Sovereigns

As Europe opens, S&P 500 e-mini futures (ES) have given up all gains for the day and are back below yesterday's day session lows (down 9pts from the close). German and Dutch 2Y interest rates just hit record lows at -0.021% and 0.033% respectively (and Swiss 2Y is back at -35bps just off its lowest ever). Major AUD weakness following its worst of the year drop in employment is impacting carry pairs (notable JPY strength) and the EURUSD is back at yesterday's lows - which is pushing the USD up to week's highs and dragging commodities lower (with Silver and WTI dropping the most). Treasury yields are leaking lower but remain well off post-10Y-auction spike lows for now. Meanwhile - Italian and Spanish sovereign bond spreads are modestly lower. This seems like a combination of technicals from CDS-cash basis traders stepping in at notably wide spreads as well as the considerable decompression in subordinated bank spreads relative to senior/sovereigns - which is/was a popular trade and seems to have gathered steam once again as the Spanish MOU is leaked (and as we suggested Subs get 'bailed-in'). European credit remains markedly underperforming European stocks post EU-Summit, but the stocks seem to be playing catch-down for now today.

While virtually every European risk indicator is now being gamed to underreport the true nature of the capital flow panic on the continent, one remains steadfast: Swiss nominal yields, which as we pointed out a month ago, have become the only true indicator of liquidity stress. And as noted this morning, Swiss 2 Year bond just hit a record nominal -0.37% (which coupled with record low yields in German yields explains everything about where money is sprinting to in Europe, and just how much "confidence" in the system is left). And while the SNB continues to suffer massive losses on its EURCHF peg, the reality is that it continues to offer a free put to all those who wish to move away from EUR exposure and into the relative safety of the CHF (the risk of cantonal disintegration is still relatively low). Which is why the only recourse authorities have in dealing with the now record flight to Swiss safety is brute force. Sure enough, as Reuters reports, clients of the two largest Swiss banks: Credit Suisse and UBS was raided in two independent, but likely linked, operations in Germany and France, respectively, in a show of force that moves beyond mere tax-evasion and has a goal of scaring anyone who still thinks of keeping their money in the relative safety of Geneva and Zurich bank vaults.

We have long warned that the effects of a ban on 'free-market' hedging instruments could well have a negative impact on the underlying market that political leaders are 'trying' to protect (consider the fall in equity prices after the short-sale-bans) and this week brought some clarity with regard Europe's Short-Selling-Regulation (SSR) on CDS. As Citi's Matt King notes: "the technical standards underlying its short selling ban reinforce the view we held previously: the ban seems likely to add to selling pressure on cash bond spreads in peripherals, even if it brings down CDS and tightens the basis." The SSR defines 'naked' as CDS that are 'highly correlated' with long bond positions, but bonds have only tended to be quite correlated to their own CDS at periods of low volatility, and this correlation breaks down over sell-offs, which is precisely when hedging is needed most. This will leave portfolio managers unlikely to want to rely on sovereign CDS hedges (which they may now be forced to unwind at any moment) and presumably means they will be reluctant to take out initial long positions in both peripheral sovereigns and corporates in the first place - reducing demand for cash bonds. Once again - regulators and politicians should be careful what they wish for.

With Spanish bond spreads over 30bps wider from their open this morning, EURUSD has just broken its 200-hour moving average trading back close to 1.2500 for the first time since the summit. While this is an 75% retracement of the EUphoria, broad equity markets are only modestly off their highs (we assume on rate cut hopes - which is likely helping driven EUR down a little) - and yet corporate and financial credit spreads are at two-day lows. Hope fades even in equity markets where once we dig into the individual indices that most are down modestly (though Spain and Italy are down around 1%). We also note that Bunds have outperformed Treasuries by 20bps from the initial risk-transfer spike on Friday morning - though TSYs are closed today as Bund yields dropped 10bps from open to close today. On a side-note, Spanish 5Y CDS briefly traded wider than Ireland 5Y CDS today for the first time in two years.

