Bond

In the world of bonds, few things have perplexed investors as much as the ridiculously low (and going lower) rates of Japanese Government Bonds (JGBs), at last check yielding 1.22%. Granted "deflation" in Japan has long been quoated as the key driver for the ongoing decline in real and nominal rates, but in practical market terms it was always the fact that there was a buyer of first and last resort, usually this being either Japanese citizens directly or their proxy, the Japanese Government Pension Investment Fund (GPIF) that kept yields in check and sliding. No one has been following the story of the perpetually collapsing JGB yield better than SocGen's Dylan Grice (for the best overview of this issue we suggest: "Upcoming Government Funding Crises: Japan Edition"). And while as Dylan has pointed out before, the direct purchase of bonds by the population has slowed if not reversed entirely (and in the aftermath of the March 11 earthquake we are confident many have entered run off mode - we will attempt to confirm as soon as official fund flow data is released), the GPIF has always been a buyer of last resort. Until now. Reuters reports that the Kyle Bass pain trade, which has for so long gone counterintuitively, may be about to pay off in spade.

For a stunning reminder of just how much of a haircut the market is expecting on Greek debt in actual cash terms, look no further than the country's 30 Year bonds. These are now trading just above 50 cents on the euro. That's a "50% off" blue light special and roughly comparable to the recovery the market is expecting on the paper. Alternatively any "liability management exercise" price on these notably above 50 will result in a Greek revolution.

As if insane FX vol (has anyone looked at the EURUSD chart recently) and failed LCH.Clearnet margin hikes to prevent surging vol in Irish and Portuguese bond was not enough, the CME is doing its best to make sure developed world sovereign bonds, which had for the time being been recently stable, follow in the footsteps of all other assets that actually trade (read: not stocks) and see volatility surge (perhaps so the Fed can sell more of it). The CME has just announced it is launching cash-settled Sovereign Yield Spread futures beginning May 22 for a trade date of May 23. What this means simply said, is that after discussions with Dealers, the CME has realized that its biggest clients are all too willing to hedge sovereign risk (pocketing wide bid/ask spreads in the process). It also means that the market for sovereign bonds is about to be opened up to all Mrs Watanabes in the world who are willing to express a direction bias in the 10 Year bonds of France, Germany, Italy, Netherlands, UK and, of course, the US. Now on the surface there is nothing wrong with that, however it does open the Treasury market to two traditional risk factors always seen when an otherwise ration market is opened up to everyone: 1) the herd, which tends to be always wrong, steps in and exacerbates prices moves in either direction and 2) here comes HFT: very soon the spread arbs will be trading the living daylights out of Treasury bonds, which courtesy of market reflexivity, where the derivative actually sets the price of the underlying, means that a bunch of computers will soon be the reason for why 10 Years trade at 0 or 10%. Coming next: circuit breakers in the Treasury market. At least this means that CDS traders will no longer be scapegoated for sovereign insolvency.

Following the S&P news, oddly enough, one is not seeing a flight to safety away from US paper and into Greek. In fact, observing the absolutely record 20% yield print on the 2 Year Greek bond, one may be excused to speculate that the inverse is happening. Also, with the cash price of the 2 Year now at 20% and the prices of longer duration bonds in the 60s, there is now no reason to actually restructure the country: bonds have it pretty much fully priced in. After all, the Santorini liquidation value should be worth at least 20-30 cents on the bond dollar, er, euro.

Now that the global financial system is down to living literally auction to auction, with negligible available cash and deficits as far as the eye can see, not to mention a European continent living day to day on the whims of either political extreme, issuance of government paper, and particularly its proper uptake, takes takes on a especially significant role. Below we present not only Goldman's summary of the key events in the past week as well as those in the next 5 days, but a bond auction schedule, together with a POMO summary, for the next two weeks.With everyone selling as much paper as they can wet away it, not even the global central banking cartel selling unlimited long term puts on the worldwide treasury curve will do much to prevent the upcoming global yield tsunami.

Busy day with quite a bit on the economic front: if Gallup is right March retail sales will be weaker than expected. Other key events include the JOLTS survey, business inventories, a Treasury auction and the inverse - POMO; and last Obama is presenting at noon his deficit reduction plan.

While the last time there was a major market swing minutes before POMO completion force the Fed to delay the end of that particular POMO after Primary Dealers had to make sure they are going to be guaranteed their hundreds of millions in taxpayer funded capital gains, this time around there was no such issue. Today's monetization of 5 Year Notes closed with $6.580 billion of debt bought by Brian Sack in this week's last POMO (none tomorrow). And in what should not be a surprising development to anyone, the one issue which represented over half of the total operation was the just issued 5 Year QA1 which was placed literally a week ago (highlighted on the table). And so the grand scam continues: the Fed pretends not to be monetizing, the Primary Dealers pretend not to be making millions in preferential Bid terms, and taxpayers pretend to care.

