Investment Grade

While the EURUSD's recovery post Europe's close seemed to modestly support stocks, the USD is still up from Friday's close as ES (the e-mini S&P 500 futures contract) closes marginally in the green against the direction of FX carry, Treasuries, commodities broadly, and credit. The volumeless (and gravitationally unchallenged) push from post-Europe dip lows this afternoon were generally ignored by VIX, investment grade, and high-yield credit markets, after the morning was a relatively significant amount of selling pressure in HYG (the increasingly significant high-yield bond ETF) to pre-NFP levels only be bough all the way back and some more into the close. Average trade size and deltas had a decidedly negative feel on every algo-driven push higher from VWAP to unchanged but the divergence between Brent and WTI dragged the Energy sector over 1% higher (as every other sector lost ground with Financials and Materials underperforming. Treasuries rallied well from the Europe close and closed just off low yields of the day as commodities all ended lower from Friday's close with Copper and WTI underperforming and Silver just edging Gold as they hovered around USD's beta for the day. VIX dropped modestly after the cash close but ended higher on the day with a notably low volatility of vol from mid-morning onwards (and the late-day vol compression seemed index-driven as implied correlation also fell commensurately). A quiet day in European sovereign and financials along with the disastrously low volume day in ES and on the NYSE really don't feel like signs of broad participation as Greek events slowly but surely unfold along the path of known resistance.

Equity and credit markets eked out small gains on the day as Treasuries limped a few bps lower in yield (with 30Y the notable underperformer) and the EUR lost some ground to the USD. ES (the e-mini S&P futures contract) saw its lowest volume of the year today at 1.35mm contracts (30% below its 50DMA) as NYSE volumes -10% from yesterday but average for the month. Another small range day in almost every market aside from commodities which saw significant divergence with Silver (best today) and Gold surging (up around 1.15% on the week) while Oil and Copper dived (down 2.6-3% or so on the week) with the former managing to scramble back above $96 into the close. ES and the broad risk proxy CONTEXT maintained their very high correlation as Oil and 2s10s30s compression dragged on ES but AUDJPY and TSYs post-Europe inching higher in yields helped ES. HYG underperformed all day (often a canary but we have killed so many canaries recently). Energy names outperformed on the day (as Brent and WTI diverged notably) but financials did well with the majors now back up to the late October (Greek PSI deal) highs. All-in-all, eerily quiet ahead of NFP but it feels like something is stirring under the covers as European exuberance didn't carry through over here (except in ZNGA and FFN!).

The divergence between credit and equity marksts that we noted into the European close on Friday closed and markets sold off significantly. European sovereigns especially were weak with our GDP-weighted Eurozone credit risk index rising the most in six weeks. High beta assets underperformed (as one would expect obviously) as what goes up, comes down quicker. Stocks, Crossover (high-yield) credit, and subordinated financials were dramatically wider. Senior financials and investment grade credit modestly outperformed their peers but also saw one of the largest decompressions in over a month (+5.5bps today alone in the latter) as indices widen back towards their fair-values. The 'small moderation' of the last few weeks has given way once again to the reality of the Knightian uncertainty Europeans face as obviously Portugal heads squarely into the cross-hairs of real-money accounts looking to derisk (10Y Portugal bond spreads +224bps) and differentiate local vs non-local law bonds. While EURUSD hovered either side of 1.31, it was JPY strength that drove derisking pressure (implicitly carry unwinds) as JPYUSD rose 0.5% on the day (back to 10/31 intervention levels). EURCHF also hit a four-month low. Treasuries and Bunds moved in sync largely with Treasuries rallying hard (30Y <3% once again) and curves flattening rapidly. Commodities bounced off early Europe lows, rallied into the European close and are now giving back some of those gains (as the USD starts to rally post Europe). Oil and Gold are in sync with USD strength as Silver and Copper underperform - though all are down from Friday's close.

