Sovereigns

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.

Moody's: "The Probability Of Multiple Defaults By Euro Area Countries Is No Longer Negligible"

If all it takes for the ES to soar by over 30 points is some propaganda about US consumer spending (pretty much ridiculed by all at this point), and two outright lies about Europe being fixed, the following factual statement by Moody's should certainly send risk soaring now that bizarro mode is fully on: "over the past few weeks, the likelihood of even more negative scenarios has risen. This reflects, among other factors, the political uncertainties in Greece and Italy, uncertainty around the final haircut imposed on holders of Greek debt, the emphasis in the recent Euro Summit statement on the conditional nature of the existing support programmes and the further worsening of the economic outlook across the euro area. Alternative outcomes fall into two broad categories: those involving one or more defaults by euro area countries (in addition to Greece's PSI programme); and those additionally involving exits from the euro area. The probability of multiple defaults (in addition to Greece's private sector involvement programme) by euro area countries is no longer negligible. In Moody's view, the longer the liquidity crisis continues, the more rapidly the probability of defaults will continue to rise." Oddly enough, for once Moody's is not alone.

Daily US Opening News And Market Re-Cap: November 28

  • According to La Stampa, the IMF is preparing a EUR 600bln loan for Italy, in case its debt crisis worsens, although the report was swiftly denied by IMF officials
  • Several papers reported that Germany is considering the option of joining the five other AAA-rated Eurozone member states to issue common bonds. However, the German finance ministry dismissed the report later in the session
  • Particular narrowing was observed in the Belgian/German 10-year government bond yield spread partly after Belgian negotiators reached an accord on the country's 2012 budget during the weekend, together with well received OLO bond auctions from Belgium

Goldman: "As The Endgame Approaches, The Rally In AAA-Euro Area Sovereign Bonds No Longer Seems Sustainable"

Goldman Sachs has for the time being been very quiet in joining all of its colleagues from around the street in screaming for an immediate intervention by the ECB or else. The reasons are glaringly obvious: with a Goldman alum in charge of the ECB, and a 23 year Goldman veteran acting as ambassador to Germany, whatever Goldman wants, Goldman will get, without the need for convincing pitchbooks and dramatic expostulations that the world is ending unless... Intuitively it makes sense for Goldman to wait: after all why not take advantage of the situation a la Bear and Lehman, and wait for 3-4 major European banks to collapse, which will be the green light for Goldman to do what it does best: step in and fill the financial and power vacuum. Needless to say, when UniCredit, Commerzbank or Raiffeisen are down, the ECB will have no choice but to intervene with or without the Fed's help. Which is why anyone looking for clues as to what will happen in Europe has to focus on Goldman alone as we already know too well how everyone else is axed. Luckily GS' Francesco Garzarelli and Huw Pill have just released a much overdue note presenting just how the firm feel ont he topic of Europe's continuation as a going concern, or, alternatively, collapse. While we present the full note below in its entirety which naturally seeks to avoid broad panic, here are some notable extracts from a nuanced read: "considering how much damage to confidence has now been inflicted, one must also entertain the possibility that the intensification of market tensions and/or deterioration of economic activity reinforce each other feeding domestic political and social pressures precluding a final agreement among EMU member states from being reached. In this case, rather than being the ‘forcing mechanism’ that drives agreement, the economic and financial environment could feedback into the political process in a negative way, leading to a vicious downward spiral and, ultimately, to the failure of the Euro project." Simply said "an alternative scenario of a ‘break-up’ of the Euro area certainly cannot be ruled out", which leads to Goldman's conclusion: "For the same set of reasons, as the ‘end game’ approaches the rally in AAA-rated Euro area sovereign bonds (Germany’s especially) no longer seems sustainable and could reverse in coming weeks. In our base case of more intrusive control on future deficit financing, the core countries will, in exchange, have to shoulder a greater part of the legacy credit risk of their peers if they want to keep EMU alive. In a ‘break-up’ scenario, the creditor ‘core’ countries will be confronted with a wave of insolvencies, which would also worsen their fiscal position. And in the middle ground between these two outcomes, where we currently stand, the ECB will be intermediating growing intra-Eurosystem imbalances. Through this monetary channel at the heart of EMU, the ‘shadow’ credit risk of the core countries is already rising, and at an increasingly rapid pace." As expected, it appears that Goldman sure will like occupying those European bank HQs for about $1 in equity.

