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Carry, LTRO, Data, and VIX

Tyler Durden's picture




 

From Peter Tchir of TF Market Advisors

Carry, LTRO, Data, and VIX

Once again we seem to have a discrepancy between what “credit” people think and what “equity” and “FX” people think.  The broad market rallied strongly today, at least in part because of the LTRO.

On one thing, everyone agrees, the take up rate will be high.  There will be strong demand for the LTRO.  What differs is the impact that will have on the market.

At one end is a belief that banks will be borrowing this money so they can purchase new assets.  The allure of carry will be too much to pass up, and with government encouragement, they will rush to purchase new sovereign debt and maybe even lend more.  That will turn the tide in the European debt crisis since there will be buyers for every new issue, and the market can move on to “strong” economic data in the US.

The other end of the spectrum is that the banks will use this facility to plug up existing holes in their borrowing.  They won’t have to rely on the wholesale market or repo market as much as they can tap this facility.  It will take some pressure off of the “money market” as banks won’t be scrambling for as much money every day, or over year end, but it won’t lead to new asset purchases by the banks.  Banks need to deleverage and that hasn’t changed.  The bonds can have a 0% risk weighting, but that doesn’t mean anyone, including the banks, believe it.  The road to hell is paved with carry.  That is an old adage and likely applies here. 

High Yield did well today (with HY17 outperforming HYG and JNK).  Investment Grade did okay as well (LQD tightened on a spread basis, though it shows up as a loss for most retail investors).  IG17 also was tighter as no one wanted to be hedged.  Away from that, more exotic trades, like curve trades didn’t show a similar strength.  These are the sorts of trades that would do well if everyone was looking for carry and thought the problems were solved.  Little things like that further underscore how likely it is that banks will participate.

Most banks are overexposed to these risks in the minds of investors anyways.  Will buying more of something that is risky really help?  Will loading up on a single position to the point that it can wipe you out be deemed as prudent?  I think banks that have managed themselves well to this point will be very reluctant to add significantly to their exposure.  You may get some token purchases so they can tell their regulators that they are playing nice, but beyond that, they will wait and see if the situation is really fixed.

The reason banks are not buying more of these bonds has little to do with funding costs being too high.  Risk and leverage are too high.  That hasn’t changed here, and most credit people believe that this new funding will encourage new asset purchases.  Without that, it helps the banks by reducing some uncertainty on their existing debt rollover needs (let’s not forget the hundreds of billions of bank issued debt that needs to be rolled this year), but doesn’t encourage asset purchases or balance sheet expansion.

Earlier today I had a bullish tone and did see 1300 and 1100 as being equally possible.  With a 40 point move from overnight lows it seems like a lot, especially since to the extent I was right, it was for all the wrong reasons.  I continue to believe that there may be an agenda behind the truth that is emanating out of Europe recently, but this LTRO plan doesn’t do it for me.  With our models showing seasonality being strongest from close of business tomorrow until the 27th, it is hard to be short, but without real news, we will be fading this.

On the data front, I am a bit confused why housing starts going up is a good thing.  The only industry that may be worse at predicting future demand than the airline industry, is the homebuilder industry.  They build homes, it’s what they do.  Carefully managing inventory to demand is not their strong suit.  A story about great demand and shortages of homes for sale would be much bigger news and may warrant a rally, I put this in a neutral category, at best.

On the earnings front, it seems like as many companies are missing as beating.  Oracle missed after the bell and is being punished.  It is far from clear to me that the earnings story is that compelling, and the strength in the dollar is the last thing the nascent surge in manufacturing needs.

We have a political system that couldn’t agree that the sun comes up in the morning without holding special sessions.  Their ability to provide any help to the economy is zilch and no matter how many times people say it, there is no strong evidence that “gridlock” and “a government that does nothing” is actually a good thing for stocks over the short term (even though it may be by far the best thing for the economy in the long run).

