Sovereigns

Citi's Buiter On Plan Z: Unleash The Helicopter Money

All is (once again) failing. What to do? Much more of the same of course. Only this time whip out the nuclear option: the Helicopter Money Drop. This is the logical next step that Citigroup's Willen Buiter sees as "Central Banks should also engage in 'helicopter money drops' to stimulate effective demand" - temporary tax cuts, increases in transfer payments, or boosts to exhaustive public spending - all financed directly by the willing central bank accomplice in the monetization gambit. In his words: "This will always be effective if it is implemented on a sufficient scale." It is not difficult to implement, would likely be politically popular (nom, nom, nom, more iPads), and in his mind need not become inflationary. He does come down to earth a little though from this likely-endgame scenario noting that "helicopter money is not [however] a solution to fiscal unsustainability." It is just a means of providing a temporary fiscal stimulus without adding to the stock of interest-bearing, redeemable public debt. Any attempt to permanently finance even rather small (permanent) general government deficits (as a share of GDP) by creating additional base money would soon – once inflation expectations adjust to this extreme fiscal dominance regime - give rise to unacceptably high rates of inflation and even hyperinflation. His estimate of the size of this one-off helicopter drop - beyond which these inflation fears may appear - is around 2% of GDP - hardly the stuff of Keynes-/Koo-ian wet dreams. The fact that this is being discussed as a possibility (and was likely always the end-game) by a somewhat mainstream economist should be shocking as perhaps this surreality is nearer than many would like to imagine.

Spain Appears Unsure What A "Bank Bailout" Means

Spain's banking system bailout is quickly becoming farcical. According to the WSJ this evening, Spain is to require its banks to set aside more provisions (between EUR20 billion and EUR40 billion) in an effort to overhaul the country's financial sector. This additional need for reserves (or provisioning) puts yet more pressure on the banks' balance sheets as it comes on top of the already EUR54 billion that has been set aside from February. Interestingly the EUR20-40 billion still falls dramatically short of Goldman Sachs' estimate of an additional EUR58 billion that is needed to cover reasonable loss assumptions. We can only assume that the game is to create as large a hole as is possible without tipping the world over the brink and then fill it with the state funds a la TARP (as Rajoy has indicated will be the case).

European Credit Risk Surges Near 4-Month Highs

Just as we warned last night, the lack of an active European credit market to look over the shoulders of their more exuberant equity colleagues quickly came to bear today as London traders turned up for work in no mood for bullish hope. Investment grade credit spreads in Europe jumped their most in a month and pushed close to four-month wides as the entire credit complex sold off aggressively. It seemed Main (the European IG credit index) was instrument of choice for hedgers (cheaper and more liquid with a smattering of financials) as opposed to XOVER (the European HY credit index) but we suspect the latter will rapidly catch up. Stocks fell further with Greece hitting multi-decade lows but Italy and France underperforming (as reality bit following yesterday's pump). Euro Stoxx 50 was down around 2% (now -3.5% YTD) but Spain remains the YTD biggest loser -18.2% (as opposed to Germany's DAX +9.25%). Sovereign credit was also not happy (just like yesterday) but as US opened, Italy and Spain saw notable derisking pushing their 5Y spreads +7bps and +15bps respectively on the week now. Portugal is +24bps on the week so far as the basis trade unwind begins. Europe's VIX surged above 31% for the first time since the beginning of the year and while Treasuries were bid (with 30Y touching 3%), 10Y Bunds outperformed on the safety rotation now 28.5bps inside of the 10Y TSY. EURUSD slid back under 1.30 shortly after the US opened but some miraculous gappiness (and comments from Greece) dragged its lumbering body back over the 1.30 Maginot line for now.

David Rosenberg's Take On Europe

"In less than two years, we are now up to a total of seven European leaders or ruling parties that have been forced out of office, courtesy of the spreading government debt crisis — tack on France now to Ireland, Portugal, Greece, Italy, Spain and the Netherlands. Even Germany's coalition is looking shaky in the aftermath of the faltering state election results for the CDU's (Christian Democratic Union) Free Democrat coalition partner. This is quite a potent brew — financial insolvency, economic fragility and political instability."

A Market Full Of Sound And Fury Signifying Unch

Three important things occurred today: 1) US equities converged down to high-yield credit's less sanguine view of the world; 2) US equities converged to US Treasuries hope-less view of the world; and 3) Gold was the leading indicator for where risk assets should be today - as its stability was the only rock upon which to anchor expectations of intervention once again. The equity market fulfilled every technical analyst's wet dream today with a low volume gap-fill - which notably left today's VWAP at almost exactly the closing price from Friday (i.e. gave bigger players a chance to get out without losing their short - which was exemplified by the sell-off into the close on much bigger than average trade size). Never have we heard just whimsical exuberance at the market closing practically unchanged (ES +2pts) but critically risk markets in general did nothing but revert ahead of tomorrow's real action as the UK (and that means the European credit market) comes back from a long-weekend. Broadly speaking - US equities outperformed risk-assets modestly until the late-day give back dragged them back to reality but overall - IG credit underperformed, HYG outperformed (inflows dominant), and HY and S&P 500 e-mini futures (ES) stayed in sync.