European Equity And Credit Diverging As Sovereigns Implode

European sovereign credit curves are bear flattening (inverting wider) in almost all cases as short-dated yields breaks to new records in several names. At the same time, European credit is breaking to new lows in Corporates and financials with Subordinated financials underperforming. Somewhat strangely - though not exactly surprising given the market's behavior in the last few weeks - European equities are holding up as they ignore the reality priced into credit. It seems equities see the light at the end of the tunnel, but credit knows its an oncoming train. US markets are in sync with the broad risk-asset basket (CONTEXT) for now but correlations are tending to be much lower than on average so far.

Behold The New Anschluss: ECB's Paramo - "Prepare To Give Up Significant Sovereignty"

The only quote worth noting from the just delivered speech by ECB executive board member José Manuel González-Páramo is the following: "We cannot completely delegate governance to financial markets. The euro area is the world’s second largest monetary area. It cannot depend solely on the opinions of ratings agencies and markets. It needs economic governance arrangements that are preventive and linear. This underscores my central point that a much more comprehensive approach to economic governance is now the priority for the euro area. And this means more economic and financial integration for the euro area, with a significant transfer of sovereignty to the EMU level over fiscal, structural and financial policies." In other words, in order to protect people from the "stupidity" of rating agencies which after years of lying have finally started telling the truth, and the market which does what it always does, and punishes those who fail, Europe must be prepared to give up "significant sovereignty" (sounds better than Anschluss) to Europe's "betters" which is another way of saying 'he who pays the piper calls the tune." And "he" in this case is, of course, Germany. In other words, courtesy of one failed monetary experiment Germany will succeed, without sheeding one drop of blood, where it failed rather historically some 70 years ago.

Devastation In Adjusted Euro-Sovereign Basis Trade Resumes: Generali And Allianz CDS Update

Continuing our coverage of our favorite European implosion derivative trade for entities which, unlike countries, are not too big to fail, namely Italian and German mega insurers loaded to the gills with Italian and other Euro sovereign debt, Generali (ASSGEN) and Pimco parent Allianz (ALZ), we find that their CDS continue to implode (or soar as the case may be), more or less as expected. We anticipate that more and more traders will proceed to switch basis trade hedges not with sovereigns (where the CDS is now clearly defunct) but with sovereign derivatives such as insurers which can certainly fail (at least for the time being). In the meantime, below is a refresh on how ASSGEN and ALZ has done since we suggested buying protection in the two companies.

Fitch Pours A-98 Gasoline On The European Fire, Threatens AAA Rating Of Parent France

It just goes from bad to surreal in Europe where the latest moment of pure Greek "gods kill titans" tragicomedy, comes from French rating agency Fitch threatening to cut... France? Excerpts via Bloomberg:

  • FITCH: FRANCE CAN'T ABSORB MORE SHOCKS WITHOUT UNDERMINING AAA
  • FITCH: FRENCH AAA WOULD BE AT RISK IF CRISIS INTENSIFIES
  • FITCH: ADDED MEASURES LIKELY NEEDED FOR FRANCE '13 DEFICIT GOAL
  • FITCH PROJECTS FRANCE DEFICIT IN '13 ABOUT 4% OF GDP

 

From Bad To Worse As Europe Opens

The overnight news of worries over Dexia's bailout deal and the weak Chinese PMI print did nothing to help the generally poor sentiment as the US closed on the stress test news. Equity and Treasury Futures (as cash was closed in Tokyo) were in risk off mode but stabilized with ES around 1170 (-1% from US close). With Europe opening and TSYs trading once again, CONTEXT shows that the sell-off is broad based and supports equity weakness for now. European sovereigns are opening generally higher in yield and spread across the board with Ireland the stand-out currently. France and Belgium are also weak performers (Dexia?) followed by Italy and Spain. European credit has gapped down on the open with senior and sub financials worst performers (+7bps and +14bps respectively) followed by XOver and Main (+11bps and +3.5bps) - in line with US underperformance for now. Bloomberg's BE500 equity index just opened gap down around 1% but is outperforming credit for now as EURUSD touches 1.3440 again.