VIX is back to levels last seen in August.  The fact that those levels preceded a sell-off is largely being ignored on a day the DOW moved up 337 points, but as far as I can tell, VIX is as much a “risk on” / “risk off” asset as anything else and has limited predictive value (as in none).  Somewhere out there, the quants are analyzing the skew of longer dated options as a better tool that may retain predictive value, but that is complex, and requires effort, but is probably the work that is required to make some sense of what the “vol” market is telling us.  It is definitely the sort of work that serious tail risk hedge funds and quant funds are looking at and analyzing. 

Here is the “vol skew” graph function on the SPX on Bloomberg.  As far as I can tell you would need to be either a rocket scientist or a Deadhead to understand it.  I am neither, but am convinced that to the extent the vol market contains useful information, it is far more complex to figure out, than pulling up a VIX closing level. 

 

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Tue, 12/20/2011 - 19:38 | 1999333 Irish66
Irish66's picture

I had to watch the evening news, I'm just giddy about the world.

Pass the tequila

Tue, 12/20/2011 - 20:05 | 1999392 lairdwd
lairdwd's picture

I fully expect the risk on trade to work through the end of year as banks will due their duty and buy sovereign paper - at all ends of the curve. Looks like S&P will hold off on a downgrade until beginniing of January.

At some point, the banks will start the deleveraging again. For now though, it's party time and lever up

Wed, 12/21/2011 - 03:12 | 2000235 Manthong
Manthong's picture

At something around €400 billion (?) the LTRO seems to be a band aid with days to weeks half-life, and that’s IF the banks actually use it all for sovereign debt.

That will buy you 1260 or so on the S&P for days or a couple weeks, and if you look at the chart it fits perfectly with a (black?) swan dive to who knows where. I am not much of a chart guy but it sure looks like it could have come out of a text book.

http://i40.tinypic.com/119a26c.jpg

Tue, 12/20/2011 - 19:45 | 1999343 apu123
apu123's picture

I wish I could still drink, these markets are driving me nuts!  Looks like I picked the wrong year to stop drinking!  I noticed that when ever BofA gets around $5 there is a big rally the next day, its the new Bofa BS risk on indicator.

Tue, 12/20/2011 - 19:48 | 1999352 walküre
walküre's picture

Most of Europe in recession. Germany at best growing 0.5%.

Fundamentals matter.

Tue, 12/20/2011 - 19:51 | 1999357 Irish66
Irish66's picture

when?

Tue, 12/20/2011 - 19:54 | 1999368 apu123
apu123's picture

Maybe when the ECB and FED finally print so much money and do so much bailing and propping that people can no longer suspend their disbelief.

Tue, 12/20/2011 - 19:55 | 1999370 LookingForTruth
LookingForTruth's picture

WARNING - A BIT OFF TOPIC:

When the collapse occurs, and there is a bank "holiday" where withdrawals are limited or prevented, what happens to those who have savings in bank A, but a mortgage from bank B, and there is equity in the home in which the mortgage is against (not under water).  If one is not able to withdraw funds from Bank A, then one cannot pay the mortgage to bank B.  Will Bank B then foreclose on the homes with equity and sell those for a profit.  Is bank B's answer to its solvency issue to foreclose on properties with equity, and then sell the property for a profit? 

Tue, 12/20/2011 - 20:02 | 1999388 economics1996
economics1996's picture

I am not a banker but in this market I seriously doubt that a bank would risk selling a property for some equity. 

Tue, 12/20/2011 - 20:26 | 1999442 bob_dabolina
bob_dabolina's picture

For what it's worth -

Until December 31st of this year ALL funds in a non-interest bearing checking account are FDIC insured. So if you have say $10,000,000 in a non-interest bearing checking account, you're insured by the FDIC. This measure was put into place to prevent a bank run during the credit crisis and avoid a bank holliday type of event.

However, the new year is coming up.

