Bill Gross: The Global Monetary System Is Reaching Its Breaking Point

The global monetary system which has evolved and morphed over the past century but always in the direction of easier, cheaper and more abundant credit, may have reached a point at which it can no longer operate efficiently and equitably to promote economic growth and the fair distribution of its benefits. Future changes, which lie on a visible horizon, may not be so beneficial for our ocean’s oversized creatures. Both the lower quality and lower yields of previously sacrosanct debt therefore represent a potential breaking point in our now 40-year-old global monetary system. Neither condition was considered feasible as recently as five years ago. Now, however, with even the United States suffering a credit downgrade to AA+ and offering negative 200 basis point real policy rates for the privilege of investing in Treasury bills, the willingness of creditor whales – as opposed to debtors – to support the existing system may soon descend. Such a transition occurs because lenders either perceive too much risk or refuse to accept near zero-based returns on their investments. “There she blows,” screamed Captain Ahab and similarly intentioned debt holders may soon follow suit, presenting the possibility of a new global monetary system in future years, or if not, one which is stagnant, dysfunctional and ill-equipped to facilitate the process of productive investment.

European Bloodbath Continues

Europe was a sea of red (apart from Bund prices) today. With yesterday's window-dressing done and overnight dismissal of Spain's hopeful ECB-workaround, European equity and credit markets were dismal, EURUSD ended under 1.2400, and 2Y Bunds at 0.00% yield. Financials underperformed in stocks and credit with senior bank spreads back up to 300bps and LTRO Stigma jumping 12bps to 177.5bps (near record wides). Spain and Italy dominated both single-name banking and non-banking credit and equity moves as well as sovereigns with Spanish 10Y now +45bps on the week and Italy +37bps (with Belgium, France, and Austria all around 9bps wider). All European equity indices are down for the week with Spain down almost 8%. EUR-USD 3Y basis swaps turned back lower (worse) back to -70bps - not a good sign for funding (especially in light of the drop in LTRO we noted yesterday). On a final note of despair, Spanish 2s10s is now flatter than at any time since LTRO1 - implying that any LTRO debt used to fund a real carry trade is now a loser.

Germany Shoots Down European Union "Envisagings" Of Bureaucrat Utopia

And to think it was not even 2 hours ago that a regurgitated and largely impotent news story hit the WSJ (following up on an identical Reuters story yesterday, as ZH noted), sending the EURUSD higher by 50 pips. As we said, expect Germany to come out with a prompt refutation in minutes. The minutes in question were 90. The official denial to Gollum's lie panderings has arrived courtesy of Market News: "Government spokesman Steffen Seibert said at a regular press conference here that the German rejection of the idea of any direct recapitalisation of banks by the ESM "is well known." Summary: B+ for effort, C for execution, C- for market reaction halflife, and F for content, as usual.

National Acronym Day In Europe

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

Overnight Sentiment: Now, It's Italy's Turn (As Spain Continues To Break All Records)

... Which is not to say that the other usual suspects are fine, they aren't: Spain's 10 year just hit a record 6.72%, a spike of nearly 30 bps on the day, and just shy of the apocalyptic 7.00%, at which point everyone will quietly move to the bomb shelter (and JPM is not helping things, saying the total Spanish bank bailout may hit €350 billion even as the Spanish bailout fund has just €4 billion left in it...), even as the 2 Year rises above 5% for the first time since December 2011 on some rapid curve inversion moves. No: today the market simply had one of those epiphanies where it sat in front of a map, and finally remembered that last year as part of the continental contagion spread that forced the November 30 coordinated global central bank intervention, Italy was at the forefront. Sure enough, 2011 is once again becoming 2012. Today's catalyst was an Italian sale of €5.73 billion in 5 and 10 year bonds, less than the maximum €6.25, where €3.391 billion of the 5 Year was sold at a 5.66% yield, compared to 4.86% on April 27, and the BTC of 1.35 vs 1.34. But the optical killer was the €2.341 billion in 10 Years which priced above 6% for the first time in a long while, coming at 6.03% compared to 5.84% in April, and a dropping BTC of 1.40 compared to 1.48 before. The result is a blow out in the entire Italian curve, with the 10 Year point widening by 28 bps, and sending Italian CDS wider by 21 bps to 543 bps. In other words: welcome to the party Italy. You have been missed.

