European Credit - Wider & Entering Risk Aversion Mode

Tyler Durden's picture

From Peter Tchir of TF Market Advisors

European Credit - Wider & Entering Risk Aversion Mode

The CDS Indices are wider today and in many cases, hitting new highs for the year.  SOVX is 10 wider, trading at 320.  Main, the investment grade index, is 11 wider, trading at 176.  Its previous high was 170 back when the SPX was close to 1100.  Finally the Senior Financials CDS index is over 265, which is 20 wider on the day and is wider than at any other time throughout the entire financial crisis.  SocGen stock price is at a multi-year low and approaching March 2009 levels.  Deutsche Bank is doing much better than its immediate post Lehman price, but is now down close to 40% on the year.

The Greek 1 year bond is at 61 now.  That is down 10 points in 2 weeks, and is a clear sign that Greek default is being priced by the bond market and mark-to-market accounts.  That makes sense as the IMF seems to be more contentious than before, there is growing public disagreement between the various countries, and the staunch support of Germany is becoming more questionable, as their economy stagnates and their leader is losing public support.  The fact that people remain hopeful of Eurobonds saving the day is just a clear indication of how little risk of default, the market is pricing in.  The Eurobonds seem unlikely at the best of times and virtually impossible in this stressful, fragmented, and more and more insular market.

While adding fuel to the fire, it is worth noting that Italian 10 year bond yields are back to almost 5.5% after being driven below 5% on some actual ECB purchases and the threat of more purchases.  Spain is doing a little better, but like virtually all their previous attempts, all the ECB open market purchases seem to have done is stabilize the markets briefly, with no lasting impact, and to saddle the ECB balance sheet with more mark to market losses.

I think we are entering a new crucial phase in the problems in Europe as quarter end reports will drive a notional reduction.  During parts of 2007 and 2008, CEO's of banks and other financial institutions, did not want to show any exposure to sub-prime, or to certain banks, or to leveraged loans, etc.   The CEO's in particular were convinced that they needed to show ZERO net exposure to the asset classes most in question.  As part of the "window dressing", their risk management departments were told to be short and told to reduce notional exposures.  It was no longer just an economic decision it had become a "what's best for the share price" decision.  The reality, is making money is best for the share price, but that notion gets thrown out the window once CEO's panic.  I believe we are there, and there are some real repercussions from that.

The main problem is that we will see credit curves flatten and possibly invert.  As short dated paper to the current "culprits" (sovereigns and financials) matures, the lenders will not want to roll over the positions.

This will create pressure at the short end of the curve, normally a relatively safe haven.  We are seeing that in Greek bonds as the short end sells off, it also shows up in OIS where that rate increases. 

The banks that are late to the hedging party, and it seems like there are a lot of them, will be reluctant to lock in losses on longer dated assets. Due to the duration, those losses are now large, so they will sell shorter dated assets or buy protection on a shorter maturity in order to show that they have taken notional exposure down, but have some chance of not locking in losses (losses the accrual accounting banks haven't even recognized).  As investors see curves flatten or invert, they will get concerned, and will sell stock.  This may take some time, but if I'm correct and we are entering the first real quarter end where every bank is going to want to show minimal notional or "jump to default" risk on PIIGS and Banks, this can happen.

It also means that we are less likely to see a relief rally in credit, particularly in the cash market until October.  The hedges are now as much for reporting purposes as economic purposes, which means these institutions will stubbornly keep themselves hedged to the level deemed appropriate by the boss until October.

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papaswamp's picture

At this point it would be much smarter for the ECB, IMF, Germans, etc. to step away..let the sick countries implode and come in and clean up. Trying to propthem up and and taking on more sickness onto their own and other banks balance sheets is madness....they will bring down everyone.

oogs66's picture

yeah, much better to let some dominos fall and pick up the pieces in a less complicated will sell off into it, but only way to really try and rebuild properly

snowball777's picture

When, not if, the periphery goes....they all go.

Thomas's picture

Yup, it might be better to let them go, but they are legitimately afraid as well.

