Bond

Risk is solidly bid this morning as the EURUSD has jumped to overnight highs of just under 1.45, and the DXY has just dropped to a one month low, following two Spanish bond auctions which saw yields surge yet came at far higher bids to cover than previously. From Reuters: "Spain saw strong demand for 3.95 billion euros ($5.67 billion) of medium-term bonds on Thursday, though a broad drop in risk appetite and lingering uncertainty over how talks on fresh aid for Greece will pan out kept yields high. In a litmus test of investor appetite for peripheral euro zone debt as policymakers thrash out a plan to avert a Greek default, the 2014 bond, with a 3.4 percent coupon, sold 2.75 billion euros at an average yield of 4.037 percent. That compared with 3.568 percent at the previous auction in April, while the bid to cover rate rose to 2.5 compared with 1.8. The 2015 bond, last issued in September of last year and with a coupon of 3 percent, sold 1.2 billion euros at an average yield of 4.230 percent, slightly lower than yields on the secondary market. The bond was 2.9 times subscribed after being 1.6 times subscribed at its last auction. "Since the (2014) launch early April, we've had an escalation on the peripheral side, so a firm selling since then, which is why (the yield) jumped so much," economist at 4Cast Jo Tomkins said. "You'll see plenty of buyers coming in at that level, especially since the Greek deal seems to be moving in a positive direction." Also adding to the risk appetite are statements from Trichet that in the longer term, he could suggest forming a finance ministry of the European Union, adding there is no crisis in the EUR. Lastly, he added that if aid programs fail, as a second stage he could consider deeper integration of economic policy, more central command of domestic policies. Of course they will: once all is plundered, the ECB will become the defacto "protector" of its colonies. And falling solidly into the trap is Greece where according to a government source the privatization plans may run faster than expected.

Today's $35 billion 5 year bond auction was one of the strongest auctions completed in recent years, with a Bid To Cover of 3.20, the highest in the series, compared to 2.77 before and a 2.79 average in the last twelve auctions. This happened despite the yield dropping from 2.124% to 1.813%, the lowest since December 2010. Total competitive bids tendered surged from $97 billion to $112 billion, primarily due to Indirect bids rising from $18.6 billion to $24.4 billion, resulting in a drop in the hit rate from 74.9% to 67.5%. The Primary dealer hit rate also dropped from 25.7% to 20.7%. Indirect take down at 47.1% was the highest since September 2010. Completing the internals, was the -1.7 tail. As a reminder, on March 18 Goldman advised clients to short the 5 Year. That trade did not work out too well. As for the fact that this auction takes total Marketable Debt even further above the debt ceiling, that's irrelevant: the Treasury can just underfund retirement account holdings by another $35 billion.

Yesterday 55%, today 65%, tomorrow: all cash, next week: Greek gold only (and evil silver speculators think they had a rough day).

A month ago, we reported that the Japanese public pension fund, which holds JPY152 trillion in total reserves, would for the first time withdraw 6.4 trillion yen in order to cover pension payouts, a process which once started, eventually ends up with the "Illinois" conclusion where it has to issue bonds to pay accrued pension obligations. The reason why the Japanese pension fund is particularly important for japan is that not only does it have implications for the welfare system of the land of the rising sun, any future dispositions will explicitly affect the supply and demand of JGBs, of which pension funds have traditionally been a major buyer. Not only that, but as Dylan Grice reminded us some time ago, a liquidation process would also impair US Treasury holdings: " As Japan's retirees age and run
down their wealth, Japan's policymakers will be forced to sell assets,
including US Treasuries currently worth $750bn, or Y70 trillion "eight
months" worth of domestic financing." Today, another SocGen analyst, Takuji Okubo, presents a realistic outlook of what will happen when one takes government projections to the pension system and applies realistic assumptions. In a nutshell, instead of a build up of JPY100 trillion over the next 15 years, pension reserves will likely decline by JPY36 trillion, a swing of almost 140 trillion, or nearly $2 trillion in incremental and very marginal JGB and treasury demand actually becoming supply. And in a world in which the Fed is suddenly (allegedly) pulling out as the biggest source of sovereign paper demand, this swing factor out of Japan will have substantial implications for the bond market, especially when coupled with a Japanese economy that suddenly finds itself on the rocks.