And Back To Euro-Math: Up To €210 Billion Funding Shortfall For Spanish, Italian Banks In 2012

While events over the weekend have had a dramatic impact on the political landscape of Europe, that's just what they are: political events. Yet for all the rhetoric, promises, and bluster, only one thing matters in the end: cold, hard math. The same math which last weekend indicated that Europe is still facing trillions and trillions in bank deleveraging. That has not changed one cents between then and now, regardless who is the puppet (muppet?) head of this country or that. But since that won't become evident for at least a few more years, it can be safely forgotten, until the time comes to recall it that is, at which point there will be a full blown crisis even though there were years of advance warning to prepare for the crunch. So here is some more math: in a downside case forecast looking at funding capacity of Spanish and Italian banks - the same banks that would have been long insolvent had it not been for a $1.3 trillion injection by the ECB - Deutsche Bank predicts that the two groups may have as vast a funding shortfall as €210 billion in 2012 (€114.4 billion in Spain, €96.1 billion in Italy). Which to DB means one thing of course: more LTROs coming because once the market has habituated to the now periodic infusion of monetary heroin it will not let go until it is convulsing in its death rattle, something the status quo will never allow, or until it gets just one more hit.

Visualizing Why LTRO = QE

Quantitative Easing (QE) is/was seemingly a magic remedy, at least in the short-term. As GLG's Pierre Lagrange notes, central bankers can conjure up money out of thin air and use it to purchase assets - transforming transferring toxic debt, stimulating demand for risk assets, devaluing currencies (this deflating debt), and maintaining low interest rates on govvies. The ECB's more restrictive mandate, however, does not allow them to print money for any other purpose than lending and so direct QE was out of the question and so, as the chart below demonstrates, they ingeniously created the LTRO - delivering an infusion of liquidity (potential profits from carry and hope for capital raises).

Facing Up To 2012

The recent LTRO by the ECB provided lquidity; but at a cost. It is apparent that the banks in Europe pushed up the prices for European sovereigns in the short term but also increased their own risks by doing so. Recent data suggests that almost 10% of foreign buyers exited many of the weaker sovereign credits in Europe while their domiciled banks picked up the slack but, in doing so, increased their own risk and as yields have gapped back out in Italy, Spain et al the banks are facing significant losses on their balance sheets. It is quite possible now that with this weekend’s elections in Europe that Germany will find itself backed into a corner and nationalism could become a self-centered affair in Berlin with surprising consequences that could result from finding itself backed up against the wall. As much of Europe now finds itself in recession I note the continuing possibility of social unrest that could burst at any time as the unemployment numbers for much of the youth in Europe are abysmal and idleness can ignite in the most controlled of societies.

Larry Summers Resumes Exercises In Pontificating Sophistry

Over the weekend, just because apparently someone really needed content at any cost (in this case zero), we got a new intellectual stillborn from none other than the man who more than anyone is responsible for the global economic collapse the world has been in for the past 4 years, and from which it is nowhere even close in escaping. The man of course is Larry Summers, who first crushed global finance, then Harvard, and finally Obama's economic platform, whom the FT saw fit to give the chance to pontificate on such concepts at growth and austerity, because apparently, growth through austerity, whereby banking sector debt is written down in parallel is not growth, but there is some subsegment of "growth", heretofore unknown, that Europe has not tried before, and will instead focus on that going forward. To paraphrase Lewis Black: don't think about that sentence too hard, or blood will shoot out of your nose.

The Next Circle Of Spain's Hell Begins At 5% And Ends At 10%

Three weeks ago we discussed the ultimate-doomsday presentation of the state of Spain which best summarized the macro-concerns facing the nation and its banks. Since then the market, and now the ratings agencies, have fully digested that meal of dysphoric data and pushed Spanish sovereign and bank bond spreads back to levels seen before the LTRO's short-lived (though self-defeating) munificence transfixed global investors. However, the world moves on and while most are focused directly on yields, spreads, unemployment rates, and loan-delinquency levels, there are two critical new numbers to pay attention to immediately - that we are sure the market will soon learn to appreciate. The first is 5%. This is the haircut increase that ECB collateral will require once all ratings agencies shift to BBB+ or below (meaning massive margin calls and cash needs for the exact banks that are the most exposed and least capable of achieving said liquidity). The second is 10%. This is the level of funded (bank) assets that are financed by the Central Bank and as UBS notes, this is the tipping point beyond which banks are treated differently by the market and have historically required significant equity issuance to return to regular private market funding. With S&P having made the move to BBB+ this week (and Italy already there), and Spain's banking system having reached 11% as of the last ECB announcement (and Italy 7.7%), it would appear we are set for more heat in the European kitchen - especially since Nomura adds that they do not expect any meaningful response from the ECB until things get a lot worse. The world is waking up to the realization that de-linking sovereigns and banks (as opposed to concentrating that systemic risk) is key to stabilizing markets.

