Bond

On one hand we have FT "reporting" about Chinese Italian bond purchasing ambitions citing "unidentified Italian officials" one day ahead of a major Italian bond auction (wink wink nudge nudge). On the other hand, we have Reuters, citing a real live Italian Finance Minister (though not for long) Giulio Tremonti, who tells us a slightly different story, which, gasp, cites real live people: "Italian Economy Minister Giulio Tremonti said on Thursday that Asian investors are reluctant to buy Italian bonds because it sees they are not being bought by the European Central Bank."

And so the ECB's balance sheet, once upon a time clean of any monetization interventions, continues to deteriorate, and has now grown to a record €143 billion, after the bank disclosed €13.96 billion in PIIGS debt purchases in the prior week. This is an additional €70 billion since the SMP was expanded to purchase Italian and Spanish debt in early August (predicated by Italy complying with an Austerity prgoram that it has since made a complete mockery of). So for those complaining about the ECB pursuing Quantitative Easing, we wonder what one would call nearly $100 billion in bond repurchases in the open market in the past month: this is about as much as the Fed would purchase in its most active monetization month during either QE1 or QE2!

In the chart below, for all intents and purposes, green means red. Also, the probability of Greek default according to at least one data service is a little over 100%.

As we speculated on Friday, Europe has opened, and it is ugly. In fact, Europe has never been closer to a bank and market holiday than it is right now. Why? Let's go down the list...

How good is ECB at buying Eurozone Bonds? First couple of days, they are in the money, but.....

We have been discussing the indications being sent by the credit markets and the turn in the credit cycle that appeared to be developing. Just to add to the pile of cyclical turn indicators, we note that the number of corporate bonds receiving S&P credit rating downgrades exceeded upgrades this quarter for the first time since Q1 2010. Obviously, this is led by the high-yield names but the withdrawal of liquidity often rapidly pushes crossover names closer to the edge and inevitably leads up the capital structure and quality spectrum.

As previously reported, Italy is stealthily undoing its entire €45.5 billion austerity plan proposed two short weeks ago, first cutting the provision for tax hikes for high earners, and now also scrapping the proposed pension changes as Ansa reports - the pension proposal, would have excluded time at university, mandatory military service, from calculations of the retirement age and pension level. That is now gone due to a vocal opposition against every single austerity line item. Unfortunately for Italy, which has been hoping nobody would notice: Bloomberg, which has released an analysis titled "Berlusconi’s Backpedaling May Push Italy Back Toward The Brink of Disaster." It is rather self-explanatory: as a reminder the ECB is only buying Italy bonds as part of its SMP monetization expansion due to promises that Italy would slash its deficit and implement austerity. Now that this is obviously not happening, the SNB is expected to balk at future purchases of Italian debt due to Germany complaining loudly that it is supposed to carry the burden of Italy's consistent lying. Already Italian bonds have resumed their climb wider, and explains the weaker than expected BTP auction of 3 and 10 year bonds conducted yesterday.

The reward for lending money to various sovereign governments around the world is ridiculous based on the amount of risk involved in doing so. At one end of the scale you have the juicy 44% yield for lending money to Greece which, let’s face it, is done. At the other end of the scale you can get basically nothing for lending money to the governments with the poorest balance sheets on the face of the planet. Your choices? Japan with its 200% debt-to-GDP and dying economy? Europe, which will likely no longer exist in its present form come the end of 2012 and which has broadened it’s accumulation of debt from the worthless kind issued by Greece to the severely dubious varieties issued by Spain and Italy (with France just waiting to be put into the game)? Or how about the United States? With its $14 trillion (and rising) deficit, it’s bloated balance sheet of toxic assets, its inestimable unfunded liabilities and its paralyzed political process? Some choice. And yet, people continue to flock to these perceived safe havens largely because, over the years, they have become used to doing so. At some point they will figure out that the ‘safety’ offered by government bonds is now a phantasm and when they do, you can be sure their awakening will be felt across the world. As fire and ash billowed into the skies over Pompeii and Herclaneum all those years ago, the terrified citizens below poured into the safety of their cellars where they had always sought protection previously. Only this time it WAS different and the cellars that had always offered them shelter from the storm became their tombs; proving conclusively that what may well have afforded protection in the past, may not do so in the future. Sadly, the 20,000 people living at the foot of Mount Vesuvius found that out the hard way. 1932 years after arguably the most storied of volcanic eruptions in history, at the foot of a volcano that still smoulders but, despite an eruption in 1944, hasn’t had a major eruption since 1631, 700,000 people now reside.

