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Financial Bonds Are Hit By Deleveraging - Basis At 2008 Levels
We have long discussed the relative changes in the bond, CDS, and equity markets and attempted to infer market sentiment from them. The last few weeks have seen financial stocks for instance sell-off and converge back to their CDS-inferred levels - after much poo-pooing of CDS in general. We have also pointed to the worrying drop in the basis (spread) between bonds and CDS. While there are a number of drivers for this basis, the current level for investment grade bonds is akin to 2008 crisis levels and implies both inventory deleveraging and funding stresses in the markets.
This chart is a little apples-to-oranges as the underlying indices for the Bond and CDS legs are different but they are broad enough that the general trends are very clear and undeniable.
Peter Tchir, of TF Market Advisors, takes a deeper dive specifically into MS to highlight just how potentially bad a signal this could be.
Remember how many people were complaining about how illiquid CDS was. What a bad indicator it was compared to bonds. That it was unfair that MS bonds were under pressure due to CDS? That was the "spin" back in late September and early October. It didn't matter that CDS volumes are higher than any individual bond and compare well to total volumes in bonds. It didn't matter that CDS trades with a tighter bid/offer than the bonds and both sides are really, rather than an "order catching" run that is what the bond market has reverted to.
This just looks at the MS 3.8% of April 2016 bond spread vs the UST 2% of April 2016 and the 5 year CDS spread. You can see that back in the darkest moments, CDS was close to 600 (and I believe it traded at 600). Bonds were slightly wider than CDS back then. They both rallied throughout the month of October with CDS leading the way, but over the past couple of weeks, we have seen the "basis" blow out. MS bonds are now back to their widest levels, but CDS is actually contained.
This reminds me a lot of August 2007. The basis was blowing out, because the banks had to cut inventory. No one wanted to hold bonds. Banks were trying to deleverage so the basis started moving out. That continued until it climaxed in late 2008 (the Citadel "basis" phone call, was pretty much the end of the capitulation).
On a "Z-spread" basis, the move isn't quite as dramatic as 5 year swap spreads have moved out from 30 bps to 40 bps, that that only explains 10 bps of the spread differential, confirming that this move is a sign of aversion to using cash, and deleveraging.
The price of the bonds was about 87.5 at their lows in early October. The bonds are back to trading at that price, so the spread widening isn't the "good" type (bonds going up in price but widening relative to treasuries). So with prices on the bonds back to the lows, spreads back to the wides, but the CDS reasonably contained, I would come to the conclusion that demand for bonds (financials in particular) is weak, and it is related to deleveraging and not just risk aversion.
Someone should thank all the CDS shorts who are wondering why CDS spreads won't widen and are probably the main source of buying in the bond market.
I didn't mean to pick on MS, it was just the first name that Nahil suggested to take a close look at. On the bright side, depending whether MS uses CDS or bond spreads to calculate their DVA, they won't have to report a big DVA loss for the quarter.
Bonds are underperforming CDS - the basis is dropping - as dealers are forced to delever and unwind inventory impacting secondary prices in general.
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Free market and central banks are incompatible. Central bank intervention is akin to the end of natural selection, with an all powerful being coming down to earth to save the dodos by force feeding it the flesh of other creatures. Moral hazard created by constant bailouts in the form of liquidity and inflation have created a universe where there is no benefit to being small and nimble because being the larger and more lumbering made you more appealing and justified of a bailout by an incompetent almighty. We now live on a planet where only a dozen or so gargantuan creatures reside. The incompetent creator lives in fear that these colossus may breakdown and bring about the end the world, forgetting that the lowly muskrat may just evolve into something greater if they were saved from the maw of such heinous creations. In the meantime, the blood and sweat of creatures unloved by the almighty continue to be grind up to feed the behemoths, who grow more sickly by the day. Perhaps there is something to biodiversity after all, perhaps a being that cannot interpret and foresee a chaotic universe is not omnipotent after all.
"Central bank intervention is akin to the end of natural selection"
That is not quite true, since supply-demand dynamics are driven by the SUBJECTIVE preferences of market participants. The mathematical models of smart economists are a far more objective and natural means of allocating resources.