Jeff Lebowski's picture

Share your sentiments, but respectfully disagree. Given economic policy these past several years, there is no choice but to attempt to hold it together to avoid... Excuse me... "delay" the inevitable and spectacular fail.

unky's picture

That will never happen, as the german government is just following the wishes of financial elite. Angela Merkel just said in an interview that Greece will keep the Euro no matter what the cost is.

john39's picture

no worries, they will now implement the financial NWO and all will be just fine, er, for the elites anyway.

MFL8240's picture

Not about Europe, all about deriative expossure to the US gansters at GovtSacks and JP Morgan.

Derpin USA's picture

War on the horizon, bitchez.

snowball777's picture

On the plus side, bombing the PIIGS will require less jet fuel than bombing Libya.

Josephine29's picture

I remember being told that the Euro was supposed to bring lower interest rates and yields to its members so the tweet below chimed with me.

A Greek 1 year bond yields some 79% over the UK equivalent & her 2 year bond is 49% over! Wasnt the Euro supposed to cut bond yields? @notayesmansecon Of course the Germans have ever lower bond yields....
Judge Holden's picture

Somebody please tell me that I am missing something here, for a minute there I thought the spread b/n Italian and German 10 year yields jumped from 3.27 to 3.72 today?

tom a taxpayer's picture

Breaking News: In response to the European sovereign risk crisis, the Troika (ECB, EU, IMF) announced an emergency meeting for tomorrow at Disneyland Paris. The Troika has reserved Fantasyland to host the crisis summit with the larger-than life characters of Merkel, Sarkozy, Trichet, Lagarde, Berlusconi, Papandreou, and Pomphew. Meeting arrangements hit a snag when Disneyland said it no longer accepts Euros or Greek collateral for admission tickets. However, Trichet was able to buy the Disneyland tickets by using his U.S. Federal Reserve credit card.

snowball777's picture

"It's a small world, after all..." ;)

Pool Shark's picture

I'm sure they'll all be taking the Tower of Terror freefall...

props2009's picture


The important events and meetings for the month of September
September 7: The German Federal Constitutional Court is set to rule whether of recent bond purchasing actions by the European Central Bank are in violation of euro zone rules. If the bailouts are determined to be illegal, this has the potential to seal the fate of the monetary union.

September 8: Two important speeches come on Thursday. The most notable of the two is President Obama’s jobs speech to a Joint Session of Congress. But perhaps just as critical will be Fed Chairman Bernanke’s speech in Minneapolis that day. Not only will this potentially provide a hint at potential policy actions at the upcoming Fed meeting, but it is also his first scheduled appearance following the German vote on September 7. If this vote were to go badly, Bernanke may be much more explicit in his policy language.

September 20-21: The U.S. Federal Reserve is scheduled for a once one day, now two day meeting to discuss its various monetary policy options. Some investors are anticipating some form of stimulus including perhaps a full blown QE3 with more large scale asset purchases. How global events and economic data unfold over the next 16 days will go a long way in determining how the Fed might react if at all. And even if the Fed does react with a full QE3, it may not be the panacea for the stock market this time around that some may be hoping for.

September 23: The German Parliament will vote on the Greek bailout and the expansion of the European Financial Stability Facility. While Germany is the backbone of the euro zone and has been the primary source of funding thus far for at risk economies across the region,he world is the bailouts are becoming increasingly unpopular in the country and political support for any further action is becoming increasingly fragmented. So the vote is far from a sure thing, and this assumes the fiscal situation stays together in Greece long enough to actually get to the vote. In addition, 16 other euro zone nations are scheduled to vote on the bailout program roughly around the same time including Finland, which has demanded collateral from Greece in return for their approval of the rescue plan.

There is a whole lot of things/issues being dealt with in the month of Sept 2011. While Germany votes on the critical bailout program, US FED will be dealing with ways to excite the markets into believing that 'all is well' with the economy. A third aspect will be liquidity positions of many financial institutions across EU and US.