Wed, 12/21/2011 - 02:53 | 2000223 slewie the pi-rat
slewie the pi-rat's picture

if you need help, i can drive a wheelbarrow

Tue, 12/20/2011 - 21:45 | 1999662 Quaderratic Probing
Quaderratic Probing's picture

Easy answer..... Think what a criminal would do and you will be close

Tue, 12/20/2011 - 19:56 | 1999375 heremynkitty
heremynkitty's picture

I call head fake.  Was watching GOV's action, and it was pure sell into strength all day.  So much for yield being chased by anything other than momos.

Tue, 12/20/2011 - 21:01 | 1999513 youLilQuantFuker
youLilQuantFuker's picture

Today is the first day of what traditional celebration?

Call it what it is.

'Guest Post:'. Only a few goy in the house.... What?

Tue, 12/20/2011 - 19:56 | 1999377 disabledvet
disabledvet's picture

but the carry trade is now the euro. that makes Ben "shalom" Bernanke perhaps the most effective war financier (if it comes to that and i think it will imminently) since FDR's Morgantheau. Throw in a Treasury Secretary who "speaks Chinese"and I really don't think you could ask for a "more perfect union."

Tue, 12/20/2011 - 20:00 | 1999380 firstdivision
firstdivision's picture

Massive reverse skew with short-term vol rising.

Tue, 12/20/2011 - 20:01 | 1999383 Big Ben
Big Ben's picture

If Euro banks were to buy sovereign bonds, borrow against them using LTRO, use that money to buy more sovereign bonds, borrow against them using LTRO, etc. this would be highly inflationary. The only way LTRO is non-inflationary is if banks hold their LTRO money as reserves and do not reloan it. I wonder how the Europeans plan to enforce this discipline on their banks.

Assuming that Euro banks are not allowed to reloan their LTRO money, it seems to me that the only thing that LTRO really does is to help the European banks meet their capital requirements. If I am a Euro bank, why would I want to pay 1% interest to obtain some money that I cannot do anything with?

Tue, 12/20/2011 - 20:18 | 1999421 bob_dabolina
bob_dabolina's picture

Why would people buy Treasury products with negative yield? It's happened.

The question is...where else would they get the money?

At the end of the day it comes down to ponzinomics and keepin' the ponz pumped. What you're gona' see is another gold/oil rush.

Tue, 12/20/2011 - 20:59 | 1999517 Big Ben
Big Ben's picture

Suppose I offer to loan you $1000 at 1% using your car as collateral. But as a condition of the loan you are not allowed to spend the $1000 or loan it out to anyone, etc. You are only allowed to keep the money in a safe or coffee can in your home and count it every now and then. Would you be inclined to accept that loan?

I think that Euro banks would only want to use LTRO in order to get money to satisfy their capital requirements. To that extent, LTRO might tend to generate some extra demand for Euro sovereign debt. But once a bank has satisified its capital requirements, I don't think that it would make sense for it to participate in LTRO.

But perhaps (probably) I am missing something...

Tue, 12/20/2011 - 21:09 | 1999543 bank guy in Brussels
bank guy in Brussels's picture

In some ways European countries are like Japan, like small villages even. They are small societies where there are 'constraints' and pressures not visible to the casual observer.

The banks will do what they're told if they get the order clear enough. That's what the usually astute Peter Tchir is, I think, missing here.

It doesn't matter how 'irrational' an invesment it is for European banks to buy EU sovereign bonds. The banks here are on the edge, propped up by the ECB and the EU and their own governments. There will be a Quiet Meeting and if the Word is to Buy European Government Bonds, the banks will find 'good reasons'.

Otherwise it's no liquidity, and the banks who don't co-operate will get restructured with new management, as quickly as Greece and Italy were recently restructured with new management. Maybe quicker.

Tue, 12/20/2011 - 22:03 | 1999708 Ned Zeppelin
Ned Zeppelin's picture

Good point - buy our debt or find a new job, dickbeat.

Wed, 12/21/2011 - 00:14 | 2000022 oogs66
oogs66's picture

Find a new job with crap pay :)

Tue, 12/20/2011 - 20:01 | 1999384 Cheesy Bastard
Cheesy Bastard's picture

I believe that saying goes back to the 2004 presidential campaign.  "The road to hell is paved with Kerry".

