UPDATE: *ITALIAN TWO-YR NOTE YIELD RISES ABOVE 5%, 1ST TIME SINCE JAN 11
While every wannabe bond-trader and macro-strategist can quote 10Y Spanish yields, and maybe even knows what the front-end of the Spanish yield curve is doing (and why), there are three very significant events occurring in the Spanish sovereign credit market. First is the inversion of the 5s10s curve (5Y yields were above 10Y yields at the open today); second is the velocity with which 2s10s and 5s10s have plunged suggesting a total collapse in confidence of short-term sustainability; and perhaps most critically, third is the record wide spread between the bond's spread and the CDS (the so-called 'basis') which suggests market participants have regime-shifted Spain into imminent PSI territory (a la Greece and Portugal) as opposed to 'still rescuable' a la Italy for now. As we pointed out earlier, there is little that can be done (or is willing to be done) in the short-term, and the inevitability of a full-scale TROIKA program request is increasingly priced into credit markets (though its implicatios are not in equities of course).
Just as the summer finally arrives in Northern Europe, the Eurozone crisis is heating up once again. With an increasingly flat (heading to inversion) yield curve, and spreads at record wides, Spain appears to be in a downward spiral of market turmoil that might require a full-fledged TROIKA bail out. However, as UBS points out, rather than taking the country off the market, the program would have to allow Spain to keep borrowing from private investors. Any bail out of Spain would have to be designed in a way that would also be applicable to Italy. Spain has been the most recent crisis focus, and looks to intensify further with nothing immediately in sight that could reverse the trend. We, like UBS, have argued for some time that a full-fledged TROIKA program will ultimately be unavoidable and the following six reasons briefly explain why anything else is a pipe-dream - as we remember Draghi's recent shift: "creditors should be part of the solution of the crisis. It is a matter of limiting the involvement of taxpayers. They have already paid a great deal."
While Monti claims there is no need for an emergency summit and Spain and Italy ban short-sellers (but not long-sellers yet), Europe's Dow-equivalent is down around 2.5%. Interestingly Italy and Spain 'bounced' off ugly lows intraday (which we are sure Monti/Rajoy are patting themselves on the back briefly) but France's CAC40 and Germany's DAX were sold hard - both down around 3% (as proxies as much as contagion-gatherers). More critically, equities are catching down to European credit markets. European financial credit is now notably wider than pre-Summit levels but it is the front-end of the Spanish and Italian sovereign yield curves that has been absolutely monkey-hammered in the last few days. Spain 2Y is now at 16 year highs in yield (biggest 1- and 2-day jumps in over two years) but all-time record wides in spread as we await for the ultimate death cross of inversion to signal the approaching endgame. EURUSD hovered around 1.2100 (down around 50 pips from Friday) and while oil prices slumped, Brent priced in EUR remains above its levels 2 months ago. Meanwhile, Swiss 2Y rates are at a new record low of -44.4bps, German 2Y same at -8bp, and Denmark remains -31bps - though we do note some of the other higher quality 2Ys leaking a little higher in yield such as Austria and France.
While it seemed somewhat inevitable given the trend, the dismal reality from Europe has sent investors scurrying for the 'safety' of the US Treasuries overnight. The entire yield curve has fallen to all-time record lows with 10Y trading below 1.40% and 30Y below 2.48%. 7Y - the seeming cusp of Twist - is below 90bps now and 2Y below 20bps. The shortest-dated T-Bills still trade around 4-6bps (as opposed to the deeply negative rates in Switzerland and Germany this morning with FX risk premia expectations, and Twist+, affecting this differential). Not a good sign at all - and definitely not yield curve movements on the basis of renewed QE as we see stock futures plunging to the old new reality (as those pushing dividend yields as the 'obvious move here may note that since Friday's highs, you've lost half a year's dividend as equity capital has depreciated 2%). Perhaps the sub-1% 10Y we noted yesterday is not such a crazy idea after all...
There is no mystery to the “headwinds” that continue to plague and mystify monetary policymakers. The global economy is not pulled into re-recession by some unseen magical force, conspiring against the good-natured efforts of central bankers. Instead, the very thing central banks aspire to is the exact poison that alludes their attention. Conventional economics will continue to believe and empirically “prove” that the theory of the neutrality of money is valid, giving them, in their minds, unrestricted ability to intervene and manipulate over any short-term period (though it is getting harder to argue that these emergency measures are “short-term” nearly five years into their continued existence). The occurrence of panic in 2008 and the unresolved and unremoved barriers to recovery in the years since, however, fully attest to nonneutrality, an ongoing form of empirical proof that their models will never be able to refute. And we are all condemned by it.