Charts and Analysis for September: 20% setups:
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Cursive's picture


A third aspect will be liquidity positions of many financial institutions across EU and US.

Lack of liquidity is driving the whole crisis.  We may be at the point where the spackle and paint applied since 2009 has worn off.

MoneyWise's picture

Inability of politicians to act in timely manner

already costing more them bailout Greece and Italy combine

and causing chaos and panic within investors.

Lock of leadership including US.

snowball777's picture

Yes, things always turn out better when they act quickly without thinking too much. Like TARP!

Cursive's picture

Due to the duration, those losses are now large, so they will sell shorter dated assets or buy protection on a shorter maturity in order to show that they have taken notional exposure down, but have some chance of not locking in losses (losses the accrual accounting banks haven't even recognized).  As investors see curves flatten or invert, they will get concerned, and will sell stock.

Think the SPX can't reach 400?  Think again.  Once the deleveraging starts, all bets are off.

MoneyWise's picture

"Think the SPX can't reach 400?"

It could reach 1000 perhaps and then Bernank will shoot big.

In 2008 there were luck of liquidity, this time complete

different picture money supply probably doubled or tripled since then.

Real deleveraging will cut both Gold and Silver in half as well, and

made USD (CASH) a king ones again,

so you definitely don't want that ;)

MoneyWise's picture

EUR falling off the cliff. it should be below parity with

the Dollar long time ago. Currency overvaluation is the one

of the causes for sluggish economy growth and rising debts

after all.

--Freedom--'s picture

On the bright side, I learned today that closing bell Europe is going to find me some bargain stocks in the midst of today's sell off, right after this commercial break. A "value trade." So, despite 3-4% selloffs, the news is good for investors. Hmmm, where have I heard that before...I'm guessing that to cut costs, they have cut the cnbc writing crew to 1 guy who just recycles scripts.

As a value investor, maybe I'll put a spare 5 billion into Barclays.

oogs66's picture

maybe they have that 29 year old guy who wrote for obama as he "transitions" to writing comedy?

--Freedom--'s picture

Indeed. Maybe ex-Obama staffers are not all that welcome in hollywood anymore.

Pool Shark's picture

Nah, Hollywood will do just fine in the upcoming depression. Starving sheeple need escapist entertainment; just like the last depression...

MoneyWise's picture

Greece, Portugal, Spain, Italy needs their own currency,

which would be valued according to Economic conditions,

and boost domestic economy tremendously.

Check Russia after 1998 Default, GDP almost doubles in just

quick 3-4 years following default, because local currency was

devalued from 6 rubles to 1$ to 25 rubles to 1$..

fxrxexexdxoxmx's picture

Russia has natural resources to rape.... what does G,P.S.I have? They only have people to rape and China still has 600 million to go...

Judge Holden's picture

A shared currency of the PIGS?  Talk about a shit sandwhich.

shortus cynicus's picture

I don't understand why are yields for Greek 1Y bonds higher than for 2Y.

Is the risk of default for 1Y bonds higher than for 2Y ?

Any help from PhDs in economic or even from laureates of The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel would be welcome.

oogs66's picture

Looks at the GGB 4.1% of 8/20/12   Assume a price of 62 which gives a yield of 71%.

Then look at the GGB 4% of 8/20/13  Assume a price of 52 which gives a yield of 47%.

It is important to look at the price and the duration.

If you buy the 1 year bond, you would make 38 points in a year (100 - 62) plus your coupon.

If you buy the 2 year bond, where would it trade in 1 year?  If Greece is solved, it could trade very high, making even a 1 year trade more profitable than owning the bond.

Or, if Greece defaults, next month, the two bonds should expect a similar recovery.  If recovery was 40 points for example, the 1 year bond would have loss 22 points, versus only 12 points for the 2 year bond.

As a company or country nears default, the difference between price paid and expected recovery becomes extremely important.  It just isn't worth paying  high price for the short dated bonds, as in event of default, the loss is too huge.  Yield is less important than price for distressed situations.

And for what it's worth, if the 1 year bond was at 63 instead of 62, the yield changes by about 3%

shortus cynicus's picture

Thank you for explanation.

