As we have repeatedly said, "Credit anticipates and equity confirms". Last year from Feb to June, credit markets (risk-priced not USD-priced remember) were flashing fundamentally orange-cum-red warning signals of the unreality that was engulfing the nominal price of stocks. We know how that ended as stocks crashed and caught up to credit's weakness. Sure enough, as we have been warning for a month or two now, the same pattern of credit deterioration is occurring this year with equities remaining willfully ignorant of the true reality of a non-QE world. At current levels the credit market is pricing the S&P 500 at around 1275 (which would basically remove YTD/LTRO/Twist gains) but as JPM's efforts extend the credit index losses to better reflect the reality of single-name credit, the situation looks set to get worse. In a QE-world, credit markets remain the only trustworthy 'market' indication of the business cycle.
As first pointed out here last week, IG9 10Y credit risk has pushed nothing but wider since the JPM news broke. Between the size, common-knowledge, and technical richness of the position, liquidity is providing its helping hand as the legacy credit index is now 25bps worse than last week's lows (and 17bps worse than when JPM announced) - while the on-the-run IG18 is only 10bps wider over this period. Extrapolating the $200mm DV01 we assumed from the initial announced loss and spread movement, this is potentially an additional $3.4bn loss for JPM already (who we can only assume have been trying to unwind). Until the skew (the spread between the index and its components) narrows further - which it is today (though momentum will take over at some point in the index itself) - it is likely that the runaway train will keep going and going, until JPM issues a formal announcement that the firm is fully out of the trade, together with a final tally of its losses, which will probably be double the reported loss as of Thursday. Here is the good news: we are 100.4% certain JPM was the ONLY prop trading bank to be massively, massively short IG9-18 into this epic blow out. Because if other had suffered billion dollar losses, they would all pull a Jamie Dimon and fess up. Right?
Things are moving fast now.
While our earlier discussion of the implications of Greece's exit from the Euro are critical reading to comprehend the real-time game of chicken occurring in front of our eyes, JPMorgan's somewhat more quantifiable estimates of the costs and contagion, given the results of the Greek election have raised market expectations of an exit of Greece from the Euro, also provide key indicators and flows that should be monitored. Identifying what has gone wrong with Greece's co-called 'adjustment' program, they go on to identify key transmission mechanisms to Spain and Italy, how it could potentially improve (Marshall-Plan-esque) and most critically, given the exponentially growing TARGET2 balances, if and when Germany throws in the towel. Immediate (cross-border claims) losses are estimate at around EUR400 billion, but the EUR1.4 trillion of Italian and EUR1.6 trillion of Spanish bank domestic deposits is the elephant in the room which a Greek exit and the introduction of capital controls by Greece has the potential to destabilize.
Just because it is always amusing to watch the cognitive dissonance in the head of a permabull, here is Jim 'Soon to be head of the BOE... allegedly' O'Neill's latest missive to (what?) GSAM clients. Yes, the same O'Neill who week after week, letter after letter kept on saying that 2012 is nothing like 2011, finally being forced to admit that 2012 is, as we have been saying since January 1, nothing but 2011, as the central planners' script writers prove painfully worthless at coming up with anything original. That, of course, and that the lifelong ManU fan had to suffer the indignity of interCity rivals picking up the trophy this year after a miraculous come back win against QPR. Oh, the horror...
While gold is now negative year to date in dollar terms, it remains 0.7% higher in euro terms. Gold prices dropped 3.7% last week and silver fell 5.1% to $28.89/oz. The smart money, especially in Asia, is again accumulating on the dip. Demand for jewellery and bullion in India has dipped in recent weeks but should resume on this dip – especially with inflation in India still very high at 7.23%. Also of interest in India is the fact that investment demand has remained robust and gold ETF holdings in India are soon to reach the $2 billion mark. This shows that recent gold weakness is primarily due to the recent bout of dollar strength. Morgan Stanley has said in a report that gold’s bull market isn’t over despite the recent price falls. Morgan Stanley remains bullish on gold as it says that the ECB will take steps to shore up bank balance sheets, U.S. real interest rates are still negative, investors have held on to most of their exchange traded gold and central banks are still buying gold.
Last week, the Spanish government carried out the biggest financial bailout since the outbreak of the economic crisis. BFA-Bankia (BKIA), the giant which resulted from the merger of seven savings banks only a year and a half ago, was nationalized by Prime Minister Mariano Rajoy’s government through the conversion of a 4.5 billion euro holding of preferential shares into equity. As part of the bailout, and as part of a more comprehensive effort to reform the country’s ailing financial sector announced on Friday, the bank will need to provision additional taxpayers’ money (7-10 billion), which will come in the form of contingency bonds (CoCos). Bankia has put Spain’s financial system under scrutiny from investors and analysts worldwide who worry about the country’s capacity to strengthen its banks while adopting harsh fiscal consolidation policies in the midst of a recession. However, among the many questions raised by Bankia’s nationalization in extremis, there is one that cannot go unanswered: who is responsible?
