Bond

Who would have thought that all it takes for a proposed ETF to be pulled is a complete loss of faith in the underlying. Today, Vanguard has announced it has canceled plans for a short, intermediate and long-term muni ETFs. "We believe that this delay is prudent given the high level of volatility in the municipal bond market, which began in November 2010 and continues today," said John Woerth, spokesman for the Valley Forge, Pennsylvania-based firm. "This volatility could impede the funds' abilities to tightly track their respective benchmarks, deliver on the funds' objectives, and meet shareholders' expectations." Well, what if shareholders expectations were to short the ETFs? It would certainly meet that particular set of expectations.

While the fact that PIMCO is not a big fan of Europe is not surprising, nor is it surprising that Bill is talking his BAB book, and is therefore bullish on the muni question (especially on a relative basis, in essence saying that the US Treasury is in the same insolvency boat as California), what is surprising is that Newportbeachian, at least superficially, appears honestly confused what happens in June when QE2 ends. Which is funny: Fed's Fisher earlier said that the central bank has reached its limit of asset purchases... barring unexpected shock. Which of course means completely expected to the Fed. And since the Fed has to continue monetizing all the deficit issuance, it has no choice but to continue QE2. The conclusion is that in April or May, something "unexpected" will happen to give the Fed ammo to continue monetizing. May 6 anniversary anyone?

The reason for today's most recent bizarro boil up per Bloomberg: "The European Central Bank spent between 1 billion euros ($1.3 billion) and 1.5 billion euros in government bonds in the last two days, according to Nomura International Plc estimates." No news yet on how much Japan, China, the Smurfs, and Uranus ended up having to purchase to bring you today's 1% surge in stocks.

The most expected yet anticlimactic bond auction for 2011 has come and gone: after getting the backstops of the ECB, China and most recently, Japan, Portugal managed to sell €1.25 billion in 4 and 10 year paper. And while the the yield on the 10 year was better than expected, and notably lower than the 7% where the point had been trading on the curve recently, the 4 year priced notably weaker compared to previous. Of course, none of this would have been possible had the ECB not been buying Portuguese bonds in the open market for two days this week, and continuing into Wednesday, into the biggest farce of a market currently operating in Europe.

Ever since Repo 105 (and long before that), it has been well-known that Primary Dealers enjoy padding their books before the end of every quarter, typically collapsing their asset holdings in the week just before the quarter end in order to have cash on the books, and to make their capitalization ratios appear better than they really are. Well, the "book padding" that just occurred in Q4 2010 was a doozy, with total PD asset holdings plunging by a stunning $126 billion in the past month, the bulk of which was due to a drop in PD holdings of Treasurys. Was this huge selling by the Primary Dealer community, either for window dressing reasons, or due to expectations of future increases in Treasury yields, one of the main reasons for the drop in bond prices? It is unclear, but the massive selling certainly has not helped. And now that window dressing is again over for at least three more months, PD holdings can only go up (or so the myth goes). So with PDs now back with fresh books for 2011, and once again lifting offers, is the sell off in bonds about to be replaced with a major buying spree?

A few days ago some were very surprised by the previously announced decision from the SNB that it the bank would cease accepting Irish bonds as collateral. Considering that the Swiss National Bank is now the only responsible institution left in Europe, now that floundering Jean Claude Trichet is willing to accept even used condoms at a 120% LTV as long as they have a sterling CCC- rating by S&P, we fail to see how this is surprising. That said, those same people may be even more surprised that the SNB has just added Portugal to its "restricted" list. The FT reports: "The Swiss National Bank confirmed on Friday that it had stopped accepting Portuguese government securities as collateral for repurchase (repo) agreements, adding Lisbon to Dublin among the eurozone governments on its ineligible list. The decision to exclude both countries follows steep downgrades of Portuguese and Irish debt and was based on the Swiss central bank’s strict, but highly transparent, acceptance criteria." What this means is that on Monday JCT will be very busy BTFD in Portuguese bonds. He will have many opportunities to do so, as everyone holding the paper will be bailing in droves. Furthermore, this disclosure could not have come at a worse time: with Portugal slated to hold another major bond auction next week (following last week's abysmal 6 Month Bill auction), there is actual risk the entire affair could be a failure and set the European sovereign market ablaze, kicking off the 2011 round of "bail out Europe."

