Capital Markets

We previously observed that the US Treasury, under advisement of TBAC Chairman Matt Zames, who currently runs JPM's CIO group in the aftermath of the London #FailWhale and who will become the next JPM CEO after Jamie Dimon decides he has had enough of competing with the Fed over just who it is that run the US capital markets, would soon commence issuing Floating Rate bonds (here and here) as well as the implication that the launch of said product is a green light to get out of Dodge especially if the 1951 Accord is any indication (which as we explained in detail previously was the critical D-Day in which the Fed formerly independent of Treasury control, effectively became a subservient branch of the government, in the process "becoming Independent" according to then president Harry Truman). Sure enough, minutes ago the TBAC just told Tim Geithner they have given their blessing to the launch of Floating Rate Notes. To Wit: "TBAC was unanimous in its support for the introduction of an FRN program as soon as operationally possible. Members felt confident that there would be strong, broad-based demand for the product." Well of course there will be demand - the question is why should Treasury index future cash coupons to inflation when investors are perfectly happy to preserve their capital even if that means collecting 2.5% in exchange for 30 Year paper. What is the reason for this? Why the Fed of course: "Whereas the Fed had, as a matter of practice, reinvested those proceeds in subsequent Treasury auctions, Treasury must now issue that debt to the public to remain cash neutral. For fiscal years 2012-2016, this sums to $667 billion." Slowly but surely, the Fed's intervention in the capital markets is starting to have a structural impact on the US bond market. 

Another week of central bank watching ahead, and markets will play their customary game of chicken with the U.S. Federal Reserve and the European Central Bank.  Both central banks have policy meetings this week – the Fed’s concludes on Wednesday, the ECB’s on Thursday – and capital markets have been moving higher in recent days on the hope of coordinated action.  For investors and traders, this sets up a classic “Buy the rumor, sell the news” pattern for the week ahead - as the overarching theme is that human history repeats because human nature does not change.  But Nic Colas of ConvergEx asks the deeper question, and the one that will retard any lasting move to the upside, is how much central banks can do without help from fiscal policymakers.

The insolvent banana continent is back. Recall back in May 2011: 

“When it becomes serious, you have to lie." -Jean Claude Juncker

Ergo, things in Europe are very serious again because the Eurogroup's head, who until recently promised he was quitting his post because "he had gotten tired of the Franco-German interference in managing the region's debt crisis", only to spoil the fun and say he was lying about that too, is back to doing what he does best - lying. To wit: "the euro countries are preparing together with the bailout fund EFSF and the European Central Bank to buy government bonds if necessary clip euro countries." And now cue Schauble: "Federal Finance Minister Wolfgang Schaeuble has rejected speculation about impending purchases of government bonds by Spanish EFSF and ECB."

Since the 2009 stock market lows, Europe has demonstrated what happens to capital markets when there is no central planner willing and able to accept the risk of runaway inflation in the future (not to mention soaring deficits and deferred austerity) in exchange for instant stock market gratification right here, right now. End result: the French, Italian and Spanish stocks markets have barely budged since their 2009 lows (and Spain is well below). How does this look in the context of all global stock markets on a Price to Book ratio? The answer is below.

Sayonara internal funding. In what we suspect will become a major issue (and warned in April of last year), Bloomberg reports that Japan’s public pension fund, the world’s largest, said it has been selling domestic government bonds as the number of people eligible for retirement payments increases. "Payouts are getting bigger than insurance revenue, so we need to sell Japanese government bonds to raise cash." It would appear the Ponzi has reached it's Tipping Point. Japan’s population is aging, and baby boomers born in the wake of World War II are beginning to reach 65 and eligible for pensions. That’s putting GPIF under pressure to sell JGBs so it can cover the increase in payouts. The fund needs to raise about 8.87 trillion yen this fiscal year. GPIF is historically one of the biggest buyers of Japanese debt and held 71.9 trillion yen, or 63 percent of its assets, in domestic bonds as of March.

Every day the Fed's control of all capital markets becomes greater and greater, and every day ordinary investors, and even habitual gamblers, realize they have had enough with participating in a rigged casino, in which the now completely meaningless and irrelevant level of the S&P or the DAX or Nikkei or the 10 Year bond is nothing but a policy tool in the global devaluation race to the inflationary bottom. And while we have shown the week after week of relenltess equity outflows as aging baby boomers call it quits and instead opt for return of capital (than on), the full impact of this boycott on Bernanke's usurpation of capital markets, in which a simple WSJ scribe can move the market more than the deteriorating fundamentals of the world's biggest company-cum-gizmo maker is best seen in trading volumes. Which as Securities Technology shows, are now down 19% in the first half of 2012. Of course, if one were to exclude the robotic presence in stock trading, which is anywhere between 50 and 70%, it would be a miracle to find any human beings still trading with each other.