The failure to form a coalition government in Greece this weekend has prompted risk averse trade across the asset classes this morning with publications across Europe continuing to speculate about the potential exit of Greece from the Euro-area. As a result of this the Spanish 10yr yield touched 6.2% and the respective spreads over benchmark bunds in Spain and Italy have traded as wide as 30bps so far today. The knock on effect has been a sell-off in the financials which has seen the IBEX and FTSE MIB under perform in the equity markets with a relative safe-haven bid into the USD weighing on crude futures and precious metals. Spanish t-bill auctions and a variety of lines tapped out of Italy did stem the tide after selling around the top end of their indicative ranges but focus will remain solely on Greece given a lack of tier 1 data out of the US. Moving forward the next meeting of party heads in Greece is scheduled to commence at 1730BST, however, the head of the Syriza party has already indicated he will not be attending with the leader of the democratic left suggesting he is doubtful that a coalition can be formed.
The only good news spin this morning was that the Greek, pardon Spanish contagion, has not reached Italy, after the boot-shaped country sold €5.25 in bonds this morning at rates that did not indicate a meltdown just yet. It sold its three-year benchmark at an average 3.91 percent yield, the highest since January but below market levels of around 4 percent at the time of the auction. It also sold three lines due in 2020, 2022 and 2025 which it has stopped issuing on a regular basis. And this was the good news. The bad news was the not only has the Spanish contagion reached, well, Spain, but that everything else is now coming unglued, as confirmed first and foremost by the US 10 Year which just hit a new 2012 low of 1.777%. Spain also is getting hammered with CDS hitting a record wide of 526 bps overnight, and its 10 Year hitting 6.26% after the country sold 364 and 518-Day Bills at rates much higher rates than on April 17 (2.985% vs 2.623%, and 3.302% vs 3.11%). But the highlight of the day was the Banco de Espana release of the Spanish bank borrowings from the ECB, which to nobody's surprise soared by €36 billion in one month to €263.5 billion, more than doubling in 2012 from the €119 billion at December 31.
- Default now or default later? (FT)
- Monti warns of tears in Italy's social fabric (Reuters)
- Fear Grows of Greece Leaving Euro (FT)
- Greek Elections Loom as Key Bailout Opponent Defies Unity (Bloomberg)
- Santander, BBVA to Set Aside 4.5 Billion Euros for New Cleanup (BBG) - Thank god they both passed the stress test
- Austerity Blow for Merkel in German State Election (Reuters)
- Apple Founder Wozniak to Buy Facebook Regardless of Price (Bloomberg) - so... another ponzi.
- Dimon Fortress Breached as Push From Hedging to Betting Blows Up (Bloomberg)
- Saudi and Bahrain Expected to Seek Union: Minister (Reuters)
- Obama Pitches Equal Pay to Win Women Even as Charges Drop (BBG)
Now that the Greek exit is back to being topic #1 of discussion, just as it was back in the fall of 2011, and the media has been flooded by groundless speculation posited by journalists who have never used excel in their lives and are merely paid mouthpieces of bigger bank interests (long live access journalism and the book sales it facilitates), it is time to rewind to a step by step analysis of precisely what will happen in the moment before Greece announces the EMU exit, how the transition from pre to post occurs, and the aftermath of what said transition would entail, courtesy of one of the smarter minds out there, Citi's Willem Buiter, who pontificated precisely on this topic last year, and whose thoughts he has graciously provided for all to read on his own website. Of course, take all of this with a huge grain of salt - these are observations by the chief economist of a bank which will likely be swept aside the second the EMU starts the post-Grexit rumble.
On Thursday night, after it became clear that JPM has lost at least $2 billion on what is most likely an IG9 Index skew (Index less Intrinsics) trade gone horribly wrong, we first predicted (and promptly were piggybacked on by other various financial blogs) that based on various factors, there is about $3 billion more in the pain trade coming in JPM's general direction, once IG9 blows out to catch up to a fair value not supported by JPM(artingale's) infinitely backstopped prop desk. Sure enough, by closing on Friday, IG9 (and the entire IG curve), had blown out wider, by a whopping 10 basis points: one of the biggest intraday moves in nearly a year. In P&L terms, by close of Friday, all else equal, JPM had lost another $2-3 billion on the same trade it had lost over $2 billion since the beginning of April. We expect to hear confirmation of this shortly. Which however brings another question: has JPM closed out its losing trade, or is the entire move in the index (and to a far less extent in the intrinsics) due to hedge funds who have piggybacked on the "crush JPM" trade? The truth is we don't know, and until we get the latest weekly DTCC data on CDS notional outstanding we won't know. However, our gut feeling is that it would have been virtually impossible for JPM to lift every single offer in unwinding a $100+ billion notional position without sending the entire IG curve multiples wider. Which is why keep a close eye on the IG9 10 Year skew - this is where, as ZH first noted, the action is. If the skew soars, it is likely that the runaway train will keep going and going, until JPM issues a formal announcement that the firm is fully out of the trade, together with a final tally of its losses, which will probably be double the reported loss as of Thursday. At which point IG9/18 will see an epic ripfest as those short risk will scramble to cover.