Sovereigns

Here Is The Math: Carry Trade Profits From The LTRO Are Woefully Insufficient To Make Any Impact

Following yesterday's €489 billion LTRO there are few things we know with certainty, primary among them is that the net proceeds from the 3 year refi operation are really €210 billion, due to the rolling of various other duration facilities which are already in use into the LTRO as discussed yesterday. What we do not know, is whether the net proceeds of €210 billion have been used by banks to purchase sovereign debt or as Peter Tchir suggested, are actually used in a reflexive ponzi whereby banks use the explicit ECB guarantee to buy their own debt. Perhaps the best evidence that the LTRO was an epic failure when it comes to subsidizing the peripheral bond market is the fact that hours after its completion the ECB was forced to jump into the secondary market and buy up billions in Italian and Spanish bonds: an action that was supposed to be conducted by the banks themselves. But let's assume that the entire €210 billion form the first LTRO (and there certainly will be more) is used to fund carry trades: what then? Well, luckily UBS has performed a mathematical analysis which looks at how much paper profit banks can extract from said trade and juxtaposes it with the most recent €115 billion capital shortfall calculated by the EBA in its most recent stress test (not to be confused with the second to last stress test which saw Dexia pass with the highest marks possible). The result: woefully insufficient . In other words, anyone who believes that the LTRO will be used by banks as a source of carry "profits" is massively deluded. If anything banks will find creative loophole to prop up their balance sheets and issue more of their own debt instead of chasing pennies in front of the bond vigilante rollercoaster by loading up on more sovereigns. Because the last thing Italian banks can afford is another late Novemeber blow out in yields which brought the system to within hours of imminent collapse.

"Weaker Euroland" - Two Unhappy Holiday Jingles

Credit calling, are you listening?
On the horizon, defaults are looming
A dreadful sight,
To see high yield's plight,
Walking in a weaker Euroland.

Without a pledge from the German,
Credit spreads are gonna widen
Who wants to pay?
For the peripheral disarray
Walking in a weaker Euroland.

Guest Post: Worse Than 2008

There are clear signs of a liquidity crunch in the asset markets right now, and the question I keep hearing is, Is this 2008 all over again? No, it’s worse. Much worse. In 2008 there was a lot more faith and optimism upon which to draw. But both have been squandered to significant degrees by feckless regulators and authorities who failed to properly address any of the root causes of the first crisis even as they slathered layer after layer of thin-air money over many of the symptoms. Anyone who has paid attention knows that those "magic potions" proved to be anything but. Not only are the root causes still with us (too much debt, vast regional financial imbalances, and high energy prices), but they have actually grown worse the entire time. As always, we have no idea exactly what is going to happen and when, but we can track the various stresses and strains, noting that more and wider fingers of instability increase the risk of a major event. Heading into 2012, there's enough data to warrant maintaining an extremely cautious stance regarding holding onto one's wealth and increasing one's preparations towards resilience.

Citigroup Analyzes The Failure Of The LTRO, Muses On The Upcoming French Downgrade

Now that the LTRO flop has been digested, one of the more curious explanations for the failure comes from Citi's Steven Englander, who suggests that, surprise, surprise, Italian banks were lying yesterday when they said that they were ready and willing to buy Italian debt with LTRO proceeds. To wit: " One dose of cold water were comments from the Italian Bank Association that EBA rules won’t permit Italian banks to buy sovereign debt – this is a complete reversal from reports yesterday that indicated that Italian bank collateral would benefit from government guarantees in going to the ECB and lead to incremental  Italian bank buying of sovereign debt." Gee: someone lying? NAR who could possibly conceive of that... And more to the point, Englander has an interesting observations on the market reaction to the upcoming French downgrade: "the S&P downgrade of euro zone sovereigns is hanging over the market but there is no definite timing – every day brings one rumor or another of an imminent moves. More concretely there is a chorus of French and euro zone officials managing expectations downward. S&P probably wants to manage the announcement so as to have the least market impact, but it is unclear whether that means doing it when most investors are inactive but liquidity is low or the opposite. At this point a French downgrade is no surprise. A one-step downgrade would be a positive surprise, but downgrading core-core Europe – Germany, the Netherlands, Finland – would still be a negative. Today’s LTRO may be a (reverse) template for the reaction to a downgrade: kneejerk selling followed by a rebound." Well, only one way to know for sure what happens post the downgrade - bring it on.