Europe Ends Week Green But Notably Red On Month

For the third week in a row, European equity and credit markets have remained range-bound. Equities broadly ended the week in the green with the BE500 (Bloomberg's broad S&P 500-equivalent for Europe) ending near the top of the recent range - around the pre-NFP levels from 4/5. Spain and Italy have seen improvements this week in their equity indices but they remain down notably on the month and perhaps surprisingly only the UK's FTSE 100 is in the green for the month. Credit is considerably more dispersed but also green close-to-close on the week after a strong finish today (as the dismal data started rumors of more ECB easing and QE3 lifts). Stocks and high-beta crossover credit outperformed in the liquidity rush but subordinated financials lagged on the week. Critically though, while anchoring bias might make us all feel joyous in the last few days of recovery, we remain significantly red on the month across all risk asset classes in Europe. Sovereigns followed the same path as equities and credit - with another range-bound rotation up better on bill auction success and worse on bond auction failure but as with equities/credit today's exuberance lifted them to the middle of the recent range - well off the best levels of the last few weeks. Most notably, Spanish and Italian 10Y bond spreads are over 60bps wider in April and continue to trade in a two-steps-wider-one-step-tighter rotation intra-week. Portugal is the big winner on the week (and month) when it comes to bond spreads - which are now back to mid-September levels. However - as we have tried to explain before - the massive cheapness of Portuguese bonds relative to CDS (the so-called basis) has just been too tempting and grabbing this 'risk-free' carry has provided some bid to a notably illiquid Portuguese bond market and crushed the differential between bonds and CDS. The point being - be careful in reading too much into Portuguese bond improvements as it is much more a technical arbitrage move than real money flowing into this restructuring prone nation.

Overnight Sentiment - All News Is Good News

S&P threatening to downgrade India... UK double dipping... Germany having a failed auction. It is all irrelevant, for the great fruit has spoken and people are buying iGadgets at record levels, which can only mean that once the great credit spree ends, Apple will likely be forced to use its $110 billion cash hoard to start an in house "Acceptance Corporation" vendor financing purchases of its products directly. And while the AAPL earnings beat has become a contrarian bet, now that even Gartman has said he is turning bullish on stocks, here is a summary of what happened and what will happen. In a nutshell, just like Apple was the only thing that mattered yesterday, today it is only the Fed and the subsequent press conference that matter, with the market likely to only take away whatever it wants to take away.

Guest Post: Project “End Up Like Japan” Continues To Advance Well In The West

One scene from the movie Titanic depicts a lounge in one of the upper class quarters of the ship as it slowly sinks beneath the waves. Notwithstanding the vessel listing alarmingly, a motley band of toff revelers are determined to go out in the finest style. Some continue to play at cards with a fatalistic resolve while others determinedly quaff spirits direct from the bottle. Having considered for some time the most appropriate metaphor for the current market environment, we think this may be it: one may be doomed, but one can still party on. Having already hit the iceberg, one major problem we see is the common perspective for both investors and the asset management industry to view debt and equity as the entire universe of investor choices available. Having long exhausted the armory of conventional policies to keep the unsustainably indebted show on the road, increasingly desperate politicians are doing increasingly desperate things, be that gifting money to the IMF in a brazen display of fiscal denial that we can ill afford (US, UK) or simply stealing from other sovereigns (Argentina). The ironic triumph of the Keynesians means that, in trying to save the economy, our central bank may end up destroying it completely by means of the printing press; as a consequence, we now get to experience some of the full-on horror of the Japanese malaise.

Volatile Or Not?

Maybe it is the activity in Europe that made the markets feel more volatile than the weekly changes show. Or maybe it was that the futures traded in an almost 3% range – from 1,359 to 1,390 with several 0.5% swings during the course of most days. Market darling Apple isn’t helping calm the market either. That can reverse on a moment’s notice, or a great earnings release, but the momentum that was dragging more and more hedge funds into the trade, is now working in reverse as stop losses are being triggered. So often lately, the bulls are able to point to a decent tape in face of weak data and no stimulus, and this week ended with the opposite. Bulls will be nervous that decent earnings and a mega-plan from the IMF failed to provide strength to the market. So, it was a strange week that was more volatile than the weekly changes show, and where some real cracks are being exposed.