Sovereigns

Remember, both as my research and the past 5 yrs have made clear, counterparty induced banks runs are the most damaging and Spains banks are hit from both RE and Sovereign debt crises. Who wouldn't run from this?

Spanish sovereign bonds ended the week at all-time record wide spreads to bunds, pushing back up near 7% yields today before falling back into the close, and +55bps on the week. This is a 50bps underperformance of Italian sovereigns on the week, while Spanish stocks notably outperformed Italian stocks on the week (though faded notably today having been unable to regain Monday's opening highs). German Bunds also deteriorated notably relative to Treasuries on the week (the biggest weekly jump in Bunds-Treasuries in almost 7 months) and while equity and credit markets reconverged into the weekend - with position-squaring evident - as the shifts in Swiss rates suggest all is not well under the surface as repatriation flows drove EURUSD up over 115pips on the week to near its Sunday-night opening highs (amid a 200 pip range). Finally for all the ebullient US investors, we note that Europe's VIX was bid notably higher today (to over 33%) to near a 3 week high relative to US VIX as hedges into the weekend were very prevalent.

As Predicted Last Year, The French and the Greeks Are In A Race For The Biggest Bank Run! Each stock showcased has led the drop as well...

The most effective response for Spain would be to de-link sovereigns and their banks, following recent steady accumulation of sovereign debt by peripheral banks, in our view. Reducing the link between Spanish banks and the sovereign remains one of the key aspects for relieving pressure on Spain, whether this be by removing sovereign debt from balance sheets or ensuring sufficient capitalization to absorb losses. Unemployment out this morning at 24.4% shows the fragile state the economy is in, which is likely to keep pressure on Spanish yields. Against this backdrop the effect on the asset side of balance sheets is concerning, with expected weakness in non-core government bond prices coupled with a weak economy decreasing individuals' and corporates' ability to repay

Just because there aren't enough traumatizing events in the next week to look forward to, the market has already set its sights on the next "big" (let down) event in Europe - the EU summit on June 28/29, which will only benefit just one class - Belgian caterers. But for some odd reason there is hope that Europe will, miraculously and magically, after years of failing at this, come to some understanding over either Eurobonds, a fiscal union, a deposit insurance, banking union, or some or all of the above (expect many daily rumors regarding any of the above to incite small but violent EUR and ES short covering rallies). However, as we have been observing for the past 3 years, and as David Einhorn summarized visually, nothing will come out of this latest summit. JPM explains why the one thing that can save Europe is a non-starter, and will be for years.

All you can read.

...and after all of those fancy acronoyms (ECB, EFSF, EU, ESM, ASS, BS, etc.), Italy is essentially just one big Greece. No, I'm not oversimplifying, just look at the bank bailout bailing out the insolvent country circular arguments!

With the Italian 10 year at a 6.15% and the Spanish 10 year at a 6.60% this morning; pause. My recommendation is to be out of all European sovereign and bank debt but if you have to own some because of your mandate or because you are attached to some Index then it is time to stop, look and listen. The Red Queen (Angela Merkel) and her minions are playing “off with their head” games and the situation is not a joke. The EFSF loans are going to be replaced by ESM money when the fund comes into existence and this means that your position as a senior bond holder will be subordinated to the IMF and/or the ESM. Any country including the existing troubled nations (Greece, Ireland, Portugal, Spain and shortly Cyprus) are going to have their debt replaced by the capital of the ESM so if you own any of these sovereign credits or any of their banks then you are going to be placed in a junior position by fiat. Then we have just seen what happens with “local law” bonds as demonstrated by Greece so that you need to swap out of any “local law” bonds ASAP and only own bonds governed by American, British or Swiss law. This would be for any and all nations on the Continent without exception. When it comes to bond holders versus taxpayers the taxpayer will always win so you must protect yourselves now rather than having your head handed to you later. There is no joy in finding your head on some silver platter I assure you and you must make the changes now and not later. I cannot stress this enough and I hope you are paying attention!

As Many Have Predicted for Years

When US equity futures, Treasury futures, and FX markets opened yesterday to a 'risk-on / reality-off' scenario, we made it clear that we suspected things would look very different by the European close. Sure enough, the markets in Europe (and US) have seen a dramatic shift in sentiment as the realization of the end-game here grows louder. It is evident that any strength, any rip, is to be sold. EURUSD rallied 1.2% at its best near the open last night but is ending 0.2% lower from Friday's close. Europe's broad equity market is closing modestly red after being up almost 2% at the open. Europe's financial credits led the equity market once again as senior spreads swung from a 20bps rally to a 10bps sell-off by the close. Italy was crushed after opened up over 4% to close down over 2.75% as Italian banks were halted all the way down. Spanish banks gave back all their gains (SAN was up almost 6% at the open and closed red). Investment grade credit notably underperformed and high-beta XOver swung from a 35bps tightening to close modestly wider. European sovereign bond spreads all opened notably tighter but were crushed by the close with Spain and Italy underperforming (+60bps and +50bps from their intraday low spreads respectively). Quite simply, Europe has swung from Spanish bailout fantasy to Europe's contagious panic reasserting - and that was after a weekend when Spain (and Spanish banks and every bullish trader out there) got everything they wanted. It would appear that the investing public has become better-educated at what is really going on in Europe and how these interim 'solutions' are all to be faded as Franco-German relations remain tense and Germany stoic. In liquidity/safety land, Swiss 2Y rates plunged 7bps to a new record -35.3bps.