EFSF At 5-Day Low Despite Sovereign Strength

While the world of risk explodes to the upside on the back of the LTRO-based carry trade expectations (which is not evident at all in some of the more technical relationships across the sovereign space no matter what headlines try and tell you), the very backbone of support for the fiscal evolution that Europe thinks it will achieve is now trading at a five-day low price having dropped notably post the earlier Fitch 'FrAAAnce' announcement. It is simple enough to think that banks will rapidly seek risk and buy sovereigns with their newfound wealth, but looking at CDS-Cash basis (the difference between CDS spreads and bond spreads) there has been almost no shift in supply/demand (which we would expect to tip to bond outperformance if the carry trade were being placed) and moreover, the sovereign spread curves are NOT bull steepening as one would expect from modest reach for say 2Y/3Y peripheral yield versus the 3Y LTRO. The bottom-line seems to be that equity markets are buoyed by a broad risk asset rally (and TSY selling and 2s10s30s rally) while the underlying beneficiary of this 'solution' does not seem to be improving so much. The strength in ES appears like simple momentum off an overshoot yesterday as risk assets broadly never really sold off like ES did and are now holding up well enough for today.

ECB's Stability Review: Seven Charts Of The Sovereign SNAFU

It is no surprise that the ECB has been less than overwhelming in its optimism, unlike Messers Barroso, Van Rompuy et al. when discussing the current and future state of the union that is Europe. While not pessimistic per se, the focus on zee stabilitee and lack of bazooka (no we don't see the 3Y LTROs as a magic bullet) is perhaps related to their view of the difficulties faced in addressing the needs of an increasingly disparate gaggle of countries. In their December Financial Stability Review, the ECB points to four key risks: (contagion, funding, macroeconomy, and trade imbalances), they fear "euro area financial stability increased considerably in the second half of 2011, as the sovereign risk crisis and its interplay with the banking sector worsened in an environment of weakening macroeconomic growth prospects". Summarizing into seven charts, the ECB provides a quick-and-dirty perspective on what is increasingly becoming obvious as capital flows and funding needs interplay with one another (for worse rather than better).

Moody's On Systematic Bank Downgrades

The financial crisis of the last few years has created not just a perceived shift in the creditworthiness of our financial entities but a real crack in the foundation of their business model and more importantly any explicit or implicit supports or guarantees. Moody's, in a special report on credit post crisis "The Great Credit Shift" look at the impact of the crisis on every major asset class within the credit space from sovereigns to corporates to structured finance. Noting that this crisis has profoundly changed the credit picture for sovereigns and financials, Moody's note there is some dispersion in the latter as banks have seen systematic downgrades while insurers (for now) remain on par with pre-crisis levels. More interestingly, large US regional banks represent an exception to this broad downgrade but we suspect that the continued low interest rate, low NIM, and high volatility spread environment will cause both insurers (we have long considered proxies for HY portfolios, no matter how well cushioned from vol their business models may be) and US regionals (consolidation will have the opposite effect of TBTF in our view as it will lead to more comfort with more risk-taking and expose them to more current-bank-like volatility) to face more pressure going forward (despite their lower apparent sovereign risk exposure). As BofA and Morgan Stanley trade at extreme 'crisis' levels in both CDS and equity markets, we suspect the raters have further to go and while the systemic shifts are apparent, we would expect less and not more differentiation going forward - especially if we sink into another solvency crisis.

Thunder Road Report Update: "Dear Portfolio Manager, You Are Heading Into A Full-Spectrum Crisis."