Just because the US is having so much success convincing the world its debt is money good (but don't anyone dare count the $6+ trillion in GSE debt to the total US debt), the good old US of A has now decided to backstop the debt of... Egypt. Bloomberg reports: "Egypt plans to raise $1 billion by selling Eurobonds this year to diversify borrowing and finance a widening budget deficit after its economy was rocked by the worst political crisis in 30 years. The five-year bonds will be backed by a U.S. “sovereign guarantee,” Finance Minister Samir Radwan said by telephone from Cairo today...President Barack Obama promised last week $2 billion in loan guarantees and debt forgiveness." And when it comes to Uncle Sam giving his assurances to the developing world, size does not matter: "The size is not significant but the backing from the U.S. will help raise the money at a relatively inexpensive cost." Uh, should Congress perhaps have something to say about the fact that America is now somehow the guarantor of recently revolutionary African countries? Because if, heaven forbid, should the extremely stable and economically viable, but otherwise revolutionary Egyptian country suffer default and bondholders demand to be made whole, guess out of whose pocket the deficiency claims will have to be funded...

A year after an insolvent European continent realized it is long overdue to implement fiscal consolidation, aka tightening, also known as 2010's keyword of choice: "austerity", the political regimes who have supported fiscal prudence are one after another falling victim to the general population's dissatisfaction with the gradual elimination of a myriad of socialist policies. Following recent electoral losses in Germany, not to mention the overthrow of the Portuguese government, which like Belgium, continues to be in limbo, today we move on to the second to last domino in the PIIGS chain: Spain (and Italy is next: S&P took the time at 6pm on Saturday to remind everyone about that particular unpleasant fact). Per Reuters: "Spaniards began voting on Sunday in local and regional polls expected to deal heavy losses to the ruling Socialists, who are blamed for widespread unemployment that has off a wave of pre-election protests. Tens of thousands of Spaniards demonstrated in the past week in city squares around the country against austerity measures that have kept a fiscal crisis at bay but aggravated the highest jobless rate in the European Union. [as a reminder a webcam of the Madrid protests can be found here]. The protesters have called on Spaniards to reject the Socialists and the center-right Popular Party, the main two political options in Spain." The problem is that when you overthrow socialists, it is unlikely that you will get more socialism down the road. Which, however, is what everyone in this country of 21% unemployment, and nearly 50% joblessness in the 18-25 age group really wants.

And while the US is no longer allowed to auction off debt, in China the PBoC appears to be no longer able to auction off debt. As Business China reports, "the central bank scheduled the auction of RMB 20 billion worth of
one-year treasury bonds and RMB 10 billion in six-month bonds on the
country’s interbank bond market for May 13. But banks, faced with tight
liquidity, only purchased RMB 11.71 billion worth of one-year bonds and
RMB 9.63 billion worth of six-month bonds, the report said." In other words, there was a nearly 50% miss on the 3 month auction. The key reason: "The reference yield of one-year treasury bonds was raised to 3.0246% from the previous issuance, while the bond yield of 182-day discounted treasury bonds was 2.91%, the paper said." It appears investors don't agree with the central planners that 3% is an appropriate rate to compensate them for surging inflation. That, and also the fact that banks suddenly have no liquidity: "Tighter liquidity was behind the under-subscription, as the central bank resumed selling three-year notes on May 12 after a hiatus of more than five months, a bank analyst who was not named was cited as saying. The central bank also raised banks’ RRRs by 0.5 percentage points on the same day, effective May 18, the fifth consecutive month its has raised RRRs this year." And so the Catch 22 emerges: the more China fights inflation through RRR or rate hikes, the lower the purchasing power of domestic banks to purchase bonds (and yes, the US deficit is just a few hundred billions dollars too wide for it to come to China's rescue). Should the "15 minute" inflationary conundrum continue to express itself, and China be forced to rise rates even longer, very soon the country, just like the US to which it is pegged monetarily, will also be unable to raise any incremental capital.