EURUSD sold off back to retrace 50% of its post-EU Summit spike gains but thanks to a mini-ramp-fest in the last 30 mins of the European day, spiked back up nicely into the green for the day. The same was evident in Italian and Spanish sovereign bond spreads which had leaked ever so gently tighter all day until the last 30 mins where they compressed 5-7bps more - still hardly a ringing endorsement of the game-changing moment of last week (and still wide of their initial spike tights of Friday morning). European equity markets gained on average around 1% (with France and UK underperforming) - again helped by a late-day surge of risk-on-ness (which was miraculously evident in US equity markets also). Oil prices continue to surge (with Brent over EUR80 once again) and we suspect are as much a driver of correlated risk-on as anything else but perhaps most importantly - away from the squeeze fest in every other asset class - Swiss 2Y rates are pushing back lower once again back under -30bps (down around 4bps today) as it is clear that a bid remains for safe-havens (gold and silver also surging) despite the optics of improving spreads on sovereigns and a 10% rally in bank stocks (which remember will need to be 'resolved' before the ESM can step in at par).

Given Friday’s announcements and subsequent rally, the relative dearth of weekend snippets and analyses seems a little surprising.

Even as Spain, Italy and soon France are scrambling to break the link between sovereigns and banks, an unpopular move that until recently Germany was very much against as it permitted the culture of endless unsupervised bank bailouts on taxpayer dimes to continue, we get a fresh reminder of why any unconditional aid, entitlement, or backstop guarantees funded by "other people's money" is always inevitably a bad idea. Case in point: Spain, which just said that its economy will contract in Q2 even more than in Q1. This reminds us why any claims of "austerity" are a total mockery: only Keynesian priests seem unable to grasp that countries gain much more upside from pushing their economies to the brink only to be bailed out, than from engaging in real economic viability and sustainability programs: i.e., living within your means (something we proved empirically before). Finally, this is also a stark reminder that when one removes out all the bailout noise and the daily high-beta gyrations of sovereign debt, the real reason why sovereign bondholders should be buying Spanish debt - an actual improvement in its economy-  continues to not only be absent, but by the very nature of endless now-monthly bailouts, becomes impossible as debt never fixed more debt.

It's just a matter of time before Bunds become the target of bond vigilantes unless Germany pulls out of the political fundfest that is runnnig nowhere very fast

The squeeze is on. EURUSD is probably the most extreme example of the squeeze-factor potential of what is at its heart a lot more talk and lot less action. Up almost 250 pips from its pre-summit-statement levels, EURUSD is just under 1.2700 - which in context is only back to 6/21 levels. As we noted on June 3, the epic level of CFTC non-commercial EUR spec shorts were ripe for a squeeze-fest, while on the other hand we specifically said "the pain trade will be any appeasing announcement from Europe." Sure enough we got just that (supposedly) and EURUSD is now up well over 300 pips from those levels as the clear pain trade plays out. The USD weakness has driven commodities higher with Gold reaching $1600 once again (6/21 levels). European sovereigns are (somewhat expectedly given the euphoria - though just how much has actually changed is unclear) also rallying hard on the day but while they have compressed spreads markedly, they have stalled at unchanged on the week (though Portugal remains notably wide on the week). Credit and equity markets in Europe are in sync and have snapped higher to 6/21 levels also (with financials outperforming modestly). Europe's equity markets are all soaring - up 3 to 4.5% - as DAX is now outperforming the S&P 500 on the year once again. Big moves (multiple sigma in bond and FX markets) and yet we can't help but think they were hoping for more than just a retracement of one week's price action.

As always, the most pragmatic read thru of what are now day to day rescue efforts out of Europe, which in its own words has effectively given up on seeking a long-term remedy, comes from UBS' Art Cashin who as usual cuts right to the bone of the deluge of essentially hollow endless chatter out of Europe whose sole purpose is to once again baffle all the algos with binary bullshit.

