Sovereign Risk

Sovereign Risk

Fed Injects Record $100 Billion Cash Into Foreign Banks Operating In The US In Past Week

Those who have been following our exclusive series of the Fed's direct bailout of European banks (here, here, here and here), and, indirectly of Europe, will not be surprised at all to learn that in the week ended February 27, or the week in which Europe went into a however brief tailspin following the shocking defeat of Bersani in the Italian elections, and an even more shocking victory by Berlusconi and Grillo, leading to a political vacuum and a hung parliament, the Fed injected a record $99 billion of excess reserves into foreign banks. As the most recent H.8 statement makes very clear, soared from $836 billion to a near-record $936 billion, or a $99.3 billion reserve "reallocation" in the form of cash - very, very fungible cash - into foreign (read European) banks in one week.

Italy Crashes Most In Six Months Despite EURUSD Strength

Wherever you looked today in Italy, shares were halted. From Saipem to Seat and From Banco Popolare to BMPS, individual stocks fell between 5% and 45% in some cases. Spain also fell alongside its incorrigible risk-on peripheral neighbor as dividend suspensions, outlook cuts, rating downgrades, and a growing concern about the banking system's legitimacy wear on sentiment. Italian sovereign risk was largely unchanged but as the US opened it started to bleed wider - but in general bonds ignored the stress in stocks. FX markets also were un-phased as EUR continued to test higher. CHF did, however, strengthen notably (against the USD, EUR, and mostly against the JPY - up 28% in the last six months!). The CHF strength did nothing for demand for Swiss rates though as they pushed higher to 10-month highs. The big problem though lies in credit. Just as in the US, credit markets in Europe are massively divergent from stocks' exuberance - and today's surge in Europe's VIX also echoes the disconnect we are seeing evolve in the US. Things are shifting...


Policymaker's Guide To Playing The Global Currency Wars

G4+CHF can fight the currency wars longer and more aggressively than small G10 and EM countries can.  However, as Citi's Steven Englander notes, it also takes a lot of depreciation to crowd in a meaningful amount of net exports. His bottom line, GBP, CHF and JPY have a lot further to depreciate.  In principle, the USD can easily fall into this category as well, but right now the USD debate is focused on Fed policy – were it to become clear that balance sheet expansion will end well beyond end-2013, the USD would fall into the category of currency war ‘winners’ as well. Critically, though, the reality of currency wars is that policymakers do not use FX as cyclical stimulus because of its effectiveness; they use it because they have hit a wall with respect to the effectiveness of fiscal and monetary policies, and are unwilling to bite the structural policy bullet. The following seven points will be on every policymakers' mind - or should be.

Japanese Pension Funds With $3.4 Trillion In Assets Seek Safety In Gold

In March 2012, Okayama Metal & Machinery became the first Japanese pension fund to make public purchases of gold, in a sign of dwindling faith in paper currencies. Okayama manages pension funds for about 260 small and mid-sized companies in the Okayama area. "By diversifying currencies, we aim to reduce risks associated with them," said Yoshi Kiguchi, the fund's chief investment officer. "Yields become stable if you put small amounts into as many types of holdings as possible." Of its 40 billion yen ($477 million) in assets, the fund has invested around ¥500 million-¥600 million in gold, he said. Initially, the fund aims to keep about 1.5% of its total assets of Y40bn ($500m) in bullion-backed exchange traded funds, according to chief investment officer Yoshisuke Kiguchi, who said he was diversifying into gold to “escape sovereign risk”. Other pension funds in Japan are following their lead according to the Wall Street Journal. Japanese pension funds are diversifying into gold "largely to mitigate the damage from possible market shocks"... Mitsubishi UFJ Trust and Banking Corporation said it has secured more than Y2 billion in investments from two pension funds for a gold fund it started in March.

The Year 2012 In Perspective

As in any other Ponzi scheme, when the weakest link breaks, the chain breaks. The risk of such a break-up, applied to economics, is known as systemic risk or “correlation going to 1”. As the weakest link (i.e. the Euro zone) was coupled to the chain of the Fed, global systemic risk (or correlation) dropped. Apparently, those managing a correlation trade in IG9 (i.e. investment grade credit index series 9) for a well-known global bank did not understand this. But it would be misguided to conclude that the concept has now been understood, because there are too many analysts and fund managers who still interpret this coupling as a success at eliminating or decreasing tail risk. No such thing could be farther from the truth. What they call tail risk, namely the break-up of the Euro zone is not a “tail” risk. It is the logical consequence of the institutional structure of the European Monetary Union, which lacks fiscal union and a common balance sheet.... And to think that because corporations and banks in the Euro zone now have access to cheap US dollar funding, the recession will not bring defaults, will be a very costly mistake. Those potential defaults are not a tail risk either: If you tax a nation to death, destroy its capital markets, nourish its unemployment, condemn it to an expensive currency and give its corporations liquidity at stupidly low costs you can only expect one outcome: Defaults. The fact that they shall be addressed with even more US dollars coming from the Fed in no way justifies complacency.

Equities Fade To Red As Gold, VIX, Bonds Signal Weakness All Day

US equities tried to escape the draw of a strong Treasury market and weak gold market all day but kept being dragged back to reality (with a late-day dive on decent volume making the most interesting moment of the day). The day-session range was relatively low but volumes were ok as we leaked lower on the day. NASDAQ was the weakest (thanks to AAPL's push back towards it 'generational low') and TRANS outperformed - but the latter was playing catch up to the rest from yesterday's weakness (still lagging on the week). S&P futures clung to VWAP most of the afternoon in a rather uneventful day even as VIX pushed 0.5 vols higher to close above 17% for the first time in three weeks - notably divergent from stocks. EUR strength (+0.8% this week!), while modestly supportive, has largely decoupled from equity movements this week as correlations across risk assets have dropped notably.