We hadn't heard much from legendary investor Stanley Druckenmiller since last August when he decided to shut down his Duquesne Capital hedge fund. Until today. In a must read interview, the man who took on the Bank of England in 1992 and won, says that he join the camp of Bill Gross et al, making it all too clear that all the recent fearmongering about the lack of a debt ceiling hike by the likes of Tim Geithner, Ben Bernanke and, of course, all of Wall Street, is misplaced, and that the real threat to the country is the continuation of the current profligate pathway of endless spending. From the WSJ: "Mr. Druckenmiller had already recognized that the government had
embarked on a long-term march to financial ruin. So he publicly opposed
the hysterical warnings from financial eminences, similar to those we
hear today. He recalls that then-Secretary of the Treasury Robert Rubin
warned that if the political stand-off forced the government to delay a
debt payment, the Treasury bond market would be impaired for 20 years. "Excuse me? Russia had a real
default and two or three years later they had all-time low interest
rates," says Mr. Druckenmiller. In the future, he says, "People aren't
going to wonder whether 20 years ago we delayed an interest payment for
six days. They're going to wonder whether we got our house in order." Which begs the question: if interest rates are so low today, is the market not appreciating the current path of "financial ruin"? And here is where Druckenmiller joins the Grosses and the Granthams of the world. Asked if the future is not so bad judging by today's low bond rates he says, "Complete nonsense. It's not a free market. It's not a clean market." The Federal Reserve is doing much of the buying of Treasury bonds lately through its "quantitative easing" (QE) program, he points out. "The market isn't saying anything about the future. It's saying there's a phony buyer of $19 billion of Treasurys a week." Of course, there is another name for this type of arrangement and so far only Bill Gross has used it: Ponzi Scheme.

Today, we get the March trade balance and JOLTS reports. Also, the Treasury continues its exercises in debt ceiling breach by issuing another $24 billion in 10 Year notes, while the Fed explains its monetization intentions for the next month as it releases the latest POMO schedule at 2 pm EDT.

Today's $32 billion bond priced at the memorable 1.000%, with auction strength confirmed by no surprises to the WI, and also the highest Bid To Cover since August, and the third highest ever. Naturally, none of this due to actual demand, but merely due to Primary Dealer expectations of a prompt and profitable flip back to Brian Sack: PDs accounted for 51.9%, with Directs taking down a notable 15.3%, leaving Indirects with the lowest allocation of the three past auctions or 32.7%, the the third lowest since January 2009. But nobody cares about the declining foreign interest: after all the ponzi game is all internal. And since this auction is potentially debt limit busting (as it is more than the total capacity under the debt ceiling), we can't wait to see what machinations Tim Geithner's henchmen will concoct to prevent an unconstitutional breach of what is now known as the "debt target." Look for Cusip QM5 to be briskly monetized as soon as the next 3 Year POMO is announced, when the next POMO schedule is revealed tomorrow at 2 pm.

It is no secret that David Stockman, former budget director in the Reagan administration, has long been a vocal opponent of the crash course America has found itself on courtesy of record debt. In this Bloomberg interview, he presents his latest take on U.S. fiscal policy and the outlook for agreement between Congress and the Obama administration on a deficit and spending reduction plan. Suffice to say, he is not a fan of either the republican or democrat plan, and is convinced both sides are playing nothing less than class warfare to promote their flawed programs. "I think the people would respond if they knew the fact, and if they'd been were told the truth, but they haven't been, they've been lied to for the last 10-20 years by both sides saying that we can live beyond our means, new entitlements, new tax cuts constantly, tax stimulus for everything that we could imagine, and as a result of that the country doesn't know that sacrifice is going to be required, and that everyone is going to have to give up something." On the recent "spending cut" much touted by Washington: "even this noisy $39 billion package cutback, that was all flimflam and swindle: there wasn't $39 billion in that, maybe there was $5 billion at best, and had anybody in the business community reported that they had $39 billion in a package that was this fraudulent they would have every prosecutor in the country and the SEC on their tail right now." And on the much endorsed by Zero Hedge Tobin tax: "We out to put a major tax on transactions on Wall Street, because Wall Street is turning into a high speed casino. We need to start thinking about new revenue sources and that is one of them." So what will finally awake America? "I think it's going to take a major dislocation in the bond market, a real conflaguration on the part of the people who have to buy this debt, before the country wakes up." Of course, if the Fed is able to sell virtually unlimited Long-Term Treasury puts, the synthetic push on sellers will never abate and the Fed can manipulate the curve virtually in perpetuity, or until such time as those buying Treasury vol protection, ironically, decide it makes no more sense to hedge against a curve yield surge.