What's Ben gonna do?
This Is The Government: Your Legal Right To Redeem Your Money Market Account Has Been Denied - The SequelSubmitted by Tyler Durden on 07/19/2012 18:05 -0500
Two years ago, in January 2010, Zero Hedge wrote "This Is The Government: Your Legal Right To Redeem Your Money Market Account Has Been Denied" which became one of our most read stories of the year. The reason? Perhaps something to do with an implicit attempt at capital controls by the government on one of the primary forms of cash aggregation available: $2.7 trillion in US money market funds. The proximal catalyst back then were new proposed regulations seeking to pull one of these three core pillars (these being no volatility, instantaneous liquidity, and redeemability) from the foundation of the entire money market industry, by changing the primary assumptions of the key Money Market Rule 2a-7. A key proposal would give money market fund managers the option to "suspend redemptions to allow for the orderly liquidation of fund assets." In other words: an attempt to prevent money market runs (the same thing that crushed Lehman when the Reserve Fund broke the buck). This idea, which previously had been implicitly backed by the all important Group of 30 which is basically the shadow central planners of the world (don't believe us? check out the roster of current members), did not get too far, and was quickly forgotten. Until today, when the New York Fed decided to bring it back from the dead by publishing "The Minimum Balance At Risk: A Proposal to Mitigate the Systemic Risks Posed by Money Market FUnds". Now it is well known that any attempt to prevent a bank runs achieves nothing but merely accelerating just that (as Europe recently learned). But this coming from central planners - who never can accurately predict a rational response - is not surprising. What is surprising is that this proposal is reincarnated now. The question becomes: why now? What does the Fed know about market liquidity conditions that it does not want to share, and more importantly, is the Fed seeing a rapid deterioration in liquidity conditions in the future, that may and/or will prompt retail investors to pull their money in another Lehman-like bank run repeat?
The world's largest hedge fund is not as sanguine about the hope that remains in the markets today. The firm's founder, Ray Dalio, who has written extensively on the good, bad, and ugly of deleveragings, sounds a rather concerned note in his latest quarterly letter to investors as the "developed world remains mired in the deleveraging phase of the long-term debt cycle" and has spread to the emerging world "through diminished capital flows which have weakened their growth rates and undermined asset prices". Between China, Europe, and the US, which he discusses in detail, he sees the lack of global private sector credit creation leaving the world's economies highly reliant on government support through monetary and fiscal stimulation. The breadth of this slowdown creates a dangerous dynamic because, given the inter-connectedness of economies and capital flows, one country's decline tends to reinforce another's, making a self-reinforcing global decline more likely and a reversal more difficult to produce. After discounting a relatively imminent return to normalcy in early 2011, markets are now pricing in a meaningful deleveraging for an extended period of time, including negative real earnings growth, negative real yields, high defaults and sustained lower levels of commodity prices. Lastly he believes the common-wisdom - that the Germans and the ECB will save the day - is misplaced.
When it comes to insight into what is on Ben Bernanke, nobody is quite as capable as the firm that runs not only the NY Fed, but virtually every other central bank in the world: Goldman Sachs. Below we present Jan Hatzius' thoughts on what to expect when Bernanke takes the stand at 10 am today when he delivers the first day of his semi-annual Humphrey Hawkins presentation to Congress. Many expect him to hint at more QE, and lately a tempest in a teapot (to use the parlance of our times) has erupted over the possibility that the Fed will lower IOER to 0 or even negative. Here is what Goldman has to say about that: "we do not expect an IOER cut at this time." In fact, Goldman is rather skeptical Bernanke will hit at much if anything, especially with bond yields already at record lows: after all, how much more frontrunning of the Fed's bond or MBS purchases is there? Instead look for much more grilling on the Fed's role in Lieborgate: congress is now realizing it is woefully behind its UK political cousins when it comes to reaping points from years of global Libor manipulation. More importantly, Maxine et al have finally finished all those "Libor for absolute corrupt idiots" books they ordered almost a month ago so they are truly prepared.
Just under two years ago, when we mocked then Morgan Stanley's analyst Jim Caron's call for a surge in long-dated yields on the back of an improvement in the economy (not something more realistic like the Fed losing all control of the TSY curve), we penned "Visualizing The Past Of The Treasury Yield Curve, And Deconstructing The Great Confusion Surrounding Its Future" in which we said that contrary to pervasive expectations of a bull steepener, the treasury curve would continue flattening more and more, until the whole thing would become one big pancake. Today, we have decided to revisit that post: in short - Jim Caron was fired by Morgan Stanley as head of rates following 3 consecutive years of bad calls starting in 2009 (only to be rehired in June as a Portfolio Manager... oops), while our view that sooner or later the 2s30s will be 0 bps is over one third complete.