While the ubiquitous pre-European close smash reversal in EURUSD (up if day-down and down if day-up) was largely ignored by risk markets today (as ES - the e-mini S&P 500 futures contract  - did not charge higher and in fact rejected its VWAP three times), some cracks in the wondrously self-fulfilling exuberance that is European's solved crisis are appearing. For the first day in a long time (year to date on our data), European stocks significantly diverged (negatively) from credit markets today. While EURUSD is up near 1.3175 (those EUR shorts still feeling squeezed into a newsy weekend), only Senior financials and the investment grade credit index rallied today, while the higher beta (and better proxy for risk appetite) Crossover and Subordinated financial credit index were unchanged to modestly weaker today (significantly underperforming their less risky peers). European financial stocks have dropped since late yesterday - extending losses today - ending the week up but basically unch from the opening levels on Monday. High visibility sovereigns had a good week (Spain, Italy, Belgium) but the rest were practically unchanged and Portugal blew wider (+67bps on 10Y versus Bunds, +138bps on 5Y spread, and now over 430bps wider in the last two weeks as 5Y bond yields broke to 19% today). The Greek CDS-Cash basis package price has dropped again which we see indicating a desperation among banks to offload their GGBs and needing to cut the package price to entice Hedgies to pick it up (and of course some profit-taking/unwinds perhaps). All-in-all, Europe's euphoric performance has started to stall as perhaps the reality of unemployment and crisis in Europe combine again with US's GDP miss to bring recoupling and reinforcement back.

GGP part deux, as the hopium high sold by US regulators that allowed banks and borrowers to pretend bad loans were good wears off and reality sets in..

For a new investor in gold and silver, here is the most lucid piece of advice I can offer. Identifying severe undervaluation points in gold and silver, buying gold and silver assets during these times, and not worrying about interim short-term volatility, even if the immediate volatility is downward, is much more likely to impact your accumulation of wealth in a positive manner than trying to perfectly time market tops and bottoms in the highly manipulated gold and silver game.

Markets have become far less volatile than last year, but many investors remain focused on the Credit Markets for signs and cues as to the next move.  With so many people looking to moves in credit markets and trying to determine how successful an auction has been, we thought it would make sense to go through some examples of how credit trades.  At one extreme you have a real market like for the E-mini S&P futures.  That trades from Sunday at 6pm EST until Friday at 4:15 EST.  It is virtually continuous and at any given time you can see the bids and offers of the entire market.  Then you have credit trading, which has almost nothing in common with ES futures and their incredible liquidity and transparency.

Where did all the bears go?  We cannot find more than one person willing to be outright bearish.  What is particularly strange is that the reasons most people are bullish seem to have little, if anything to do with fundamentals – either macro or micro.  The reason for being long that is closest to being “fundamental” is that Europe is muddling through.  We're not sure Europe is muddling through, but in any case, wasn’t the bullish case for US stocks that we were decoupling?  Conspicuously absent as a reason to be long is earnings. It seems as though everyone is reasonably long (though not fully committed), but thinks everyone else is underweight.  It really feels like the “consensus” is that everyone else is underweight so you better be long for when that money comes into the market. The conversations are far more bearish than the positioning.

Amid the lowest NYSE volume of the year (-24% from Friday - OPEX) and pretty much the lowest non-holiday-period volume in 9 years based on Bloomberg's NYSEVOL data, ES (the e-mini S&P 500 futures contract) ended the day almost perfectly unchanged underperforming 5Y investment grade and high-yield credit indices on the day as both moved to contract tights (their best levels since early August last year) even as their curves flattened. There has been lots of chatter about how the steepening of the short-end of the European sovereign bond markets (Italian 2s10s for instance) is a sign that all-is-well in the world again, well unfortunately the flattening of the short-end of US IG and HY credit markets sends a rather less positive signal than headlines might care to admit (as jump risk in the short-term remains 'high' relative to bullish momentum in the medium-term). At the same time, vol markets are showing extreme levels of short-term complacency as 1m VIX is almost at record low levels relative to 3m VIX (and diverging today from implied correlation). Broadly speaking , risk assets rallied into the US day session open only to sell off into the European close (with Sovereigns leaking back the most). The afternoon saw risk rallying as the path of least resistance appears to be up all the time there is no news. Stocks ended well off their highs of the day, in line with broad risk assets, as TSY yields rose 3-4bps higher, Oil and Copper 1.5-1.75% higher (outperformed) while Silver and Gold hugged USD weakness at around a 0.5% gain from Friday's close.