As US equity futures open up 15pts or so (stalled at post April NFP and Greek Election open levels from May 6th), it seems EURUSD's initial 130pip spike from Friday's close merely jogged it back up to Friday's late day ramp close in equities (just above Thursday's highs for the major FX cross). Of course it was a see-saw weekend for Spain - they got all the money they wanted (and probably some ponies and unicorns) but only managed a tie against Italy in Euro 2012. Given the short-interest, as we noted in our widely read analysis of #Spailout yesterday (Item 5 here), it is little surprise that we are seeing EURUSD rally. EURUSD is still around 200 pips shy of its swap-spread-implied rate (which seems to be the common level to revert to after 'stress' liquidity hits the EUR and is then 'fixed'). We won't be surprised to see other risk assets levitate on this and while some traders will resist the urge to fade, we suspect that by the time Europe opens things will look a little different as Spanish sovereigns bondholders realize what just happened. The USD is weak against all the majors except JPY as risk-on carry trades hold it practically unch against the USD. Gold has opened modestly higher (in line with USD -0.8% weakness) but Silver is its high beta self +1.9%. Treasury futures are open (cash not yet) but imply a 10-12bps jump in yields for now (which is just normalizing them to ES from Friday's close). WTI just opened 2.3% higher at $86 (so much for that tax-break?) 

Over the past 24 hours, Zero Hedge covered the various key provisions, and open questions, of the Spanish bank bailout. There is, however, much more when one digs into the details. Below, courtesy of Deutsche Bank's Gilles Moec is a far more nuanced analysis of what just happened, as well as a model looking at the future of the pro forma Spanish debt load with the now-priming ESM debt, which may very well hit 100% quite soon as we predicted earlier. Furthermore, since the following comprehensive walk-thru appeared in the DB literature on Friday, before the formal announcement, it is quite clear that none other than Deutsche Bank, whose "walk-thru" has been adhered to by the Spanish government and Europe to the dot, was instrumental in defining a "rescue" of Spain's banks, which had it contaged, would have impacted the biggest banking edifice in Europe by orders of magnitude: Deutsche Bank itself.

Morgan Stanley's *hilarious* comic strip on our *hilarious* credit markets.

With a quiet start and more violent end to the week, Europe was a technical mess across asset classes. Sovereign bond strength through Thursday seemed much more a story of a missing CDS market (Monday and Tuesday) and basis traders into the end of the week than any underlying confidence. As Spain's and Italy's basis (the spread between CDS and bonds) pushed back up and over zero so sure enough Friday saw their bonds underperforming. Further banking system bailout fears weighing on debt concerns and the contagion to Italy were evident as Italy and Spain gavce up most of the week's gains into the close. Notably France and Austria were significantly wider on the week (burden-sharing). The bailout hopes spureed significant outperformance in European financial credit spreads - both relative to their stocks and the broad credit market overall. The long credit, short stock trade played out as the capital structure effects of any banking bailout were figured into dilution or further encumbrance of whatever equity value is deemed left. Swiss 2Y rates plunged under -30bps today and EURUSD weakened notably (almost roundtripping the week's strength) as clearly the seeming positives of the word 'bailout' are beginning to sink into the reality of what more debt, more encumbrance, and more stigma means for banks and sovereigns now more and more closely tied thanks to LTRO.

Perhaps some novel solution is found but this is not the muddling along kind of thing at all. This is the changing of charters kind of thing, the changing of national banking regulations kind of thing; the ceding of power to Europe kind of thing and anyone who thinks that this can all be accomplished in a matter of days is out having tea with Cinderella’ fairy godmother. Yet equities have rallied and bond spreads stopped widening on just this kind of hope but I predict that this will all be short-lived because, on its face, it is irrational. There is nothing wrong with having hopes and prayers but to base investment decisions on irrational interventions of some Divine power where there is not even a door for the Divinity to enter is just poor judgment by this name or any other you may concoct. It is no longer a case of “Risk on/Risk off” but of “Reality on/Reality off” and I advise you to keep pressing the “Reality on” button!