Waiting To Exhale

Tyler Durden's picture

Via Peter Tchir of TF Market Advisors

You can feel the tension. Traders with one eye on European bonds prices deteriorating and the other eye watching the headlines, hoping for some positive news.

Without a doubt the situation in Europe has deteriorated. Spanish t-bills priced above 5%. Greek bonds at new lows. French and Belgium debt under pressure. The banks are struggling too. The desperate pleas and self-righteous demands for the ECB to do something have reached a crescendo. The market is clinging to hope that the ECB or IMF or China or anyone will step up and do something or anything.  With bond markets under pressure and stocks well off their "Grand Plan Europe Gets It" rally highs, I suspect that Merkozy and crew are working on some ideas to talk the market up.  I don't see unlimited ECB printing being a realistic option here. Some softer tones out of Germany and maybe a surprise rate cut along with the ban of some naked shorting tool wouldn't surprise. I don't think that would do much as they have lost credibility and fast and sleepy money would try and sell into any rally.

Realistically Europe needs to do something "big" to start a meaningful rally. The problems at the country and bank levels are just too big for anything other than unlimited printing or a huge infusion from BRIC's to have a meaningful impact. Yet, for once calmer heads may prevail. For as much hue and cry as there is for printing there is also a growing chorus who seem to accept that defaults (at banks) and restructurings (for countries) is the better longer term solution.  It finally seems that some people with power are actually pausing and trying to figure out a real endgame and not just a short term "fix" that creates more problems and spreads the risk further and deeper into the system. Germany gets that they risk dragging themselves down, and even some French people - with some prodding from the bond market - are questioning how wise it is to save other countries and the banks.

Saving the banks seems to be finally getting some definition. For too long "saving the banks" seemed to mean keeping bank share prices where they are or higher. Now, defining saving the banks as "protecting depositors and senior lenders" is gaining some traction. The task of saving the share price is Herculean. The task of protecting depositors at all banks and the senior creditors of the big banks is much more doable - without printing.

We may still get a print it all rally, but I am getting more hopeful that Europe will finally do the right thing and take some near term pain to create a sustainable rally and economy. Maybe in a year they will be able to tell Geithner and Bernanke that more Lehman's not fewer a re the way to go and that manipulating the money supply and yield curve in extreme amounts does more harm than good for the economy.

There is still hope that economic data here would save the day, but it is really only okay and shows more signs that it could get weaker than it does that we are on the verge of a break-out to the upside on the economy. The super committee failure doesn't help - unless you are a defense industry lobbyist - where you have over a year and 100's of billions at stake to get paid on.

The last leg that was supporting the rally was the "price action". So many people were touting positive price action as "confirming" the Grand Plan and Economic data legs of the rally. That seemed circular and feeble at best and is long gone.  Now people are just hoping we are oversold. It really was strange how many people were buying and saying that prices going up made them want to buy more - it is rare for that too be used as an excuse to be long as often as it was in the past few weeks.

I don't like IG or HY bonds right now. I think rising yields in Europe will siphon off some money with Spitaly appealing to some vs HY and France competing with some IG corporates and Financials struggling. I keep hearing how these are cheap on a spread basis. IG ex fins doesn't seem that cheap - the financials are driving the spread, and I don't know anyone who buys hy bonds on a spread basis. The convexity for hy bonds still works against you and make spread a somewhat irrelevant number. On a yield basis, both IG and HY seem to have hit a virtual floor.  Due to capital requirements the insurance companies in particular can't chase yields much lower as it doesn't generate a good return on capital.