Why anyone thinks that any one of a group of highly interlinked and interdependent countries heavily reliant on EU trade & toursim in a severe economic downturn facing harsh auterity measures may be doing well in the near to medium term is beyond me!
As expected in the aftermath of the concluded S&P ratings action on European sovereigns, the next action is for the rating agency to go ahead and start cutting related banks and insurers, as we noted over the weekend with many of the main European banks anticipated to see one or two notch cuts potentially as soon as today. Which is why the just released report "How Our Rating Actions On Eurozone Sovereigns Could Affect Other Issuers In The Region" will be read by great interest by many to get a sense of when the next shoe is about to drop. Here is what it says on that topic.
The Real Dark Horse - S&P's Mass Downgrade FAQ May Have Just Hobbled The European Sovereign Debt MarketSubmitted by Tyler Durden on 01/13/2012 19:55 -0400
All your questions about the historic European downgrade should be answered after reading the following FAQ. Or so S&P believes. Ironically, it does an admirable job, because the following presentation successfully manages to negate years of endless lies and propaganda by Europe's incompetent and corrupt klepocrarts, and lays out the true terrifying perspective currently splayed out before the eurozone better than most analyses we have seen to date. Namely that the failed experiment is coming to an end. And since the Eurozone's idiotic foundation was laid out by the same breed of central planning academic wizards who thought that Keynesianism was a great idea (and continue to determine the fate of the world out of their small corner office in the Marriner Eccles building), the imminent downfall of Europe will only precipitate the final unraveling of the shaman "economic" religion that has taken the world to the brink of utter financial collapse and, gradually, world war.
It will come as no surprise to anyone (other than Dallara and Venizelos perhaps) that all is not rosy in the Greek Public Sector Involvement (PSI) discussions. Whether it is the Kyle-Bass-Based discussions of the need for non-Troika haircuts to be 100% for any meaningful debt reduction, or the CDS-market-based precedent that is set from chasing after a purely voluntary, non-triggering, agreement, the entire process remains mired in a reality that Greece needs much broader acceptance of this haircut (or debt reduction) than is possible given the diverse audience of bondholders (especially given the sub-25 price on most GGBs now). As Goldman points out in a note today, the current PSI structure does not encourage high participation (due to the considerable 'voluntary' NPV losses), leaves effective debt-relief at a measly EUR30-35bln after bank recaps etc., and as we have pointed out in the past leaves the door open for a meaningful overall reduction in risk exposure to European sovereigns should the CDS market be bypassed entirely (as the second-best protection for risk-averse investors would be an outright reduction in holdings). The GGB Basis (the package of Greek bond plus CDS protection) has been bid up notably in the last month or two suggesting that the banks (who are stuck with this GGB waste on their books) are still willing to sell them as 'cheap' basis packages to hedge funds. This risk transfer only exacerbates the unlikely PSI agreement completion since hedgies who are holding the basis package have no incentive to participate at all.
As one can glean from the title, in this comprehensive report by Goldman's Paul Hissey, the appropriately named firm deconstructs the divergence between gold stocks and spot gold in recent years, a topic covered previously yet one which still generates much confusion among investor ranks. As Goldman, which continues to be bullish on gold, says, "There is little doubt that gold stocks in general have suffered a derating; initially with the introduction of gold ETFs (free from operational risk), and more recently with the onset of global market insecurity through the second half of 2011. However, gold remains high in the top tier of our preferred commodities for 2012, simply because of the extremely uncertain macroeconomic outlook currently faced in many parts of the world. The official sector also turned net buyer of gold in 2010 for the first time since 1988, and has expanded its net purchases in 2011." And so on. Yet the irony is, as pointed out before, that synthetic paper CDO, continue to be the target of significant capital flows, despite repeated warnings that when push comes to shove, investors would be left with nothing to show for their capital (aside from interim price moves of course), as opposed to holding actual physical (which however has additional implied costs making it prohibitive for most to invest). Naturally, this is also harming gold stocks. Goldman explains. And for all those who have been requesting the global gold cash cost curve, here it is...
As EURUSD leaks very gently lower into the new year (but stocks popped excitedly across quiet European markets that lacked a bond market supervisor to keep them honest), we thought it might be interesting to look at the relative strength of the Euro against six different measures. From FX option risk-reversals to ECB's European Bank Lending statistics, QE and sovereign risk relationships to Fed/ECB balance sheet dynamics, and finally from futures commitment of traders data to EUR-USD swap spread frameworks, the results are unsurprisingly mixed with a bias towards EUR weakness. Between the European auctions (and redemptions) of the next two weeks, and the FOMC meeting on the 24-25th January, we face quite a rude awakening from the low volume holiday week malaise.
UPDATE: Spanish bonds are leaking wider after the defiict projection looks set to be significantly worse than previously expected.
