Sovereigns

The Hill Just Killed The Market - Stocks, Euro Stumble As Conservatives Push To End IMF Bailout

As rumors and chatter circulate across trading desks, European equity and credit markets are starting to lose their giddiness. European sovereigns are leaking back wider and financials starting to underperform and it is being noted that, as reported by The Hill, that conservatives say they will try to block the IMF from bailing out Italy and Spain. Pointing to the huge bill this could leave at US taxpayer's feet, Republicans are concerned at the secrecy with which Geithner has acted. Sen. Tom Coburn appears to be at the helm of this legislation, noting:

"We're throwing good money after bad down a hole that I think is not a solvable problem. Europe is going to default eventually, so why would you socialize their profligate spending."

As we have been saying all along, with every reincarnation of the idiotic "IMF to bailout [XXX]" rumor, there always is just one snag. A rather substantial one at that: US congressional approval for expanded IMF bailout capabilities.

Fiscal Federalism Or Bust! Morgan Stanley Sees Dec 9th As Real European D-Day

We have often discussed the temporary and tenuous nature of any and all government-suggested solutions so far to the European crisis on the basis that the 'model' is broken. Following the decision to go for PSI, and the possibility of a sovereign leaving the Euro-zone (Greek referendum ultimatum), money is no longer fungible in and across European banks (deposits) and sovereigns as it seeks the stability of a narrower and narrower core. Arnaud Mares, of Morgan Stanley, who wrote the initial and definitive Greek story long before most others, brings up this very point; questioning the fungibility of Greek Euro deposits with French Euro deposits, for example, and interpreting the situation as a 'run on banks and governments'. His view that without a clear path to a fiscal lender of last resort - or a true fiscal federalism across a united Europe - which ensures solvent governments will never go illiquid, then the December 9th decisions mark a bifurcation point of critical import.

If governments choose to engage on the route to fiscal federalism, we believe that this does not mark the end of the crisis. It could, however, mark the beginning of the end of the crisis, as it would be a decisive first step towards stabilisation and a European federation. The alternative could well be the beginning of the end for the European confederation.

Europe has to choose between debt assumption (enhanced federal control of national budgets accompanied by centralised funding of governments) and a debt jubilee (wide-scale debt repudiation), with all the social, economic and political consequences this entails. Mares' four-question-framework for considering the words and deeds of December 9th is critical, though complex, reading to comprehend the tipping point we are at.

Dismal End To Day After In Europe

Just when you thought it was safe to go all-in buying financials, stocks, commodities, Chinese IPOs and even Tilson's fund, the last few hours of Europe's day was very disappointing. Commodities took a fairly serious plunge as the dollar strengthened (macro data? or just a reality slap). Credit and equity markets oscillated but legged down into the close and ES also slipped to day's lows as we closed. Sovereigns were on a tear, thanks obviously to a helping hand early on from ECB's SMP program, but even they started to leak back wider in spread and higher in yield into the close. It was not cataclysmic, obviously, but was hardly the follow-through risk-on day that so many had hoped and dreamed of last night and most notably, broad risk assets in general have been leaking lower since US close last night, leaving ES rich relative to CONTEXT.

Is The Risk-On Rally Real?

Whether its non-confirming volumeless rallies in stocks, hard-to-find collateral, sovereign risk, counterparty risk, USD funding stress, GDP growth dislocations, EM credit dispersion, or equity market outperformance, Nomura's EEMEA FX and Fixed Income team has a little for everyone in today's '10 Things We Did Not Know'. Today's obvious risk-on knee-jerk-response rally is perhaps not so broadly supported even as Ben's promise trumps a totally failed Grand Plan.

Market Snapshot: European Close

Equity and Credit markets rallied significantly on the day with credit catching up to equity's recent strength in an unusually biased move. The higher beta XOver (high yield European credit) and Subordinated financial credit outperformed close to close but lags overall relative to equity and investment grade credit, suggesting less than stellar demand to lay out new risk and more likely shorts covering in a hurry. Seniors underperformed Subs in financials - again suggesting some covering on the SEN-SUB decompression trade on the back of the ratings actions this week. Sovereign spread moves were actually largely unimpressive with spread curves flattening, some decompressing, and the fulcrum security BTPs, not exactly ripping across the curve.