Guest Post: As The World Crumbles: The ECB Spins, FED Smirks, And US Banks Pillage

Most of the media goes along with the notion that US banks exposed to the ‘euro-contagion’ will hurt our (nonexistent) recovery. US Banks assure us, they don't have much exposure - it's all hedged. (Like it was all AAA.) The press doesn't tend to question the global harm caused by never having smacked US banks into place, cutting off their money supply, splitting them into commercial and speculative parts ala Glass-Steagall and letting the speculative parts that should have died, die, rather than enjoy public subsidization and the ability to go globe-hopping for more destructive opportunity, alongside some of the mega-global bank partners. Today, the stock prices of the largest US banks are about as low as they were in the early part of 2009, not because of euro-contagion or Super-committee super-incompetence (a useless distraction anyway) but because of the ongoing transparency void surrouding the biggest banks amidst their central-bank-covered risks, and the political hot potato of how many emergency loans are required to keep them afloat at any given moment.  Because investors don’t know their true exposures, any more than in early 2009. Because US banks catalyzed the global crisis that is currently manifesting itself in Europe. Because there never was a separate US housing crisis and European debt crisis. Instead, there is a worldwide, systemic, unregulated, uncontained,  rapacious need for the most powerful banks and financial institutions to leverage whatever could be leveraged in whatever forms it could be leveraged in. So, now we’re just barely in the second quarter of the game of thrones, where the big banks are the kings, the ECB, IMF and the Fed are the money supply, and the populations are the powerless serfs. Yeah, let’s play the ECB inflation game, while the world crumbles.

Japan's Kokusai Liquidates Remainder Of Euro Sovereign Exposure, Just As European Primary Issuance Supply Surges

When we discussed the specifics of the ongoing European bank run, we cited from the NYT which noted the actions of a core Japanese mutual fund with European sovereign exposure, namely that "earlier this month, Kokusai Asset Management in Japan unloaded nearly $1 billion in Italian debt." The Nikkei has just reported that this was merely the beginning: "Kokusai Asset Management Co. has sold all Spanish and Belgian government bonds that were part of its flagship fund, Global Sovereign Open, The Nikkei learned Monday. As of Nov. 10, Spanish and Belgian bonds accounted for 1.8% and 3.1% of the fund, respectively. The share of the bonds in the fund's portfolio fell to zero as of Thursday." Just what prompted this drastic move and very loud slap in the face of the European confidence building exercise? "A Kokusai Asset Management official said the company sold off the bonds, amid widespread concerns about the outlook for Europe's sovereign debt crisis to avoid hurting the value of the fund, given volatile prices of the bonds. The mutual fund operator had already divested the fund of all its French government bonds in October and all Italian bonds in early November." It is safe to say that where one core asset managers has been (and no longer is), everyone else will shortly follow. For the simple reason that it is now if not cool to not have European exposure, it is certainly required by one's LPs to cut down on all European bonds. Kokusai is merely the canary: expect everyone else to go ahead and dump the €741 billion in non-domestically held Italian (and then all other European sovereigns) bonds. Good luck ECB buying these in the secondary market. And one market where the ECB can do nothing by charter, is the primary issuance one, where as the following update from Morgan Stanley shows, things are getting from from bad to worse.

Buyers Of Last Resort: As Dumping Accelerates, Here Is Who Is Stuck Buying Another €741 Billion In Italian Bonds

Spoiler alert: There will be no surprise "I see dead bondholders"-type ending here. Having suggested precisely what the BTP trading dynamics look like previously, we now get official confirmation. With everyone else dumping Italian bonds in the open market, there are only two parties on the bid side: the ECB, and Italian banks. That's it. The only question is "how much" in order to determine at what point the selling onslaught will overhwhelm both insolvent Italian banks whose Risk Weighted capital will soon become too high forcing them out of the market, as well as drag down Draghi's recently expanded bond buying desk (we would say trading, but that would imply a two way market). Here is Barclays with the full breakdown: "Italy’s government bonds, representing the largest bond market in Europe, or the third largest in the world, have been particularly unstable since the beginning of July. The sheer size of the €1.6trn outstanding stock, of which around €220bn of bonds and €120bn of bills are rolled over every year, begs the questions who will be the buyers going forward. We thus update the breakdown of Italian bond holders which we presented in July (see Who Owns Italy's Government Debt? July 29, 2011), and analysed who has been selling and buying between the beginning of July (when widening started) and end of September (as of the latest available data). ECB has been the main buyer since August 8th, and held 4% of the Italian bond market as of September. Domestic holders, mainly financial institutions (banks) have gradually increased their holdings, taking domestic holding from 55% to 56% of the total market. Foreign investors, consisting of European non-Italian banks and real money investors as well as international asset managers, have been the main seller of BTPs, reducing their holdings from 45% to 39%." As said earlier - nothing at all unexpected: everyone who can get out is getting out. The only buyers are those for whom selling equates to suicide. That said, we wish Italian banks and the ECB the best of luck as they seek to purchase the €741 billion in bonds that are still to be offloaded as Merkel persists in refusing to let the ECB even considering announcing monetization intentions.