If August 2011 Is The "Fiscal Cliff Resolution" Template, Then Watch Out Below

Ever since late March, we have said that the only realistic resolution to the Fiscal Cliff standoff (and the just as relevant latest and greatest debt ceiling hike due weeks from today as well), driven by a congress that has hit peak party-line polarity and which the recent election loss only made even more acute, would be a market mandated "resolution" (read sell off) whose only purpose is to crack the gridlock as representatives are flooded with phonecalls from angry constituents who now, and always, will be far more concerned about the value of their 401(k) than any ideological split. By that we mean an identical replica of what happened in the summer of 2011 when the market had to tumble 17% before the debt ceiling "compromise" was finally reached. This also explains why with just 6 weeks of trading in 2012 left, Goldman still forecasts a slide to its 2012 year end target (which it has kept constant since late 2011) of 1250. So while a resolution will almost certainly come, it will not be until the very last moment. As GS summarizes, "Bush income tax cuts was not resolved until December 17th, 2010. Last year’s decision to extend payroll tax cuts was not finalized until December 23rd, 2011. The current challenge is significantly more complex. Divergent views on tax policy, defense spending, and entitlements need to be resolved in a short lame-duck session of Congress." And while the market may or may not jump after there is an actual resolution, don't expect any real buying ahead of a compromise, as any uptick in the DJIA (the Beltway has still not heard of the S&P500 apparently) will immediately lessen the impetus for a deal. In fact, if the following chart from Goldman is correct, and if we are indeed to relive a replay of the summer of 2011, watch out below, especially since true wholesale liquidation across the hedge fund space has yet to occur.

Some Context On Spain's 'Big' Week

Much is being made of the compression in Spanish bond spreads this week - the largest 3-day drop since Draghi's 'dream' speech. Four critical things come to mind: 1) increasing amounts of Spanish sovereign debt is now held by domestic banks, making the market less liquid (and far less transparent as any indication of 'reality'); 2) the ban on naked CDS (and Draghi's put) has created a hedging vacuum with CDS spreads collapsing and exposure slumping (technically dragging bond risk down); 3) Lower spreads reflexively mean lower probability of Rajoy saying "Si" - which is what is helping spreads compress (leaving event-risk high - as indicated by the outperformance of our legal arb trade); and perhaps most importantly 4) Recency bias is incredible - we have seen 100-plus percent rises in Spanish risk followed by 35-plus percent retracements a number of times and the current level of Spain risk is still above LTRO-inspired crisis levels. So let's not get all excited quite yet eh?

Spanish Bonds At Six Month Highs As 'Half Pregnant' Bailout Looms

As overseas deposits continue to flood from the periphery (e.g. Italy -15.4% YoY in Aug), yet another European Summit is about to begin delivering headline after headline of baffle-'em-with-bullshit comments. As the market switches from rallying on conditional OMT-backed bailouts (that are not needed according to Rajoy and De Guindos), now it is rallying on a precautionary line of credit (with no apparent conditionality) that Katainen also adds is not needed because Spain doesn't need a bailout. It seems that a 'half pregnant' bailout for Spain is all that it takes as 10Y Spanish spreads dropped below 400bps for the first time in six months and while IBEX is lagging the sovereign's performance for now, it is also having a great week (up over 5%). Thanks to Moody's apparently gutless contingent investment-grade-but-on-the-verge-of-needing-a-sovereign-bailout decision, more rotation from foreign real money to domestic real money and fast money is slapping Spanish credit tighter in a hurry (5Y CDS 278bps and 10Y yield under 5.5%). Now if someone would just explain how any of this has solved the underlying insolvency issues, we'll be more than happy to play along.

IMF Cuts Global Growth, Warns Central Banks, Whose Capital Is An "Arbitrary Number", Is Only Game In Town

"The recovery continues but it has weakened" is how the IMF sums up their 250-page compendium of rather sullen reading for most hope-and-dreamers. The esteemed establishment led by the tall, dark, and handsome know-nothing Lagarde (as evidenced by her stroppiness after being asked a question she didn't like in the Eurogroup PR) has cut global growth expectations for advanced economics from 2.0% to only 1.5%. Quite sadly, they see two forces pulling growth down in advanced economies: fiscal consolidation and a still-weak financial system; and only one main force pulling growth up is accommodative monetary policy. Central banks continue not only to maintain very low policy rates, but also to experiment with programs aimed at decreasing rates in particular markets, at helping particular categories of borrowers, or at helping financial intermediation in general. A general feeling of uncertainty weighs on global sentiment. Of note: the IMF finds that "Risks for a Serious Global Slowdown Are Alarmingly High...The probability of global growth falling below 2 percent in 2013––which would be consistent with recession in advanced economies and a serious slowdown in emerging market and developing economies––has risen to about 17 percent, up from about 4 percent in April 2012 and 10 percent (for the one-year-ahead forecast) during the very uncertain setting of the September 2011 WEO. For 2013, the GPM estimates suggest that recession probabilities are about 15 percent in the United States, above 25 percent in Japan, and above 80 percent in the euro area." And yet probably the most defining line of the entire report (that we have found so far) is the following: "Central bank capital is, in many ways, an arbitrary number." And there you have it, straight from the IMF.