All you need to read.

• Here we go again: IMF Said to Seek $1 Trillion Resource-Boost Amid Euro Crisis (Bloomberg)
• China said to Tell banks to Restrict Lending as Local Officials Seek Funds (Bloomberg)
• EU to Take Legal Action Against Hungary (FT)
• Portugal Yields Fall in Auction of Short-Term Debt (Reuters)
• US Natural Gas Prices at 10-Year Low as Warm Weather Weakens Demand (Reuters)
• German Yield Falls in Auction of 2-Year Bonds (Reuters)
• World Bank Slashes Global GDP Forecasts, Outlook Grim (Reuters)
• Why the Super-Marios Need Help (Martin Wolf) (FT)
• Chinese Vice Premier Stresses Government Role in Improving People's Livelihoods (Xinhua)

All you need to read.

When back in August, Europe declared a short selling ban of any financials (here we are willing to channel Romney, and make a $10,000 bet with anyone that said ban will never be lifted), and which as we predicted has had no favorable impact on bank stocks which have since tumbled, we suggested that the next step will also be the final one: the passage of laws prohibiting sales of any kind. As usual we were partially joking. And as so often happens, we are about to be proven right again. As the FT reports in its headline article today, whose gist is simple enough, that Europe is on the verge, it is the tactically-placed final paragraph that is of particular curiosity. It says the following: "Speaking on the fringes of a start-of-year retreat of her Christian Union lawmakers in the city of Kiel, Ms Merkel said she would consider calls from her party colleagues for legislation to bar institutional investors such as insurance companies from selling bonds when ratings were downgraded, or fell below investment grade." Allow us to recopy and repaste the key part: "legislation to bar institutional investors such as insurance companies from selling bonds."

All your questions about the historic European downgrade should be answered after reading the following FAQ. Or so S&P believes. Ironically, it does an admirable job, because the following presentation successfully manages to negate years of endless lies and propaganda by Europe's incompetent and corrupt klepocrarts, and lays out the true terrifying perspective currently splayed out before the eurozone better than most analyses we have seen to date. Namely that the failed experiment is coming to an end. And since the Eurozone's idiotic foundation was laid out by the same breed of central planning academic wizards who thought that Keynesianism was a great idea (and continue to determine the fate of the world out of their small corner office in the Marriner Eccles building), the imminent downfall of Europe will only precipitate the final unraveling of the shaman "economic" religion that has taken the world to the brink of utter financial collapse and, gradually, world war.

Almost six months ago we discussed the dramatic shifts that were about to occur (and indeed did occur) the last time the New York Fed tried to unwind the toxic AIG sludge that is more prosaically known as Maiden Lane II. At the time, the failure of a previous auction as dealers were unwilling to take up even modest sizes of the morose mortgage portfolio was the green light for a realization that even a small unwind of the Fed's bloated balance sheet would not be tolerated by a deleveraging and unwilling-to-bear-risk-at-anything-like-a-supposed-market-rate trading community. Today, we saw the first glimmerings of the same concerns as chatter of Goldman's (and others) interest in some of the lurid loans sent credit reeling. As the WSJ reports, this meant the Fed had to quietly seek confirming bids (BWICs) from other market participants to judge whether Goldman's bid offered value. The discreteness of the enquiries sent ABX and CMBX (the credit derivative indices used to hedge many of these mortgage-backed securities) tumbling with ABX having its first down day since before Christmas and its largest drop in almost two months. The knock-on effect of the potential off-market (or perhaps more reality-based) pricing that Goldman is bidding this time can have (just as it did last time when the Fed halted the auction process as the market could not stand the supply) dramatic impacts as dealers seek efficient (and critically liquid) hedges for their worrisome inventories of junk. The underperformance (and heavy volume) in HYG (the high-yield bond ETF we spend so much time discussing) since the new-year suggests one such hedging program (well timed and hidden by record start-of-year fund inflows from a clueless public which one would have thought would raise prices of the increasingly important bond ETF) as the market's ramp of late is very reminiscent of the pre-auction-fail-and-crash we saw in late June, early July last year as credit markets awoke to the reality of their own balance sheet holes once again.