Greece Jumps Most In 8 Months As Rest Of Peripheral Europe Slumps

The Greek equity index jumped almost 7% today, its biggest rise in 8 months, on the back of absolutely no 'real' change whatsoever (Greek opinion poll results change by the second and the stability fund payments were already known) and indeed a worsening situation across most of the rest of Europe (ex-Germany) - with chatter of growing bank runs and Bankia's epic demise. Of course, one needs to bear in mind the ASE pop is off 22-year lows before sounding that all-clear here as Bund yields collapse to all-time record lows and Spanish yields (and spreads) to Euro-era record wides (and almost all-time record highs). Broad European equities and credit gapped up at the open (as did EURUSD) but the rest of the day was spent drifting inexorably back to lows as the Euro-Stoxx ended down 0.5% (with Spain - at 9 year lows - and Italy underperforming notably also - with banks halted on and off all day). Spain and Italy saw sovereign spreads leaking (16bps and 8bps respectively) as the former broke 450bps over AAA for the first time (and 510bps over Bunds). Corporate and financial credit spreads leaked back wider from the positive start to the day and ended still modestly tighter on the day - though financials notably underperformed non-financials. EUR-USD basis swaps improved modestly but EURUSD round-tripped from a decent open to Thursday/Friday highs over 1.26 and back down towards Friday's close - with the USD -0.2% from Friday's close - as AUD strength helped exaggerate the move mildly. Commodities are following USD's lead and as it strengthens into the European close, they are losing early gains (Copper/Oil up around 0.6%, Gold Unch, Silver down 0.5%). USD and Oil weakness into the European close were the most notable micro-trends.

Mark Grant And Rick Santelli On Europe's 'Bond-Turned-Bank'-Run

We have discussed the realities of Spanish (and Italian and Portuguese and Greek) debt to GDP data relative to the official estimates a number of times over the past few months and just as Mark Grant tells Rick Santelli today, the sugar buzz of self-financed sovereign bond buying hides the truth - until now when that liquidity is fading. From inaccurate data to LTRO ineffectiveness, 'Grantelli' sum it up nicely as  the 'Bond Run' we have seen over the past few months (as professionals flee European banks and sovereigns) has now trickled down to the man-in-the-street and their equivalent - the bank-run.

Japanese Girl-Band Wants You (To Buy Japanese Government Bonds)

Whether it was Captain America's roadshow or Uncle-Sam 'wanting' your help, the US always seemed to maintain some semblance of class when propagandizing its citizens into buying its government bonds. Whether for patriotic or xenophobic reasons, it appeared to work. Japan, though, with its increasingly desperate demographic situation, deficits, downgrades, and well, general malaise of Koo/Keynesian-stuffed economic stagnation has turned to the next best thing - the all-girl band AKB48. As The Telegraph notes today, the all-female pop group will headline a summer campaign for "reconstruction bonds" aimed at financing projects in regions hammered by last year's quake-tsunami disaster. The debt campaign will see AKB48 - comprising about 90 performers, ranging in age from early teens to mid-20s - joined by sumo wrestling's champion Hakuho and female football star Homare Sawa, Japan's Jiji press agency reported. The group's bubblegum pop and synchronized dancing has proved a huge hit with young girls. Perhaps more disturbingly (and why Japan chose them maybe?) - running the gamut from girl-next-door to sultry temptress, the band also has a substantial male following - many of whom are older - who support a vast merchandising industry. Japan has the industrialized world's worst public debt, amounting to more than twice its gross domestic product - topping hard-hit eurozone countries including Greece, which have drawn fire from foreign investors over their fiscal management. All of this makes us wonder - Forget AKB48, how long until AK47 in musical, or primarily otherwise, format is used to encourage lending to sovereigns all around the "developed" world?

Spanish Bonds Slump To 17 Year Lows Amid Choppy Week

Aside from Spain (-0.3%) and Greece (-11.8%), European equity markets are ending the week green - albeit marginally - as we can only assume the hopes and prayers of every banker are being discounted into the price of corporate liabilities (an 'event' will happen but don't worry as the ECB/Germany will cave). Corporate and financial credit markets also ended the week tighter - with financials the high beta players on the week, hugely outperforming on Tuesday but fading into today's close. Today was not a pretty end to the week in credit though as both sovereigns, corporates, financials, all peaked early in the day and pushed to near their lows by the close. Senior financial bond spreads actually closed wider on the day - at their wides - and Spanish sovereign bond spreads exploded over 35bps wider from earlier tights to end at theu widest since April 1995. Italian bond spreads also jumped 32bps wider from their morning tights but end the week -9bps and France gave back almost half its sovereign bond gains of the week today. EURUSD remains the story, breaking below 1.2500 for the first time since early July 2010 as it seems the FX markets remain much less sanguine of the endgame here than do equity markets (with sovereign credit getting closer to FX's world view and corporate credit closer to equities but fading today). Europe's VIX remains above 30% (though our VIX-V2X compression trade is performing well as US VIX elevates).

Regulatory Capital: Size And How You Use It Both Matter

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.