In the final analysis Europe is quite exposed at this moment and may be for quite some time. The ESM, after the change in seniority status, must be re-affirmed in at least two countries that are the Netherlands and Finland and Germany has not yet approved it yet either. The EFSF has already spent $450 of its capacity on Greece, Ireland, Portugal and now $125 billion for Spain. The balance left in the fund is tissue paper thin and that is all that is in existence presently for any more problems in Europe. Plans and schemes aside, the amount of money that could actually be used today is a drop in the proverbial bucket.

In the aftermath of last night's bombastic European announcement coming in the late night hours, in which Europe has virtually promised the kitchen sink, one would imagine that the response for the biggest beneficiary, Spanish bonds, would be far more dramatic. Instead after ripping 60 bps tighter in a kneejerk move, the yoyo reaction has seen bonds slide wider ever since, and the result being a SPGB level last seen... on Monday. Why is the market not more enthusiastic? Because what happened last night is nothing short of the second Greek bailout announcement from October, which followed a similar pattern: a late night announcement by Europe that Greece is saved, followed by a brief rip of a rally, only to give it all back, and to require global central bank intervention one month later. Because what really happened last night? Merely promises. We will not dwell much on the fact that the ESM has yet to be ratified by the paying countries, that the ESM will now have to be scrapped in its current format, and resigned by all 17 member countries since the seniority provision is somehow scrapped: an event that amounts to a cramdown exchange offer, that while everyone is talking about the uses of funds, nobody has uttered a peep about the sources, that Germany has yet to say what the German conditions will be or whether the revised deal will even pass the Bundestag, that the deal is contingent on the formation of a "effective single supervisory mechanism is established, involving the ECB" which in Europe is next to impossible, and that finally the whole "arrangement" is nothing but an Memorandum of Understanding - the weakest form of non-binding agreement possible. Which is why we are just a little skeptical and that today's E-Tarp is merely the latest catalyst to be faded.

The early Friday morning release of an entirely conditional 'plan' for a 'plan' that will likely require the ESM contracts to be torn up and a new contract to be re-ratified (by ALL members - including Finland and Germany), due to the stripping of the ESM seniority via the EFSF 'workaround', was high-fived by any and all EU leader still standing. Is it any wonder (given the conditionality and ratifications required) that the best the market could manage, on what is now obviously nothing but yet another watered-down talking-point ridden 'promise-of-more-to-come' plan (as opposed to the impossible becoming possible as Ireland's Kenny so eloquently described it), is a 1% pop in US equity futures.

Americans are either celebrating or damning the Supreme Court’s 5-4 ruling that the individual mandate is constitutional. It is puzzling that the individual mandate to purchase healthcare might be deemed unconstitutional when the collective mandate to collect taxes to purchase next-to-everything (including both healthcare and broccoli) has been considered constitutional for the best part of a century. If America wants to overturn current legal norms America needs to elect different politicians. But with a greater and greater welfare-bound population, it seems inevitable that more and more Americans will vote themselves greater and greater quantities of free stuff. What’s stopping Congress from mandating that patriotic Americans with any spare cash dump it into government securities (or even flagging equities)? One day, Atlas may shrug. Until that day, Congress just acquired a powerful new funding tool.

Just as we noted yesterday, the ludicrous late-day ramp in European equity markets relative to the absolute nonchalance of credit (corporate, financial, and sovereign) markets, has now reverted totally as broadly speaking Europe ends the day in the red. Spain and Italy stock indices bounced a modest 0.5% on the day as the UK's FTSE and Germany's DAX suffered the most (down 1-1.5%) on Banking Lie-Bor drama and unemployment respectively. Corporate credit leaked a little wider on the day with the investment grade credits underperforming (dragged by weakness in financials). Financials were notably weak with Subordinated credit significantly underperforming Senior credit (bail-in anyone?). Sovereigns were weak overall (not just Spain, Italy, and Portugal this time) as Spain's 2s10s has now flattened to year's lows. Swiss 2Y rates dropped further - to record closing lows at -35.2bps (after being -39bps at their best/worst of the day - suggesting all is not well, and Bunds largely tracked Treasuries as the SCOTUS decision came on and pushed derisking across assets. EURUSD tested towards 1.2400 early on but is holding -35pips or so for now at 1.2430.