Paul Mylchreest, author of the Thunder Road, releases his much anticipated latest report, and it's a doozy: "2012: Dear Portfolio Manager, you are leaving the capitalist sector and heading into a full-spectrum crisis." He continues: "You were to hear a report on the world crisis. That is what you are going to hear. For twelve years you have been asking: Who is John Galt? This is John Galt speaking….Now it’s  getting serious. 2012 will be a year to remember as the globalist agenda comes into focus amidst economic and geo-political crises: The titles of the last two Thunder Road Reports were prefaced with “Helter Skelter” - “The Illusion of Market Stability” followed by “Gentlemen Start Your Engines”. Sadly, the Helter Skelter I was writing about – the second part of the Great Financial Crisis is in progress and I’m expecting it to come to a head next year (2013 if we’re very lucky). The only question is WHAT brings it to a head? We’re not short of possible causes – a bank failure, sovereign default, Eurozone tipping into recession or the Middle East. Despite all the evidence to the contrary, like overwhelming debt levels and insolvent banks/sovereigns, the consensus seems convinced that we can “muddle through”. Dow Theory veteran, Richard Russell, explained it best: “In the coming two or three years we will be going through unprecedented situations beyond the understanding of most analysts.”"

The MF Global Trade Is Not Coming To (European) Town - Why The ECB's 3 Year LTRO Is The Latest Bailout Flop

On Friday, as the Eurobond market was briefly soaring, we attributed the move to sentiment that was best captured by a note out of Morgan Stanley's govvie desk: "The carry trade is happening, there is no doubt about it. In SPGBs (45bps tighter t0) we estimate 15-20bn (incl 6bn auction) of buying from domestic mid sized banks and cajas THIS WEEK (500mm is usual 2way trading volume per day). We are seeing the same starting with Italian mid tier banks in BTPs today (35bps tighter t0). Also Ireland seems to be very well bid up to 2016 maturities (75bps tighter on day). While Huw and Laurence anticipated this in their research piece on the LTRO from yesterday, we certainly did not expect it to be this intense and front loaded, this is the strongest buying we have seen all year, it feels a lot like QE." In simple summary, what MS was hoping and praying (because if clients are buying, MS is selling) its clients would believe, is that European banks would promptly forget that Europe has trillions of rolling over financial corporate debt, and instead of focusing on generating the cash needed to pay down maturities if no buyer stepped up, banks would somehow re-lever, by buying up even more sovereign debt in hopes of catching a few bps of carry, and completely ignoring the "#1 issue at the heart of the Eurozone crisis"TM - the fundamental supply/demand paper maturity mismatch. Not to mention that any statement which needs the redundant "there is no doubt about it" is a 100% lie. It took the market about 3 hours to wake up from its zombified state and to do a 180, proceeding to rapidly sell off European debt following the realization that the Morgan Stanely thesis is nothing but a purely self-serving lie. The folks at Reuters IFR explain why MS completely botched this one up, and why Eurobanks are finally starting to wake up to the realization that the MF Global trade just may not be coming to town.

Saxo Bank's 10 "Outrageous Predictions" For "2012: The Perfect Storm"

As we wind down 2011, the time for predictions for what is to come as nigh. Having posted what UBS believes their biggest list of surprises for 2012 will be earlier, we next proceed with out long-term favorite - Saxobank's list of "Outrageous Predictions" for what the bank has dubbed "2012: the Perfect Storm." Mostly proposed tongue in cheek (unlike predictions by other pundits who actually believe their own delusions), the list of 10 suggestions represents nothing less than an attempt to force people "out of the box" and look at the world with a set of "what if" eyes. Because if there is anything 2011 taught is, it is not to discount any one event from happening. As Saxo says: "Should one, two or three of our Outrageous Predictions come to pass, it would make 2012 a year of tremendous change. This may not necessarily be a negative thing either - and given the  structure and uncertainties in the marketplace here at the end of 2011, we would suggest that even if none of our predictions come to pass, equally important and totally unanticipated events will. Sometimes we need to get to a new starting point before we can gain the right perspective. We hope 2012 will be the year where we start on the long march towards re-establishing jobs, growth and confidence." Naturally, the best outcome for 2012 would be the end of the broken status quo model, and a global fresh reset... but not even we are that deluded to believe that the quadrillions in credit money (real or synthetic) will allow such a revolutionary event to occur in such a brief period of time. At least not before everything is thrown at the intractable problem unfortunately has just one possible long-term outcome. In the meantime, here, to help readers expand their minds, is Saxo Bank's list of "Outrageous Predictions" for 2012.