As Reality Recedes, Rumor Rampage Returns

Equities and broad risk-assets were generally in sync today until around 1430ET when between rumors of a Euro-wide deposit-guarantee 'scheme' - which we had already dismissed as impossible short-term, very unlikely medium-term, and not a long-term solution to redenomination/insolvency risk - and Kocherlakota's hints as NEW QE if the fiscal cliff arrives - US equity markets took off (as did Gold). S&P 500 e-mini futures (ES) pushed to more than 12pts rich to CONTEXT (our proxy for risk-assets based on TSYs, FX carry, credit, and commodities) on all that hope - stalling at yesterday's late-day heavy volume swing highs. Of course the high-beta momo monkeys were pounced on and AAPL as well as the major financials all popped notably - breaking above yesterday's closing VWAP. Today was a low average trade size day - the lowest in a week (but a relatively high volume day) - after a large average trade size day yesterday which smells like algos pushing to enable larger selling (especially as we expect a denial any moment from Europe). VIX plunged off its highs but closed only marginally down with ES closing very marginally higher on the day - so some context is required to avoid anchoring bias intraday and while TSY yields did pop and EUR rallied after equities got going, they remain notably divergent from that sur-reality. Gold and Silver surged on the QE/EU hopes as well but remain down 2% and 3% on the week.

QE's Long Shadow Is Getting Shorter

With Europe hitting the skids, EURUSD at multi-year lows, and the US equity market down a whopping (and terrifying) 9% from its March highs, it seems the market remains increasingly hopeful that this time will not be different in that the Central Banks of the world will print and save us once more. As a reminder we suspect the ECB can't (collateral is non-existent for the most needy sovereigns/banks) and won't (Germany and the AAA-Club vehemently opposed to losing this game of chicken), China won't (inflationary concerns), and the BoJ won't (after checking to the Fed post-downgrade last night as it appears they recognize the limit). This means, the world has pretty much checked to The Fed - but with TIPS yields a good distance from his precognitive threshold for deflation-avoidance and with the S&P 500 at 1300 still, we suspect the hope is premature. And if performance anxiety is affecting all those long-only managers who are are just now unwinding their P.A. over-allotment to Facebook, we estimate (based on QE1 and QE2) that the S&P could trade down to 1100-1150 before we see Ben step in to save the world - which by the way is only early December 2011 lows. How quickly we lose perspective and anchoring bias takes over when a market rises magically for months without any looking back.

Phoenix Capital Research's picture

The “austerity” and “growth” to which EU leaders refer are simply two sides of the same coin: that of assuming that massive problems can be dealt with superficially. It’s akin to polishing the brass on the Titanic as it sinks: in the short term, you’re making a small difference, but in the big picture, you’re ignoring the very real, enormous problem you need to tackle.


Overnight Sentiment: Another European Summit, Another Japanese Rating Downgrade

There was some hope that today's European summit would provide some more clarity for something else than just the local caterer's 2012 tax payment. It wont. Per Reuters: "Germany does not believe that jointly issued euro zone bonds offer a solution to the bloc's debt crisis and will not change its stance despite calls from France and other countries to consider such a step, a senior German official said on Tuesday. "That's a firm conviction which will not change in June," the official said at a German government briefing before an informal summit of EU leaders on Wednesday. A second summit will be held at the end of June. The official, requesting anonymity, also said he saw no need for leaders to discuss a loosening of deficit goals for struggling euro zone countries like Greece or Spain, nor to explore new ways for recapitalise vulnerable banks at Wednesday's meeting." In other words absolutely the same as in August 2011 when Europe came, saw, and did nothing. Yes, yes, deja vu. Bottom line: just as Citi predicted, until the bottom falls out of the market, nothing will change. They were right. As for the summit, just recycle the Einhorn chart from below. Elsewhere, the OECD slashed world growth forecasts and now officially sees Europe contracting, something everyone else has known for months. "In its twice-yearly economic outlook, the Paris-based Organisation for Economic Co-operation and Development forecast that global growth would ease to 3.4 percent this year from 3.6 percent in 2011, before accelerating to 4.2 percent in 2013, in line with its last estimates from late November... The OECD forecast that the 17-member euro zone economy would shrink 0.1 percent this year before posting growth of 0.9 percent in 2013, though regional powerhouse Germany would chalk up growth of 1.2 percent in 2012 and 2.0 percent in 2013." Concluding the overnight news was a meaningless auction of €2.5 billion in 3 and 6 month bills (recall, Bill issuance in LTRO Europe is completely meaningless) in which borrowing rates rose, and a very meaningful downgrade of Japan to A+ from AA, outlook negative, by Fitch which lowered Japan's long-term foreign currency rating to A plus from AA, the local currency rating to A plus from AA minus, and to the country ceiling rating to AA+ from AAA. Yes, Kyle Bass is right. Just a matter of time. Just like with subprime.