Tue, 12/20/2011 - 20:20 | 1999432 Seize Mars
Seize Mars's picture

I believe that saying goes back to the 2004 presidential campaign.  "The road to hell is paved with Kerry".

According to the Three Stooges, the road to hell was paved with Larry.

Tue, 12/20/2011 - 21:06 | 1999536 Cheesy Bastard
Cheesy Bastard's picture

I think in India the road to hell is paved with curry.  Or The road to Giants stadium is paved with Jimmy Hoffa.  I get confused.

Tue, 12/20/2011 - 20:04 | 1999390 chump666
chump666's picture

excellent analysis

Tue, 12/20/2011 - 20:52 | 1999482 chump666
chump666's picture
  • UniCredit SpA (UCG.MI) and Intesa Sanpaolo SpA (ISP.MI) are among Italian banks that would use bonds guaranteed by Italy as collateral for loans from the European Central Bank.

hahahahaha,

the definition of insanity.

look a-holes just send the indexes higher to their upper resistance, so we can start to short.

thanks

Tue, 12/20/2011 - 21:08 | 1999538 sbenard
sbenard's picture

In the end, the debt black hole will be larger, and so will the risk! Some solution!

Tue, 12/20/2011 - 21:09 | 1999546 Jlmadyson
Jlmadyson's picture
El-Erian Sees Risk Europe May Spark a Lehman-Like Financial Crisis 1-3 chance

 

Heh, were screwed as that might as well be 3-3 chance.

Tue, 12/20/2011 - 21:12 | 1999555 Everybodys All ...
Everybodys All American's picture

I'm convinced that the VIX is being manipulated by the PPT ...

Tue, 12/20/2011 - 23:37 | 1999957 chdwlch1
chdwlch1's picture

Absolutely...TVIX too. Started on the 13th with the Fed's $2.5 billion injection to the PDs...

Tue, 12/20/2011 - 21:19 | 1999575 Jlmadyson
Jlmadyson's picture

Just like 08. Swap lines, Bank failures, bank penny stocks, secret bank bailouts. Manipulation, you better believe it. Yesterday was screaming plunge and ended up just a 100 off on the DJIA. 2 days so far this week and there are some really weird things going on underneath the surface.......just like 08.

Tue, 12/20/2011 - 22:08 | 1999726 Ned Zeppelin
Ned Zeppelin's picture

Today's meltup on light volume makes no sense. I think the PPT is all about getting a green screen close for the year.  All the homebuilders I know were nodding that the news on new homes was complete bullshit - nothing has changed, and some extra permits for some Fannie/Freddie financed apartment buildings in a very few locations ain't fooling nobody - housing in the the toilet, and ain't coming back for a loooooong time.  So the only other explanation is this sleight of hand LTRO or whatever the f--- program the Euroclowns are announcing (just print already and end this charade) tickling the testicles of a bunch of algos gunning for something to do.  Real goofball stuff today.

Tue, 12/20/2011 - 21:35 | 1999627 jcaz
jcaz's picture

VIX is worthless for anyone other than Bob Pisani to moan about......  Sweet spiff for selling both sides of the options on, tho- very juicy......

Wed, 12/21/2011 - 00:15 | 2000027 oogs66
oogs66's picture

Makes an idiot sound not so dumb!!

Tue, 12/20/2011 - 21:44 | 1999656 adr
adr's picture

So the market works the same as if I use a credit card to pay double the price for a classic car therfore causing the value to rise so I can hopefully sell it for more than I paid a few days later during the valuation mania allowing me to book profit off money that I never really held in the first place? Did I get that wrong? Or is it that I get my neighbor to buy my house and I buy his so he holds an asset equal in value to his debt and I hold an asset equal to my debt so somehow through the laws of accounting we no longer have any debt and can now use the value of the assets to borrow more? I may be wrong but that is exactly what all this bullshit sounds like.