Calm before the storm today, with just weekly initial jobless claims (20 out of 20 400K+ weeks with one or two very small exceptions) on the economic docket, ahead of the last bond auction of the week, which should send total US debt on the verge of breaching the provision ceiling of $14.695 trillion.

Durable goods orders for July and FHFA house prices. Also another $35 billion in 5 Year bonds to be auctioned off.

For those wondering why gold just surged by about $20 dollars, and why Gartman's cab driver once again proves to be far more astute than his passenger, we bring to your attention  a report just released by Goldman's Francesco Garzarelli which is appropriately titled "The Price of Slower Growth" - appropriately, because in it Goldman slashes the firm's outlook on global policy rates across the board, slashes to cut its 10 Year bond yield outlook from 3.75% to 2.75% in 2011 and from 4.25% to 3.50%, slashes 2012 US GDP from 3.0% to 2.10%, and once again makes it all too clear that QE3 is coming, and not only coming but is already priced in (to the tune of about $300-400 billion): "In previous work, we have estimated that every US$1trn in purchases, if maintained, decreases 10-yr Treasury yields by 25bp-50bp. If our subjective assessment that market participants now assign a greater-than-even chance of ‘QE3’ is correct, and considering that the expected ‘unsterilized’ size of these purchases is in the region of US$600-800bn, this would equate to as much as 20bp being already ‘in the price’. Clearly, these magnitudes are unobservable, and thus subject to great uncertainty. Nevertheless, our calculations would suggest that the bond market is already discounting a mild recession and the chance of a Fed reaction to it." Translation (and this is nothing new to ZH readers): Bill Dudley has his marching orders from Jan Hatzius: GS now sees deflation as the broader risk, and anything and everything must be done to make sure Wall Street has another record bonus season round, pardon, deflation must be halted.

The just completed auction of $16 billion in 30 Year bonds, was, as Rick Santelli said, "a failure". And while this may be a little dramatic, this was without doubt one of the ugliest 30 Year auctions ever seen. The 30 year priced at 3.75%, a huge 11 bps tail to the When Issued which was trading at 3.64%, the Bid To Cover plunging from 2.80 to 2.05, the lowest since February 2009, and, most shockingly, the Indirect Bidders Imploded to a paltry 12.2%! Those wondering if Chinese posturing would led to anything more than just jawboning have their answer. The Indirect tendered bids were just $3 billion or about 20% of the total auction size, which resulted in a $2 billion take down. It was so bad that the Directs were for the first time in 30 Year history greater than the Indirects. And yes, while the yield was close to record low it won't stay there especially if as is now expected, August 26 will see the BEA report a second GDP revision of ~0.6% at 8:30 am, which will be promptly followed by Bernanke's 2011 Jackson Hole address. And so the yoyo continues: what today's auction has proven is that going forward the Fed will be forced to crash the market every day that there is a Treasury auction, while ramping stocks on days when Treasury does not need to fund its borrowing binge.

After previously testing its mettle in such markets as Natural Gas and Crude Oil, the fractal algo, just like the StuxNet virus, is now ready to progress to its real test: equity products, and specifically ETFs. Courtesy of Nanex' sharp eyes (and extremely complicated market scanners), today we have the first official spotting of the fractal algo moving away from commodities and into extremely popular ETFs, in this case the bearish bond synthetic CDS better known as the TBT. The pattern below is quite unmistakeable. It is quite amazing that just one algorithm can override the entire market and determine the trading pattern of some as hugely popular as an ETF which most hold. We expect that very shortly, we will be observing daily fractal patterns in that most liquid and traded product of all- the SPY, as the market proceeds to become nothing more than a real life version of Nuke-em Duke-em robots.

Several B-grade economic developments on the docket, as well as the first post-downgrade 10 Year bond issuance. Latest monthly QE Lite POMO schedule released today.

The S&P downgrade was not as much a comment on the numbers of credit service as a comment on the political process. The political process is about confronting the probability of a hyper-inflationary collapse of our currency if fiscal irresponsibility, entitlement spending and bank bailout mentality are not addressed. If the credit rating firms had continued the charade of AAA quality, it would merely enable the not sustainable march toward hyper-inflation. Ultimately, the S&P downgrade of Treasuries is a downgrade of all dollar denominated assets. If we can print dollars to pay Treasury debt, it is the currency that is at risk. A nominal default of Treasury obligations is not going to happen. Yet, a real default as a currency event is the risk. In order to save the currency,  we must sacrifice the money center banks. A sacrifice of the international banking system is a deflationary event. For Treasuries to rally in a flight to quality as a market reaction to their own downgrade is a flight to the relative safety that remains. Anticipation of the deflationary political discipline of an S&P downgrade is the rational reaction of capital flight away from securities propped up by the reflationary status quo.