Europe is once again scrambling by clutching at broken straws and juggling dead ends.  To wit: instead of actually proposing a realistic solution to its massive debt overhang, the ECB's Ewald Nowotny "said there are arguments in favor of giving Europe’s rescue fund a banking license, reviving the debate on bolstering its firepower as leaders face the prospect of a full-scale Spanish bailout." As a reminder, this is an absolute dead end that Germany and the ECB have both repeatedly rejected as implementation would confirm just how hollow the European gutted shadow banking market (you can't have shadow banking without credible collateral). Further slamming the Nowotny comment was Daiwa which called the Nowotny statetment a Red Herring and that "remarks that ECB council member sees arguments for giving bailout fund banking license "look to be just noise," Grant Lewis, head of research at Daiwa Capital Markets Europe, says in client note. Comments appear to have been off the cuff and purely personal opinion; such a move remains “highly improbable,” as Germany and ECB “implacably opposed” to this. Finally Daiwa adds that markets will soon focus again on fact that if ESM can’t be activated in early autumn, there’s no money available to bail out Spain, “let alone Italy." 

"This market isn't real. The two percent on the ten-year, the ninety basis points on the five-year, thirty basis points on a one-year – those are medicated, pegged rates created by the Fed and which fast-money traders trade against as long as they are confident the Fed can keep the whole market rigged. Nobody in their right mind wants to own the ten-year bond at a two percent interest rate. But they're doing it because they can borrow overnight money for free, ten basis points, put it on repo, collect 190 basis points a spread, and laugh all the way to the bank. And they will keep laughing all the way to the bank on Wall Street until they lose confidence in the Fed's ability to keep the yield curve pegged where it is today. If the bond ever starts falling in price, they unwind the carry trade. Then you get a message, "Do not pass go." Sell your bonds, unwind your overnight debt, your repo positions. And the system then begins to contract... The Fed has destroyed the money market. It has destroyed the capital markets. They have something that you can see on the screen called an "interest rate." That isn't a market price of money or a market price of five-year debt capital. That is an administered price that the Fed has set and that every trader watches by the minute to make sure that he's still in a positive spread. And you can't have capitalism if the capital markets are dead, if the capital markets are simply a branch office – branch casino – of the central bank. That's essentially what we have today."

Spain is not Uganda: this morning Spain is increasingly looking like the 10th circle of bondholder vigilante hell with its 10 Year trading at 7.59% after hitting a record 7.607% moment prior. The short end has blown out even wider and the 2 Year very appropriately at 6.66% and rising. Italy has also joined the party blowing out to just why of 6.5% and Italy's banks about to be halted across the board despite the short-selling ban. Next up: selling anything forbidden. Finally, the scramble for safety into Swiss 2 year notes accelerates as these touch a mindboggling -0.44%. There was no specific catalyst to lead to today's ongoing meltdown, but the fact that Spain just paid a record price for 3 and 6 month Bills is not helping: the average yield was 2.434 percent for the three-month bills compared with 2.362 percent in June and 3.691 percent for six-month paper compared with 3.237 percent. With each passing day, the selling crew is demanding the ECB get involved and stop the carnage. For now Draghi is nowhere to be seen as Germany continues to have the upper hand. After all recall just who it is that benefits from keeping the periphery on the razor's edge and the EURUSD sliding.

UPDATE: It would appear $32.75 is the line in the sand...

After pricing its IPO at $26 and opening at $30.10, the latest poster-child for the awesomeness of the US capital markets has pushed up to over $34.50. While Fender cites market conditions, it seems 'investors' can't get enough of this Silicon Valley 'special offer'. This one should be interesting as we see some stability already and volume...