Tue, 12/20/2011 - 22:10 | 1999730 Ned Zeppelin
Ned Zeppelin's picture

Now, repledge/hypothecate the mortgaged house to three more banks, take the funds and buy 10 more homes, and rehypothecate those, and you're getting there!

Tue, 12/20/2011 - 21:45 | 1999664 omi
omi's picture

At least highlight some month series (the charts in the back are empty)

Tue, 12/20/2011 - 22:43 | 1999844 POpatriot
POpatriot's picture

Wow, look at the folds or wrinkles in the volatility in the first 4 months of 2012 of the 12/20 graph in comparison to the 11/20.  Yes 11/20 has higher values, but the 12/20 graph is broken.  It looks as though you could sell April options, buy June and arb the difference.  I've never seen an options graph like that before... Beautiful.

Wed, 12/21/2011 - 00:17 | 2000032 oogs66
oogs66's picture

You are either high or smart - either way more power to you!!!

Wed, 12/21/2011 - 00:49 | 2000075 POpatriot
POpatriot's picture

Haha, just an engineer that loves finance.  Too bad the industry is contracting, I'd love to switch occupations, but even with a personal account that has returns better than Hayman Capital no one will even talk to me.  Until then, I will continue working as an engineer and only moonlight as a financial engineer. ;)  ZH is the only "news organization" I've found competant in simple mathmatics.

Tue, 12/20/2011 - 23:01 | 1999889 chump666
chump666's picture

yeah, risk FX option trades are all being bought with high strike rates,  AUD has a 1.075.  on the back of ECB gifts to the market re: ECB's 3 year refinancing operation later.

this market will rally end yr

Tue, 12/20/2011 - 23:02 | 1999892 chump666
chump666's picture

...only to be sold to hell next year.

Wed, 12/21/2011 - 00:46 | 2000069 longonSpam
longonSpam's picture

http://m.youtube.com/index?desktop_uri=%2F&gl=US#/watch?v=hRFiee1YMZ0

Totally OT but whatever, this is a 3 person debate from last month at UCLA with Peter Schiff representing 'the right'. Good stuff, the Brit claiming to be a centrist is a fucking neocommunist with a mancrush on the Bernank who claims QE is the next stage of human evolution and wants the Fed to go buy the stock market next. I'm down for that just as soon as I can drive moral hazard to work and make accounting fraud sandwiches for lunch. Fucking amazing, I never knew communism was in between neoliberalism and libertarianism, and this bullshit goes on at my alma mater no less, I need to start reading the newsletters again. Its a good watch, Schiff & the neolib really aren't that far apart but the Limey has drunk WAY too much KoolAid.

Wed, 12/21/2011 - 03:17 | 2000238 slewie the pi-rat
slewie the pi-rat's picture

long_on_Spam has invoked the ghost of christmas spam, mon_cler_chic!

 

 

Wed, 12/21/2011 - 03:20 | 2000246 longonSpam
longonSpam's picture

Not my fucking fault a cockroach crept in

Wed, 12/21/2011 - 05:55 | 2000348 Belarusian Bull
Belarusian Bull's picture

I just might add this "QE is the next stage of human evolution" to my skype motd. Good one.

Wed, 12/21/2011 - 06:52 | 2000386 longonSpam
longonSpam's picture

10% finders fee & its yours

Wed, 12/21/2011 - 01:17 | 2000106 monclerchic
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Wed, 12/21/2011 - 07:52 | 2000429 Monkeyfuzzle
Monkeyfuzzle's picture

You can correct my ignorance here....

 

But my interpretation of the surface is that it implies people believe the market is rangebound and mildly directional in the short term. Bad news fatigue and expectation of more of the same - containment of the crisis or Deus ex. Admittedly, this is one potential option as we go in to 2012.

I guess one could also look at VIX as a buying opportunity at these levels, if you think the Eurozone crisis is going to kick off again in Q1 (Feb) of next year due to the few hundred billion of bank refi, plus Spanish and Italian sov debt refi in those months - with No ECB, No IMF and No EFSF....

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