A generation of market participants has grown up knowing only the era of central bankers and the 'Great Moderation' of (most of) the last two decades elevated their status significantly. While central bankers are generally very well aware of the limits of their own power, financial markets seem inclined to overstress the direct scope of monetary policy in the real world.
If markets fall, investors need only to run to central bankers, and Ben Bernanke and his ilk will put on a sticking plaster and offer a liquidity lollipop to the investment community for being such brave little soldiers in the face of adversity
Monetary policy impacts the real economy because it is transmitted to the real economy through the money transmission mechanism. This has become particularly important in the current environment, where, as UBS' Paul Donovan notes, some aspects of that transmission mechanism have become damaged in some economies. Simplifying the monetary transmission mechanism into four very broad categories: the cost of capital; the willingness to lend; the willingness to save; and the foreign exchange rate; UBS finds strains in each that negate some or all of a central bank's stimulus efforts. In the current climate, it may well be that the state of the monetary transmission mechanism is even more important than monetary policy decisions themselves. Some monetary policy makers may be at the limits of their influence.
The idea that short-duration bond funds are a good bet due to “the FED’s complete control with regards to suppressing and maintaining short-term interest rates” is completely wrong on every level; they’ve been a losing investment in real terms for most of the last 5 years, and the Fed is determined to keep it that way. The Fed’s control over nominal interest rates is precisely the reason that I wouldn’t want to invest in treasuries; not only has it consistently made bonds into a real losing proposition, but it also creates a good deal of systemic currency risk. Simply, the Fed will — in the pursuit of low-rates — monetise to the point of endangering the dollar’s already-under-threat reserve currency status. The only things that would turn bonds into a winning proposition — rising interest rates, or deflation — are anathema to the Fed, and explicitly opposed by every dimension of current Fed policy. Of course, creating artificial demand for treasuries to control nominal rates has blowback; if the buyers are not there, the Fed must inflate the currency. Hiding inflation is hard, so it is preferable to a central bank that old money is used; this is why Japan has mandated that financial institutions buy treasuries, and why I fear that if we continue on this trajectory, that the United States and other Western economies may do the same thing.
The Fed, by buying Treasuries is making insolvent banks even more insolvent. It is a short-term gain (liquidity) for a long-term disaster: banks need as much collateral as they can get their hands on right now. And with Treasuries rallying (raising the value of the banks' assets) any aggressive Fed program to take Treasuries out of the system would be a MAJOR step towards another solvency Crisis a la 2008.
After two days of solid gains, European equities continue the upward trend and are seen higher at the North American crossover, with the Basic Materials sector leading the way, followed by financials. The moves in equities follow overnight reports from Chinese press, once again calling for the PBOC to slash their RRR, as well as expectations that this Thursday both the ECB and the BoE will conduct monetary easing, possibly boosting future commodity demand. In the fixed income markets, the European 2s/30s curve continues to see bear-steepening following last night’s announcement from the Dutch Central Bank that has changed Dutch insurers’ Solvency II interest rate curve; modifying the maturities in which the firms must hold assets towards the longer-end. Today also saw official confirmation from the Irish debt agency that they are to return to capital markets with T-bill issuance on July 5th, their first return to the market since 2010. Investor reaction to this news is evident in the shorter-end of the Irish yield curve, where the 2-yr bond yield spread against their German counterpart is firmly indicating the risk of returning to the market; currently wider by around 20bps.
It's another one of those hope-fueled days in Europe as European stock indices across evey nation close comfortably in the green as the EU Summit begins. Germany has taken all the substantive things off the table and Cyprus and Portugal threw in the towel but nevertheless, stocks are 1-2.5% higher (with Italy and Spain outperforming). We assume this is reflexive pricing of 'the crisis is now so scary that the ECB will have to do something' but it seems the FX and Sovereign bond market missed that pre-emptive hope-driven view as Portugal yields/spreads spiked, Spain pushed back up to 6.93% and saw further flattening in its yield curve (as short-dated LTRO-enthused bonds underperform dramatically) as 2s10s is almost back to six-month pre-LTRO levels. Italian spreads pulled off their worst levels to close mixed but remains over 40bps wider on the week. EURUSD closed down over 35 pips at 1.2450 and stocks were in a world of their own also relative to credit markets today.