"The mathematical models of smart economists are a far more objective and natural means of allocating resources."
Mathematical models are BS - they make many simplifying assumptions about human behaviour, which ultimately drives the markets.
It's time to brush up on your knowledge of mathematical models.
I'm quite astute at mathematical modeling, and I've studied many financial mathematical models. They are like driving a mountain road while looking in your rearview mirror. Case in point, VAR, which is used to gauge risk. Problem is, it relies on past performance and correlation to predict future deviations.
MillionDollarBonus.
If you open your mouth with a statement like that, provide links please. There are literally thousands of models, pick one and defend it. If you have your own. Post it in great detail. Trust me on this, we'll all treat it like a model and discuss it at great length until the conversation meets it's conclusion of someone telling someone else to eat a bag of dicks in true internet fashion.
Bank run bitchez!
libertarian86.blogspot.com
I'm getting that flash crashy kind of feeling again...
must hold 1200 for month end
I'm going to need a few more pictures to understand whats going on here....
WASHINGTON (Dow Jones)--The Securities and Exchange Commission is asking lawmakers for authority to impose greater financial penalties on individuals and Wall Street firms that commit fraud following a federal judge's ruling questioning the adequacy of a proposed $285 million SEC settlement with Citigroup Inc. (C) In a letter to key senators late Monday, SEC Chairman Mary Schapiro said the agency is constrained by statute from imposing financial penalties that match investor losses. She also warned the agency can't adequately take into account the seriousness of misconduct nor its impact on victims. Schapiro's letter asks Sens. Jack Reed (D., R.I.) and Mike Crapo (R., Idaho), to increase the legal formulas by which the agency calculates financial penalties. The senators hosted a hearing this month on the issue of SEC structural reforms.
day late and dollar short - whimpy be sad
I think the important thing is that people are beginning to question sovereign debt...and all the hopes are pinned on sovereigns bailing out the system. That realization is changing everything and will not end well. The big hope is that ECB starts to print like mad (they are already printing a lot!) and that will get the game going again. I think we are going to grind lower with lots of volatility until the sovereign bluff is finally called and either debt collapses or currencies collapse - one or the other.
Mathematical models are for showoffs and fools. Show me a mathematical model and I will show you a failed hedge fund/bank.
Odd how the closer BAC get to a 4 handle the more pumped the Dow gets.
Didn't ZH have an excellent series of commentaries about 4-5 weeks ago (?) about liklihood of bond price collapse due largely to delveraging driver..... and crucial realization that 'they' are not the 'safehavens' as propounded (and this is not factoring the USTreasury 'bubble' perspective at all into the conceptual formulation?
I keep going back (maybe I am just a monkey at a typewriter ...say it often enough you are eventually correct .... remember we are talking about 'timing' as well as 'substance' re: being "correct") to possibility that Dexia is this generation's Creditanstaldt. And if 'they' ECB/Federal Reserve/PRChina/Saudis prop that up then the 'dikeleak' willl just rotate soemwhere else. If so then the 'theme' above will certainly come into focus until the 'run' dynamic has exhasuted itself. But then when was the last time the West had an honest-to-heaven 'panic'? Exactly ..... your great grandfather might vaguely remember ... but no one else does except for maybe some elderly Chinese who saw late 1940s China. Germany & Japan don't count as war ravaged although maybe China fits that better than classic 'panic' bank run.
Paul Volker is useless in that scenario ......y'all better start reacquainting yourselves to the 'merits' of Andrew Mellon's or JPMorgan's perspective on all this .... AMellon and JPMorgan were the last financial leaders to have lived and survived earlier true panics (before the distortions of the New Deal prolonged everything/inhibiteded any biz formation-growth .... ala zombie Japan post late 1980s) .... and capital safety and liquidity were/are crucial. Warren Buffett is home clear as are Apple and Microsoft (no leverage there) and some other tech titans.
As now forgotten quoted ... "The Great Depression was not so bad if you had a job" (or to paraphrase ... a business that generated cash flow) ...and some of the unemployment statistics are already near 1982 depths or 1930 depths (see 1937/8) ... especially on East & West Coasts. You add a Euro delveraging 'panic' knock-on to it all ......