Grotesque, meet tragicomic. In today's POMO the biggest CUSIP monetized was QB9, of which the Fed purchased $5.99 billion (of a total $8.03 billion). And here's the kicker: when we commented on last week's 7 Year auction we once again were rather prophetic: "Altogether a weak auction but it's not like the PDs would let it fail
especially not with QB9 becoming the next "flip back to the Fed" bond
for the PD community." And tadaa: today, the Fed bought back 50% (!) of the Primary Dealer take down ($12.115 billion) of last Wednesday's (yes that would be the QB9) auction. This is probably the fastest episode Flip That Bond on record. Anything else and the Fed would be monetizing bonds that had not yet settled.

While it is no surprise that the day after Lehman failed, every single bank scrambled to the Fed to soak up any and all available liquidity after confidence in the entire ponzi collapsed, what is a little surprising is that of the 6 banks that came running to papa Ben, and specifically his Primary Dealer Credit Facility, recently upgraded, or rather, downgraded to accept collateral of any type, two banks (in addition to Lehman of course which at this point was bankrupt and was forced to hand over everything to triparty clearer JPM), had the temerity to pledge bonds that had defaulted (i.e. had a rating of D). As in bankrupt, and pretty much worthless. Now that the Fed would accept Defaulted bonds as collateral: or "assets" that have no value whatsoever is a different story. What is notable is that the two banks that did so were not the crappy banks such as Citi or Morgan Stanley, but the two defined as best of breed: Goldman Sachs and JP Morgan. It is probably best left to the now defunct FCIC to determine if this disclosure is something that should also be pursued in addition to recent disclosure that Gary Cohn may have perjured himself by not disclosing truthfully his bank's discount window participation. However, we can't help but be amused by the fact that of all banks, the ironclad Goldman and JPM would be the only ones in addition to bankrupt Lehman to resort to something so low.

After losing almost 80% of their investment in 3 weeks, here come more bad news for TEPCO shareholders. According to Yusuke Ueda analyst for Bank of Lynch TEPCO shareholders may be wiped out by clean-up costs and liabilities. "The amount of compensation demanded of TEPCO will also vary considerably depending on how long it takes to resolve the nuclear reactor crisis. Below we set out our assessment of the nuclear power damage under the scenarios we envisage and of TEPCO’s credit enhancements in each scenario. We think TEPCO will face compensation claim demands of less than ¥1tn if the nuclear reactor accident can be resolved swiftly (roughly within two months). If the problems take a longer time to resolve (up to about six months or so), we estimate that compensation claims could amount to ¥2.4-3tn.The total could potentially reach ¥10tn under a worst-case scenario (about two years needed to resolve the nuclear power plant accident). Shareholders are very likely to be held liable, through capital reductions of a certain amount, so as to clarify responsibility for damage compensation, but given the principle of maintaining stable supplies of electric power, a scheme involving a default on the company's bonds is very unlikely to be adopted." Which means when the Nikkei opens up tonight look for another demonstration of Xeno's paradox where the stock continues selling off but never reaching zero.

And another major hit for all those still unlucky enough to own Portuguese bonds: "Following S&P's lowering of its sovereign credit ratings on Portugal to BBB on Friday 25 March 2011, RepoClear participants are advised that with effect from Monday 27 March 2011 Portuguese Government bonds will no longer be eligible for delivery in any of the RepoClear €GC Baskets. Until today’s downgrade Portugal had been eligible for the single A €GC Basket." Luckily, Portuguese bonds are still eligible for trading on OTC/Bulletin Boards, where the bid/ask will soon be greater than the actual bonds price.

Two days ago we demonstrated that the the charts of Irish bonds, which has now joined Greece, and soon Portugal, in being locked out of capital markets, looked like, as Citigroup put it, a Nightmare on Kildare Street. Today in an attempt to normalize the market, yet which will only remove even more marginal (pardon the pun) liquidity, LCH once again hiked Irish bond margins, from 30% to 35%. And just as the case is with precious metals, soon no margin will be allowed and 100% cash (or gold) collateral will be demanded. In the meantime, look for bid/ask spreads to surge, the ECB buying to be the only buying in all peripheral markets, and CDS traders to once again start being demonized following the starting EU summit which will achieve nothing, but spread further confusion, and even more doubt about the viability of the euro.

Finally, we have a true liquidation flight to safety. We expect the Fed will come to market with an announcement before market opens tomorrow.

And so the US Treasury has hit the proverbial paycheck to paycheck sustenance level. After burning $12.8 billion (without a change in gross debt) in cash today alone, and $75 billion in the month of March so far, primarily driven by a back end-loaded tax refund calendar, according to the Daily Treasury Statement, today's cash balance dropped to the scary level of just $14.2 billion. Without the benefit of incremental funding, this is the same amount that the Treasury burns on a good day! In other words, we take back what we said about the US Treasury existing paycheck to paycheck - Geithner now has to scramble to find funding on a day to day basis. If tomorrow operating outflows surpass $14.2 billion (and, again, the amount was $12.8 billion today) the world's "greatest" country (i.e. banana republic) runs out of cash, period. And as the following schedule indicates, there are no Long-Term bond issuances until next week (and the Bill issues are merely funding of rolling issues), we have some trouble seeing how the US Treasury will fund itself for the balance of the week...

Nobody seems all that alarmed that the largest bond fund in the world has dumped all of their U.S. Treasuries.