated more simply; none of the data that we are given about sovereign debt in the European Union is the truth, none of it. According to Eurostat, as an example, the consolidated Spanish debt raises their debt to GDP by 12.3% as Eurostat also states, and I quote, that guaranteed debt in Europe “DO NOT FORM PART OF GOVERNMENT DEBT, BUT ARE A CONTINGENT LIABILITY.” In other words; not counted and so, my friends, none of the data pushed out by Europe about their sovereign debt or their GDP ratios has one whit of truth resident in the data.

Jens Weidmann Defends Bundesbank Against Allegations Of TARGET2-Induced Instability

We have previously discussed the substantial, and growing, threat to the German economy that is the Bundesbank's negative TARGET2 balance, which we have formerly dubbed Europe's €2.5 trillion closed liquidity loop, which just rose to a new record over €550 billion (in "Has The Imploding European Shadow Banking System Forced The Bundesbank To Prepare For Plan B?", "Goldman's Take On TARGET2 And How The Bundesbank Will Suffer Massive Losses If The Eurozone Fails", and most recently  in "Dear Germans: Bring Out Ze Checkbooks") which in turn merely represents the taxpayer funded capital flow to insure that the Eurozone remains solvent for one more day as Germany's peripheral trading partners receive rescue capital every day in the form of recycled German current account surplus. It now appears that the Bundesbank president has taken to these allegations of monetary instability strongly enough to where he has just released the following response on Target2 in "What is the origin and meaning of the Target2 balances?" Full letter below.