What really helped is clarification, that quoted yields are on year basis (like interest rates), and not yields to maturity.

The world is now in full consistency, at least for my little no PhD mind :-)

And now I'm going back to my simplistic world and start preparation for next break over 1900$/oz.

Chestire's picture

So you're telling me if low coupon bonds were issued in the 2Y maturity, investors for cash, holding to maturity, would prefer to 4% bonds. On this occasion, that is. Roll-over for that, then.

ZeroPower's picture

No - rolling over into paper yielding >50% implies theres a clear and not so hidden danger. Theres a reason why the price is so low for these bonds which should start their pull to par (100cents on the dollar). Threat of default. Its been priced into the CDS (over 2000 for a while now, but really anything over like 1000bp is suicidal) bust has finally caught up in the bond world - not to mention its 100x easier being bearish on an entity and taking that view out on long risk (CDS) versus short the bond (also long risk, but really hard to find inventory unless a liquid issue).

Chestire's picture

Great, my view precisely - I actually dumped the statement and re-wrote another after it that attends to portfolio, issuance and the mighty error (seriously, I am not formally educated but it is my opinion) performed just after the Greek debt announcement back in '09.

And what we could do from now on. But you're absolutely right: CDS need to be taken into account.


Wait, that can't be; yield is just a practical measurement, a result - what is bid is the price attending to a certain rate. Investors pay less per bond because they consider the security is set to default... but also because they shall redeem more on maturity along the coupon. Were coupon increased, yields could decrease.

But maturities held have fixed coupon (of course, a premium paid if held to maturity by the initial buyer - beyond primary dealer - could solve the issue), investors are selling them after Greece said its debt is higher than expected. If its debt is higher, Greece shall issue less debt. Holdings of Greek debt are diminished, affecting asset hedging: selling excess period begins. It aggravates with each confirmation of lower Greek debt issuance.

Investors sought to recoup their losses, rematch their portfolios - they seek higher values (already below book value) for selling and lower values for buying. But Greece kept issuing bonds with higher interest rates: for the same yield, apparently an industry risk benchmark, this means higher security cost, in turn implying more selling to attain the same value, accordingly more offer on the secondary market and lower price. Price entered a spiral of descent.

Less interest rate assures for equal yields a lower security price. It implies revenues decline for holders until maturity (or at least those that intend to collect some of the coupons). So holders-until-maturity should collect higher coupons and pay a price for it and holders for quick-sell should collect lower coupons and pay a lower price for the security - the standard market structure of primary and secondary markets.

Greece is presently otherwise - because Greece agrees to pay 100 €c for 100 €c, it needs to calculate the coupon based on the bided price. So, it gets offers of 50 €c: it is supposed to pay 100 €c on maturity, collecting only 50 €c (bummer, no more funding to pay for that sudenly increased interest burden) and pay a .... higher interest rate, that's what reporters wrote, the '7%' of doom.

A 1Y 100€ security at 7% is worth, sold today, 107 €. But with a 7% yield, it's worth 100 €. The investor actually seeks to see returns so he demands either a higher coupon or a lower price now, that is, the investor either wants to hold money now or wants to get money later. Presently, investors seek to: hold money now (present investors) or get money later (few sure investors). Few sure investors seek a higher interest rate, making the security more expensive that present investors neglect.

But both these profiles are selling, and both want to buy. The biggest loser is that who sells more so, considering the structure is kept, Greece should have paid, in 2009 at least, the same structure. But NO (and thank the great Ms. Merkel for this and other who neglected obvious, working finance) Greece did NOT pay the same structure.

Instead, seeking to hold its few sure investors, Greece sold 5Y securities at 5.50% in April '09 (before elections and discovery of higher debt) and in February '10 (after elections and discovery of higher debt) sold 5Y securities at 6.1%.