Well, that lasted all of 3 weeks: after ICI reported outflows in taxable bond funds for all of the prior four weeks (for a whopping combined $5 billion after hundreds of billions in inflows in the past year), the bond inflows are once again back in the last week of 2010, as bond investors placed $2.5 billion with taxable bond funds. The only category that saw outflows was mutual bond funds, which in itself is obviously quite troubling as it indicates that the state funding situation is about to get rather dire especially in light of the non-renewal of the BAB program. Basically this is exactly as we suspected would happen: following the major drop in bond prices in December, investors are now back and are in fact more interested in buying bonds at more attractive prices. Which of course means that that other trend: inflows into equities is about to taper off as well, as money flows shift out from equities and into bonds once again. Indeed, last week's inflow of $335 million in domestic equity funds was revised to just $14 million, and the last week of 2010 saw another token (and probably soon to be revised downward again) inflow of just $493 million. Should the equity inflow indeed reverse to an outflow shortly, the propganda machine will be doubly confused to explain how, a mere few weeks after it made such a story out of the first inflow in 33 weeks, outflows are again back.

RanSquawk reports that the European Union has priced the marketed EUR 5bln 2015 bond, 2.5% interest, at 99.594 reoffer, swaps +12 BP, according to Leads. As a reminder, this is what Brian Yelvington had to say about this notable issue early today: "The €5B EFSF debt sale scheduled for today was reportedly 3x
oversubscribed with pricing expected to be mid swaps +15bp.  The
markets should keenly watch the actual pricing of the deal and its
secondary trading as well as the knock-on impacts on traditional Euro
sovereign issuance.  We still believe that a finite capped facility
that effectively crams down traditional issuance will cause further
pressure on spreads.  A new EU draft proposal suggests that bondholders
take losses on ailing banks rather than upstreaming the responsibility
to the sovereign level and bailouts being taxpayer funded."

Today the PIIGS are back at the ECB subsidy trough with Portugal taking center stage with its E500 million 6-month bill auction. The next country to implode sold E500mln of 6-month Bills, and while the bid to cover was just a slightly better 2.6 compared to the 2.4 before, the yield again surged, hitting an unsustainable 3.686% versus 2.045% previously. The net result of this jump in yields is that peripheral spreads have once again commenced leaking wider, with the Greek spreads to Bunds pushing to a new record wide at 974 bps, a 10 point move. This is hardly the last we have heard of record Greek spreads it, and while it is very feasible we will see a four digit spread in the next few days, who really care anymore. After all it is just the ECB that will end up holding the toxic paper.

When Nassim Taleb and Marc Faber say that US government debt is a suicide investment, one can be allowed some skepticism. After all, they are likely just talking their book. On the other hand, when the manager of the world's biggest bond fund, whose flagship fund Treasury holdings amount to almost $80 billion goes on Bloomberg and says to "avoid dollar-denominated government debt" better known as US Treasuries, and instead recommends viewers invest in "stable" currencies like the Peso, the BRL or the CAD, then you know the bottom in bonds is in. So in addition to dumping fixed rate bonds (which means Pimco will again be able to buy on the cheap ahead of QE3, which as Larry Meyer has by now likely advised Pimco is a sure thing), Gross also told Bloomberg that his other two strategies are to buy floating rate debt (over fixed), and lastly recommend credit spreads over interest rate duration risk. For those who find something troubling with a $1 trillion fixed income manager talking down his investments, and are still wondering whether or not QE3 is coming, we suggest putting one and one together. And while at it, they should also consider that Pimco now holds over $100 billion in MBS: a notional amount last held just as QE1 was announced.

The inflection point has arrived. After pulling money for 33 consecutive weeks, and withdrawing over $98 billion in capital from domestic equity mutual funds, in the week ended December 21, the Fed has finally succeeded in getting the rotation out of bonds and into stocks as per ICI. After a total of $4.4 billion was redeemed from bond funds in the same week, mostly from municipals but also $837 million from taxable bonds (still a major decline from the almost $9 billion in bond outflows the prior week), domestic equity funds saw a token inflow of $335 million, compared to last week's $2.4 billion outflow. Just enough to halt the seemingly endless outflow. Still, since the bulk of the move seems predicated upon a move out of muni bonds, with $9.5 billion in outflows in December alone, should the muni crisis accelerate, and validate the investor concern, stocks as an asset class will certainly be impaired once the muni insolvency thesis start being played out... unless of course it is met with further action from Ben Bernanke in the form of QE3, as most Zero Hedge readers believe will inevitably happen. At that point, and as always when the Fed intervenes, all bets are off, suffice to say that gold will be well over $2,000 by then.