Fitch Revises French Outlook To Negative

We spoke to soon: it appears suicide is painless after all, as Fitch just changed the French outlook to negative.The punchline: "The Negative Outlook indicates a slightly greater than 50% chance of a downgrade over a two-year horizon." As for the line that will finally shut up France in its diplomatic spat with the UK: "Relative to other 'AAA' Euro Area Member States, France is in Fitch's judgement the most exposed to a further intensification of the crisis." And now, the market shifts its attention to non-French rating agencies, who will downgrade France in a "slightly" shorter timeframe... more like 2 hours according to some rumors.

And The Euro Downgrade Hits Just Keep On Coming, This Time Fitch

Never a dull Friday when dealing with continents that have a terminal solvency, pardon, liquidity crisis.

  • FITCH PLACES BELGIUM, SPAIN, ITALY, IRELAND, SLOVENIA AND CYPRUS ON RATING WATCH NEGATIVE

Shockingly, French-owned Fitch has nothing to say about... France.

ECB Liquidity: Back-Door Bazooka Or Suspension Of Democracy, BARCAP Opines

The market's reaction to Draghi's comments over the last week have been visceral in its schizophrenia. While his 'temporary' provisions, three-year LTROs specifically, provide a life-line of liquidity (a la TLGP - and how is that working out for the US banks having to roll now?), they hardly address the real underlying problem of the vicious circle between sovereign debt's now-risky nature and financial balance sheets bloated with zero-risk-weighted re-hypothecated peripheral bonds. The last week has seen a roller-coaster of Senior-Sub debt decompression and compression, liquidation-like drops in commodities, lower correlation across European sovereign debt, and significant dispersion in high- and low-beta equity and credit markets (notably as we have previously discussed, some of which will have been driven by index roll technicals). The issue comes down to whether this is the Bazooka (buy-buy-buy) or not enough (fade-the-rallies) and BARCAP's macro sales and European Banks' research team have, like the rest of the market, been exchanging views on this perspective. While their take on the liquidity explosion is that it doesn't solve the almost unsolvable solvency problem but it the deeper insight that perhaps it is not the actual mechanics of this liquidity bazooka but the perception that democracy itself has been suspended in favor of bank and sovereign survival that interests us more. Furthermore, they do an excellent job on breaking down the mythical carry trade potential of these LTROs and mutual sovereign financing benefits since near-term (carry-trade) profit potential would be offset by additional sovereign risk - meaning that funding markets could stay closed for longer. Once again the issue of collateralization, risk-weightings, and deleveraging are front-and-center as bank 'managers' and politicians may be at loggerheads on the carry-trade-savior potential and the ECB's status on the balance sheet only serves to further subordinate existing bondholders.

Market Snapshot: European Dispersion And The CDS Roll

Next week, credit derivatives will roll from December to March maturities. The last couple of days have seen increasing dispersion across sovereign, and corporate equity and credit markets in Europe. The modestly bullish bias to credit index moves, while not totally dismissible as optimism, is likely to have a number of technical drivers implying that investors should not read too much into the compression. Liquidity has dropped notably in both single-name and index products recently and credit derivative dealers have increased the spread between the bid and the offer accordingly - this means the roll adjustment may be even more expensive this time around and for traders with a book full of single-name CDS, positioned more short, the bias will be to sell index protection to 'hedge' some of that roll-adjustment. The other technical is the indices swung once again from rich to cheap into the middle of this week (meaning the indices trade on a cheap basis to the cost of the underlying components) and so heading into a roll, arbitrageurs will want to rapidly take advantage of this - especially in the high-beta XOver and Subordinated financials space. So, all-in-all there has been some optimism in credit markets the last two days but as-ever we pour some sold water on the excitement as all-too-likely this is driven by roll and arb technicals, as opposed to a wall of risk-hungry buyers.