If we emulate thanks to oogs66 (273): 

 - a market investor that marked in its risk portfolio a yield of 10 for the June security -

that bought the security in April '09 for €82.94, decided to sell in panic in October (after the elections and subsequent excessive debt declaration) and lost just a few €, reconsidered in February '10 and decided to buy again would have to pay, for the same risk yield level, €85.22.


Thus we conclude that either the investor marked a higher yield, and thanks again to oogs66, a higher risk of default in its protfolio or would have to pay more - it's a NO GO, obviously.

With this we conclude the strategy must be to clean issued short-term securities off market and issue again with lower coupon rates to take advantage of the higher yield already inscribed in the risk portfolio; and issue higher coupon rates for longer term securities if and only if the market marks in its portfolio HIGHER yields. With yields as they are now for 30Y securities, 13, its actually better to sell with LOWER equivalent coupon rates, for the security shall be cheaper and assures a LOWER entry point.

Moral of the story: if you give me more, I'll necessarily want more (or, in case of market illiquidity, a higher interest rate means a higher yield for it implies a HIGHER price).

ZeroPower's picture

I didnt read beyond the first few paragraphs and you had the first bit right, but the rest of your premise is probably not correct as this point is wrong:

But Greece kept issuing bonds with higher interest rates:

Greece has not issued debt for a while - when you hear bbg or a blog say 'the country is shut out from capital markets' it is exactly that - no bond syndicate desk (area in inv. bank where bonds are priced, issued and traded out to the market) would dare take a coutnry with such a shitty profile to a new issue! So Greece has not kept issuing bonds with higher interest rates, because it can't. Italy and Spain issued some paper in Aug - at decent (relatively..) rates cause the ECB stepped in with a pledge to say they will suppor these prices (bid them).

Finally, nobody pays Greece anymore for its issued bonds - those are all held mostly institutionally and traded within that circle in nice amounts - 500k, 10mm, you name it. The situation is, the yield curve is inverted for Greek bond. If you do a simple search for 'inverted yield curve' youll see lots of literature dealing with the mechanics and theory behind this - when looking at government bonds, this typically can predit an oncoming recession. I.e. the UST yield curve was inverted in 2008 and thus predicted (among other things) the recession going on and later officially experienced.

Chestire's picture

It actually reports back to the October 2009 : May 2010 period - in that period, Greece issued bonds; the rest of the comment analyses what could perhaps have been done by Greece in that period to satisfy market needs; so, somewhat, trying to outline an issuing pattern for Spain and Italy that does not ward off investors from its investor base.

In fact, yes, Greece has not issued securities since May 2010 (or since the bailout took effect soon after May) with maturities beyond 3m or 1m perhaps .

Thanks, it is helpful to understand the parallel between lack of liquidity in US '08 and Greece for instance. In both cases the market thinks the sovereign is set not to pay in the short term. So it leads to think investors do not bid for long securities (leaving the yield steadier, I guess) and bid low prices for short term, pricing in the default.

For those investing in the market from that moment on, there's only so much the sovereign can do: enter the secondary market with higher bids as the ECB has done or purchase the securities gradually as the US has done in QE2. Maybe I'm wrong, but I think these statements are close to the facts.

What bugs me nevertheless is those investors that already owned securities and needed to see their risk portfolio re-designed - they sold and yet needed the securities to re-match their portfolio. What did they do and can sovereigns help them not devalue their protfolio, be it the recent 21% in Greece or the billions in '08 US. And it's in this view, in the immediate aftermath of when the market starts pricing in the recession, that I suggested lowering coupons for short term issuance.

I followed your generous suggestion and traced the inverted US yield curve (that I was also able to learn is deemed 'in backwardation') in US Treasuries to at least H2 2006, after flattening throughout H1 '06. What I now notice, and please rest assure I hadn't consulted this prior to writing the previous comment, is that between July and October '06, yields got lower as coupons got lower for 26 week maturities (there is no 52w '06) - so the Treasury or investors consider the coupon should go lower to accompany yields going down also. By mid-October until '06 end, the coupon equivalent stabilised between 5.09>5.16 and the yield also stabilised 5.09>5.16. Looking at actual auction rates, the rate kept getting higher until July '06 and then lowered from July until December (and stabilised at about 4.900 (12-26-2006)>5.105 (10-07-2006) - so at auction and market lower coupon rates translated to lower yields: I guess this indicates less pressure by investors on the security itself.