Two years ago, in January 2010, Zero Hedge wrote "This Is The Government: Your Legal Right To Redeem Your Money Market Account Has Been Denied" which became one of our most read stories of the year. The reason? Perhaps something to do with an implicit attempt at capital controls by the government on one of the primary forms of cash aggregation available: $2.7 trillion in US money market funds. The proximal catalyst back then were new proposed regulations seeking to pull one of these three core pillars (these being no volatility, instantaneous liquidity, and redeemability) from the foundation of the entire money market industry, by changing the primary assumptions of the key Money Market Rule 2a-7. A key proposal would give money market fund managers the option to "suspend redemptions to allow for the orderly liquidation of fund assets." In other words: an attempt to prevent money market runs (the same thing that crushed Lehman when the Reserve Fund broke the buck). This idea, which previously had been implicitly backed by the all important Group of 30 which is basically the shadow central planners of the world (don't believe us? check out the roster of current members), did not get too far, and was quickly forgotten. Until today, when the New York Fed decided to bring it back from the dead by publishing "The Minimum Balance At Risk: A Proposal to Mitigate the Systemic Risks Posed by Money Market FUnds". Now it is well known that any attempt to prevent a bank runs achieves nothing but merely accelerating just that (as Europe recently learned). But this coming from central planners - who never can accurately predict a rational response - is not surprising. What is surprising is that this proposal is reincarnated now. The question becomes: why now? What does the Fed know about market liquidity conditions that it does not want to share, and more importantly, is the Fed seeing a rapid deterioration in liquidity conditions in the future, that may and/or will prompt retail investors to pull their money in another Lehman-like bank run repeat?

Instead of sticking to selling short-term, LTRO covered debt, Spain was so desperate to show it has capital markets access that this morning it tried selling bond due 2014, 2017 and 2019 with a maximum issuance target of €3 billion. It failed to not only meet the target, but to price the €1.074 billion in bonds due 2017 at anything less than an all time high (6.459%) as a result sending the entire curve blowing out wider, and the 10 Year above the critical 7% threshold again, for the first time since the June Euro summit, whose only function was to give a positive return for the fiscal year to such US pension funds as Calpers and New Year. In summary:  Spain sold 2.98 billion euros of short- to medium-term government bonds on Thursday in a sale at which borrowing costs rose and demand fell. The average yield at a sale of 1.07 billion euros of five-year bonds rose to 6.46 percent compared with 6.07 percent at the previous auction of the debt last month. Investors' bids were worth 2.1 times the amount offered for the five-year paper versus 3.4 times at the last auction, and 2.9 times for the seven-year bond. The average yield at the seven-year sale rose to 6.7 percent from 4.83 percent.

The NIRP club, or those countries whose 2 Year (or longer) bonds trade inside negative territory as presented yesterday, is happy to welcome Finland among its ranks, following the country's 2 Year bond briefly touching on -.008% minutes ago (since "recovering" to 0.0000% briefly). Other proud member countries include Holland, Germany (which earlier issued 2 Year debt at sub zero rates for the first time ever), Denmark, and Switzerland, or Europe's AAA-list. On the other end, the peripherals continue to trade on an ever more unsustainable basis. Europe has now become one big pair trade: everyone is long the viable countries and short the... less than viable ones.

With central bankers dominating the airwaves, and the only thing that matters is who prints where and how much, most can be forgiven to have missed one of the more important micro developments in the past few weeks: namely the case study of emblematic French automaker Peugeot, which just happens to be Europe's second largest, and its Credit Default Swaps, which have doubled in the past  4 months, to a record high spread of 813 bps, which means the probability of default for the company has nearly doubled from 29% to 52% in a few short months. Yet what is it about Peugeot that is interesting - well the fact that the biggest spike in its default risk has taken place in the last few days, which have seen a nearly 100 basis point spike. The catalyst: "French President Francois Hollande, elected in May after pledging to block a “parade of firings,” said July 14 he would lean on Peugeot to rework the plan intended to stem losses and trim production capacity. The government will report the findings of a review later this month, as well as measures to prop up the French auto sector." The problem is that this type of state intervention into corporate viability and profitability is precisely what precipitates wholesale bankruptcy. And this is precisely what the bond market has reacted to. Because while Hollande is doing all he can to pander to populism, and to recreate America's epic failure involving GM, the reality is that by enforcing what he thinks is "right" and "fair" dooms not only Peugeot and its 200,000 employees, but millions of upstream and downstream workers.

And so it begins...Last Friday the Spanish government published a proposal to cut government expenditure and raise taxes to reduce the fiscal deficit by 56.4billion euros by 2015.  I have outlined why austerity will not work in Europe, but it looks like this is a lesson Europeans will have to learn for themselves--for a second time.  The writing is on the wall in Ireland, who ailed in the same ways that Spain is currently ailing, but what Lord Merkel wants, Lord Merkel gets.  The immediate malaise from these austerity measures will be large-scale social unrest, which is already being planned by many of the 50% of the country's unemployed young people.  Regardless of one's stance on the economic merit of austerity, what is indisputable is that riots are real and riots do not end well.  With nothing to lose, this round of Spanish austerity protesting has the potential to end in catastrophe.