As many recall, Morgan Stanley's always cheerful, and unfortunately always wrong on the first try, Jim Caron had a target of 4.5% on the 10 Year for 2010 only to see the bond trade at half the yield at year end (a call for which he later apologized). Today, following another comparable bullish call on yields (and thus inflation, and the economy) Caron has done it all over again. "We see the key risk to the market as a downgrade in growth expectations for the quarters ahead. This could happen as early as this month if the data does not materially improve after a big miss in 1Q growth and keep us on track for reaching 3.4% consensus 4Q/4Q growth in 2011. And despite today’s stronger headline release of NFP, the Household Survey, which we saw as a leading indicator of jobs, fell 190K and the unemployment rate rose 0.2% to 9%. This keeps us wary of growth prospects in the months ahead. As a result, we recently turned neutral from bearish bonds. We also see risk for curves to flatten as yield forecasts may also get downgraded along with growth." Gee, and it was only on April 7, that this strategist wrote: "Overall there is little doubt that policy in the US continues to be very easy, which presents a risk that markets may tighten those conditions well ahead of the Fed, especially if Q2 growth is back on track. This is why we think that the risks are skewed toward higher rates." What a difference month makes. But that's ok, just like when Caron turned bearish on bonds in 2010, promptly followed by Goldman going all out in its QE2 demands, so this time the very same action, now that 2011 is a carbon copy of 2010, we fully expect Wall Street demands for QE3 to hit a fever pitch within 3 months tops.

It seems like yesterday that the LCH reduced Irish bond margins from 45% to 35% (it was actually 4 weeks ago). Since then, as the CME has demonstrated so well, when in need of some temporary price hike, best to just purge the "speculators." And to wit: after hiking margins back to 45%, LCH.Clearnet has for the first time raised Irish bond margins to over half, or 55%. Whether this will work as effectively in "normalizing" Irish bond prices, as it has so far "worked" with silver, remains unclear.

While it is unclear if the 7 Year bond auctioned off last week (our commentary on that partcularly weak auction rescued by Primary Dealers is here) Cusip: 912828QG8 has even settled yet (it certainly is not on the Daily Treasury Statement as of Friday), what is clear is that as part of today's POMO which closed 30 minutes earlier, that very issue accounted for a whopping 78.5%, or $6 billion, of the entire operation. As a reminder, Primary Dealers bought $15.4 billion of the auction on Thursday, and just as we predicted, couldn't wait to flip it back to the Fed. Indeed, 39% of the entire allocation has now been flipped right back to Brian Sack. And people wonder why Bill Gross is paranoid that in the absence of the Fed this thoroughly fake bid will no longer be there. And with PDs actually forced to hold the bonds they quote-unquote bid for, one wonders: what clearing price will be appropriate, once the flip game ends?

Today's final auction of the week just closed in the form of a $29 billion 7 year bond issue (Cusip: QG8). While we will find out whether or not this is the auction that broke the debt ceiling camel's back when everything settles on Tuesday of next week, the internals were downright ugly: the WI of the bond was trading at 2.68% when the auction priced at 2.712%, a surprisingly wide tail into what everyone claims is a risk free asset. As a result the entire curve has been dragged wider on the news. Among the internals, the Bid To Cover came at 2.63, far weaker than both the previous (2.80) and the average (2.79). But the most notable metric as usual was the Indirect Bid, which traditionally strong at the belly of the curve, saw only 39.1% of the auction going to foreign bidders. This compares to 49.31% in the last auction and 51.45% on average. This meant that Primary Dealers, better known as Brian Sack, were forced to preemptively monetize 53% of the auction, and 7.8% going to Directs. Overall a very poor auction, considering that conventional wisdom was that when the Fed launches QE3 it will focus on bonds at the belly and to the right, in order to moderate inflation. Hopefully (for some) this is not a harbinger that the Bill Gross thesis is finally starting to materialize.