Market Reaction To Global Bailout, Sovereigns Disappoint

Risk markets are tearing higher globally with equities, commodities, and credit all considerably higher. Equities and CONTEXT are back in line as this is a very systemic shift up as the dollar tanks and TSY yield surge. US equities are back to 11/18 levels but are stalling out a little here as the initial spike wears off - whether this liquidity surge fixes the insolvency crisis is the question it seems markets are considering now that they have had some time to think (and squeeze). Silver and Copper seem the largest movers for now along with AUD relatively speaking as most equity and credit assets are back to 11/18 levels. We do note that while sovereign spreads in Europe are narrower, the moves are not dramatic and in some cases are actually deteriorating still.

Goldman's Sigma X Spot On Once Again: Predicts Imminent UK Contagion

Last Wednesday we put up the following blurb: "Five months ago, when Italian yields were still tame in the 3% ballpark, and not 7% where they are today, we suggested that based on trading patterns and overall volume in Goldman's dark pool, Italy may be about to experience a "Greek episode." Days later we were proven right as Italian yields and spreads started their relentless move wider, with only those who had access to Sigma X being able to get an advance whiff of what was about to happen. Well today we are happy to report that the German diversion may have worked: the truth is that nobody appears to care about Germany. Instead what everyone does seem to care about, is the nation with the greatest combined debt (government, corporate and household) to GDP in the world. Yup. The UK." Following that, a quick Twitter update from this morning indicated something was again going on with the UK from the perspective of the world's most connected insiders: "UK's LLOYDS and RBS top of most active on Sigma X this morning." Sure enough, here's Fitch with what may well be a precursor to the bond vigilantes finally focusing their attention on the last, latest and greatest AAA credit.

  • FITCH: UK GOVT MAY BE MOST INDEBTED OF AAA SOVEREIGNS EX U.S. -BBG
  • FITCH: NEW UK FISCAL VIEWS 'SIGNIFICANT DETERIORATION' VS MARCH - BBG
  • And the punchline: "the capacity of UK public finances to absorb adverse economic and financial shocks that would result in yet higher public debt while retaining its 'AAA' status has largely been exhausted"

And cue the imminent downgrade rumors - and ensuing safe-haven outflows to TSYs.

Credit Sanity Check

Once again this morning, credit markets are deteriorating with financials the notable laggards and yet equities in US and Europe are beating to their own 'Birinyi'drum. European sub financials are the worst performers, which makes sense post the Moody's downgrade concerns, but the scale of recovery this week is incredible in terms of equities post Friday rally relative to credit market's perception of reality. At the same time, Italian all-in cost of funding - yields - are near record highs post auction, even if spreads are flat and off the highs.

Gross On The Futility Of The European Deus Ex Machina: "A French/German Guillotine Hangs Over The Markets"