I also guess my informal training might fail me and 26 weeks be different of 5Y.
So checking 5Y securities, coupon rates (described as fixed when presented at auction, contrary to the US auction and competitive bidding) at auction got lower from July until December '06 as did yields - from 5.19 on 7/05/2006 to 4.50 on 10/04/2006. The behaviour in 2007 was erratic, with the curve either flat, in backwardation or indented between 26w and 5Y - but except for the Summer months, with less liquidity I read somewhere, the coupon rate at auction kept going down at 5Y auction as did yields: investors requested lower yield and Treasury lowered its coupon.


So here's a match, I thought (and that's what I write about previously) - instead of increasing the yield, if Treasury lowers the coupon it already discounts the security, at least for investors' risk profile in its portfoiio; it also implied throughout '06 and '07 Treasury was getting more $c for each $ at each auction (this must be good).
What I disagree with (and at that period I was mad at Germany and as such did not look at this, am only looking at this now) is Greece selling 5Y securities in April '09 (page 3), before the debt excess was disclosed, at 5.5% coupon an in February '10 selling the same maturity, 5Y, at 6.1% coupon - Greece's behaviour diverges clearly from that of the world's biggest debt market managers; their results also.

ZeroPower, thank you very much for the guidance and opportunity to express myself, it is incredibly motivating.

Chestire's picture

Peter Tisch, author of the post here above, today (09/14 - Successful Auctions And Chinese Buying) worte another post containing:

I am more curious by the choice of Italy to sell 1.2 billion of 4% 9 year bonds at a price of 90.2.   I will admit that I don't follow Italian bond auctions that much, but Sept 2020 seems a slightly weird maturity.  A 10 point discount sounds like something a junk rated issuer does, not a sovereign. In fact, a 10 point discount on a 10 year bond may even raise original issue discount tax problems if it was done in the US.  It seems weird, though it does seem a good fit for anyone who bought 10 year Italian CDS last September when EFSF was initially announced and Ireland and Portugal had been allegedly saved.  In fact the discounts that the new issues were done at seem to have the most use for CDS traders.  It makes the basis package more attractive.  Insurance companies and other "cash" investors tend to prefer higher coupons and more current income.  CDS and basis traders prefer the convexity of lower prices.  I wonder how much of this auction went to cover CDS short positions?  I suspect a lot, and the low coupon/low issuance price supports that view.

Notice the ubderline and compare with what is written above:

instead of increasing the yield, if Treasury lowers the coupon it already discounts the security, at least for investors' risk profile in its portfoiio; it also implied throughout '06 and '07 Treasury was getting more $c for each $ at each auction (this must be good). 

Fuck I should go to Finance; I'll add Economics, Management and Accountancy just for the sake of it.


Thanks to those who supported - ZeroPower, you're the man. "Who's the..."

MoneyWise's picture

DXY flying as result, near 75.20, that's exactly

what Bernank needs before hitting that "QE" button.

MoneyWise's picture

I wish US Markets could stay close, until those f*ckiers
in EZ sort some things out or go broke. :)))

gwar5's picture

Europe is a bank run waiting to happen. One pig taken to the slaughter house will star the squealing.


Mountainview's picture

Next shoe to drop: Belgium, home of the European Capital !!!

IMA5U's picture

Europe is like The Bears' sloppy ho. She continues to spread wider

LawsofPhysics's picture

they who default first, win.  Greece will default and this is being priced in.

how to trade armageddon's picture

Very good post. This is exactly what over-leveraged money managers do in a panic: sell the liquid stuff that's only slightly down, and hang on to the illiquid stuff till there's nobody left who will take it at any price. I watched it happen from the inside in 2008.

I published this right before today's action in Europe. Worked out pretty well. It's obviously harder to find good entry points now, but I still think this round of selling has legs.