And like that, Brian Sack's market manipulation for 2010 is over. Then again, with practically no trading days left, and no volume to speak of, it was to be expected. Of today's $5.4 billion POMO, which brings the Fed's Treasury holdings ever higher in the trillion club, $2.4 billion went to buy back the PV6 which were auctioned off barely a month ago. This means that 15% of the Primary Dealer allottment of that particular auction ($16.4 billion) has already been sold back to the Fed at a decent profit. And so the shell game continues. What is ore surprising is why the PW4s auctioned off on Monday were neither in the inclusion, nor exclusion lists for today's POMO. After all, there is nothing the PDs would love more than a last minute taxpayer gift to the tune of a few hundred million in a quick two day flip to pad that third private island sinking fund with that little extra in risk free compensation.

Following today's ugly 5 Year auction, and hot on the heels of the 180 degree EUR reversal from this morning, coupled with the renewed surge in gold and silver, the entire bond complex is again in free fall (and no, Build America Bonds has not and likely will not be renewed in its current form), lead by the 30 Year. And if this was based on an expectation of real rates rising, as the pundits would claim, which would be an expectation of economic improvement, then gold would not be flirting with its all time highs. Which means that today's market action in every asset class is representing the economy accurately, especially following the 4th consecutive home price drop be Case Shiller... every asset class except for stocks of course. Then again, with volume once again abysmal (MVOLNYE just under 1,400), HFT/Fed levitation programs are the only thing that is trading 100x P/E hot grenades as per always.

Today, to little fanfare, the ECB managed to obtain just E60.8 billion in tender interest for its most recent 7 Day SMP "peripheral bond monetization" operation, whereby it needed at least E73.5 billion to be able to offload all of its cumulative acquired sovereign bonds to other financial institutions: a de facto sterilization, which is why the ECB has so far been claiming it is not monetizing debt (as it constantly rolls the held balance on other bank balance sheets). That is no more: following today, the ECB is left with just under E13 billion in sovereign holdings and thus are not sterilized. This development follows Monday's announcement, which was reported first on Zero Hedge, that the ECB acquired 100% more in peripheral bonds in the prior week compared to two weeks ago. Another notable development: the number of bidding banks participating in the tender operation dropped to just 41- the lowest since the inception of the program in May when Greece went tits up and all of Europe was supposed to bail each other out in perpetuity. And what is most disturbing is that this complete lack of interest (or telegraphed lack of bank liquidity) happened even as the marginal rate jumped by over 50%, from 0.6% to 1%- the same as the maximum rate allowed on an auction. Should banks not come back with tender takedown interest next week, this could very well be the catalyst for the next leg down in the European crisis. Because despite what ING economist Martin Van Vliet told Reuters, "It has happened before but I wouldn't make too much of a big deal out of it", we would make a big deal out of it, as this has actually not happened before. For confirmation that ING economists may want to take an Excel 101 chart, below is the buffer shortfall in every auction since the program's inception. As is all too obvious, this was the first one that missed by a mile.

That sneaky JC Trichet: while the rest of the banker world was preparing to hit the Telluride slopes to spend some of that hard earned taxpayer bailout cash, and otherwise leaving the fate of capital markets to Getco and two or three HFT traders, Trichet was once again busy bidding up every sovereign bond in the secondary market he could find. While in the week ended December 20, the ECB bought just E600 million, which in turn was the lowest since October and before Europe went bankrupt for the second time in a row, last week purchases jumped by nearly 100% to E1.1 billion, bringing the total to E73.5 billion. Which is surprising as there was very little on the surface to indicate that there was so much revulsion associated with sovereign exposures at least as determined by European stock bourses, meaning that equities and bonds even in Europe where there has been at least some tenuous linkage, have completely decoupled and joined their American cousins.