Bill Gross continues with his rational Keynes bashing with the following statement from his latest monthly piece just released: "What has become obvious in the last few years is that debt-driven growth is a flawed business model when financial markets and society no longer have an appetite for it. In addition to initial conditions of debt to gross domestic product and related metrics, the ability of a sovereign to snatch more than its fair share of growth from an anorexic global economy has become the defining condition of creditworthiness – and very few nations are equal to the challenge." In addition he also meaks it all too clear why the sudden reappearance of the Federal states of German-funded Europe proposal is a dead end: "On the fiscal side the EU’s solution has been to “clean up your act,” throw out the scoundrels and scofflaws (eight governments have fallen) and balance your budgets. Such a process, however, almost necessarily involves several years of recessionary growth and deflationary wage pressures on labor markets in the offending countries." Gross picturesque analogies never fail to amuse (maybe not the French though): "The ultimate vote of the working men and women in these countries will always hang over the markets like a Damocles sword or perhaps a French/German guillotine. If the axe falls, then bond defaults may follow no matter what current policies may promise in the short term." That's right. He went there. As for his conclusion, he is spot on: "Investors and investment markets will likely be supported or even heartened by recent days’ policy proposals. The problem of Euroland is twofold however. First of all, they will remain a dysfunctional family no matter what the outcome. You can’t tell a German much, and while they can issue what appear to be constructive orders and solutions to the southern peripherals, there is little doubt that none of them will “like it very much.”....Secondly, and perhaps more importantly however, investors should recognize that Euroland’s problems are global and secular in nature, reflecting worldwide delevering and growth dynamics that began in 2008." And that's it folks: Europe will never submit to a federalist union controlled by Germany. And even if it does, it is not just Europe that is broken. It is the entire world.  Speaking of broken marriages, we wonder just how many CDS Gross is long parent risk-soaring Allianz?

Citi: "Forget Decoupling" - Here Is How To Trade During The Sovereign Trauma

We have been strong proponents of various relative-value (RV) trades as this highly volatile and increasingly binary world infers more Knightian uncertainty than any normal strategist, talking-head, fringe blog can cope with. What is frustrating nevertheless is the degree of confidence that many economists and strategists forecast directional bets only to fail miserably (and rapidly). Refreshingly, Citi's European credit research team take a similar perspective to ours on the current policy uncertainty and expect nothing less than spreads to keep oscillating wildly in 2012 (between depression and muddle-through). Their crucial insight is to tie the evolving crisis to the Kubler-Ross stages-of-grief and recognize that expecting a decoupling (or lower correlations between and within asset classes) is only for those in denial - trade the phases of the crisis instead (focusing on exploiting the asymmetries and dislocations as opposed aggressive directional bets). Only when there is a credible lender-of-last-resort with public funds enough for Italy and Spain will it be safe to get long and earn carry once again. Falling back on strong fundamentals and balance sheets becomes moot in their eyes (and we agree) as there are simply too many linkages from sovereign stress - "Strong corporate fortifications...are built on shaky sovereign foundations".

Subordinated European Bank Debt Face Broad Downgrades, Moodys

Perhaps this helps explain the significant underperformance of European and US bank credit today as tonight we get the full downgrade watch treatment for all European bank subordinated debt. Moody's will review 87 banks in 15 countries with the view that average downgrades will be two notches for sub debt. The initial premise for the actions is the removal of government guarantees as they believe systemic support for subordinated debt is more uncertain. The greatest number of ratings to be reviewed are in Spain, Italy, Austria and France. The EURUSD is down around 20 pips on the news and ES 4-5pts.

Fitch Revises US Outlook To Negative

French Fitch strikes back at the US for not pushing the Fed to do more to bail out Europe. Now it is US Moody's and S&P's turn..."  The Negative Outlook indicates a slightly greater than 50% chance of a downgrade over a two-year horizon. Fitch will shortly publish its revised economic and fiscal projections for the U.S. and will conduct a further review of its sovereign ratings in 2012. However, in the absence of material adverse shocks, Fitch does not expect to resolve the Negative Outlook until late 2013, taking into account any deficit-reduction strategy that emerges after Congressional and Presidential elections."

ES 13 Points Rich To Intrinsic Risk Value

Since just before the US equity day session open, ES has diverged dramatically from what was a highly correlated trajectory with global risk assets with ES now 13pts higher than the broad basket of risk assets would suggest. European credit markets are rolling over - notably off their highs, European sovereigns are leaking wider (BTPs from -25bps to -10bps now and Portugal +75bps), US TSYs are 6bps off high yields of the day and 2s10s30s is dropping fast, Oil has cracked back through $99 (2.5% off highs), and AUDJPY is losing steam. European financials were underperforming in credit-land and now we see US financials drop from best performer to sixth (admittedly still +3%) as EURUSD starts to leak back into the EUR close.