Something strange is happening in European risk markets this week. While that sentence is entirely 'normal' for what has become a diverging/converging flip-flopping correlation microstructure but the clear trend this week has been European Sovereign derisking and European Stock rerisking. The Bloomberg 500 index (that tracks a broad swathe of European stocks) is up 0.75% from Christmas Eve (and 1.6% from yesterday's lows) while 10Y sovereign spreads are wider by 10 to 30bps in the same period. France stands out as one of the worst performers - more than 25bps wider this week alone. Only Spain is notably improved on the week (-17bps) but all 10Y sovereigns are well off their best levels as stocks make new highs. Whether this is a front-run on asset rotation into the new year or expectations of the same risk-on ramp-job we saw on the first trading of this year is unclear - we do remind those front-runners that mutual fund cash levels are significantly lower this year than last. It is clear that yet another 'sensible' correlation (such as BTPs to equities) has broken but when volumes return and the reality of the huge supply calendar we face in the next month alone sinks in, perhaps equity ebullience will pull to bond bereavement. If stocks are reacting to a quasi-QE from the ECB, why wouldn't sovereigns who are the direct beneficiaries in that surreal LTRO-driven-carry trade?
While the world of risk explodes to the upside on the back of the LTRO-based carry trade expectations (which is not evident at all in some of the more technical relationships across the sovereign space no matter what headlines try and tell you), the very backbone of support for the fiscal evolution that Europe thinks it will achieve is now trading at a five-day low price having dropped notably post the earlier Fitch 'FrAAAnce' announcement. It is simple enough to think that banks will rapidly seek risk and buy sovereigns with their newfound wealth, but looking at CDS-Cash basis (the difference between CDS spreads and bond spreads) there has been almost no shift in supply/demand (which we would expect to tip to bond outperformance if the carry trade were being placed) and moreover, the sovereign spread curves are NOT bull steepening as one would expect from modest reach for say 2Y/3Y peripheral yield versus the 3Y LTRO. The bottom-line seems to be that equity markets are buoyed by a broad risk asset rally (and TSY selling and 2s10s30s rally) while the underlying beneficiary of this 'solution' does not seem to be improving so much. The strength in ES appears like simple momentum off an overshoot yesterday as risk assets broadly never really sold off like ES did and are now holding up well enough for today.
It is no surprise that the ECB has been less than overwhelming in its optimism, unlike Messers Barroso, Van Rompuy et al. when discussing the current and future state of the union that is Europe. While not pessimistic per se, the focus on zee stabilitee and lack of bazooka (no we don't see the 3Y LTROs as a magic bullet) is perhaps related to their view of the difficulties faced in addressing the needs of an increasingly disparate gaggle of countries. In their December Financial Stability Review, the ECB points to four key risks: (contagion, funding, macroeconomy, and trade imbalances), they fear "euro area financial stability increased considerably in the second half of 2011, as the sovereign risk crisis and its interplay with the banking sector worsened in an environment of weakening macroeconomic growth prospects". Summarizing into seven charts, the ECB provides a quick-and-dirty perspective on what is increasingly becoming obvious as capital flows and funding needs interplay with one another (for worse rather than better).
The financial crisis of the last few years has created not just a perceived shift in the creditworthiness of our financial entities but a real crack in the foundation of their business model and more importantly any explicit or implicit supports or guarantees. Moody's, in a special report on credit post crisis "The Great Credit Shift" look at the impact of the crisis on every major asset class within the credit space from sovereigns to corporates to structured finance. Noting that this crisis has profoundly changed the credit picture for sovereigns and financials, Moody's note there is some dispersion in the latter as banks have seen systematic downgrades while insurers (for now) remain on par with pre-crisis levels. More interestingly, large US regional banks represent an exception to this broad downgrade but we suspect that the continued low interest rate, low NIM, and high volatility spread environment will cause both insurers (we have long considered proxies for HY portfolios, no matter how well cushioned from vol their business models may be) and US regionals (consolidation will have the opposite effect of TBTF in our view as it will lead to more comfort with more risk-taking and expose them to more current-bank-like volatility) to face more pressure going forward (despite their lower apparent sovereign risk exposure). As BofA and Morgan Stanley trade at extreme 'crisis' levels in both CDS and equity markets, we suspect the raters have further to go and while the systemic shifts are apparent, we would expect less and not more differentiation going forward - especially if we sink into another solvency crisis.
It appears Moodys is not having server issues.
- BELGIUM'S CREDIT RATINGS CUT 2 LEVELS TO Aa3 BY MOODY'S
The market's reaction to Draghi's comments over the last week have been visceral in its schizophrenia. While his 'temporary' provisions, three-year LTROs specifically, provide a life-line of liquidity (a la TLGP - and how is that working out for the US banks having to roll now?), they hardly address the real underlying problem of the vicious circle between sovereign debt's now-risky nature and financial balance sheets bloated with zero-risk-weighted re-hypothecated peripheral bonds. The last week has seen a roller-coaster of Senior-Sub debt decompression and compression, liquidation-like drops in commodities, lower correlation across European sovereign debt, and significant dispersion in high- and low-beta equity and credit markets (notably as we have previously discussed, some of which will have been driven by index roll technicals). The issue comes down to whether this is the Bazooka (buy-buy-buy) or not enough (fade-the-rallies) and BARCAP's macro sales and European Banks' research team have, like the rest of the market, been exchanging views on this perspective. While their take on the liquidity explosion is that it doesn't solve the almost unsolvable solvency problem but it the deeper insight that perhaps it is not the actual mechanics of this liquidity bazooka but the perception that democracy itself has been suspended in favor of bank and sovereign survival that interests us more. Furthermore, they do an excellent job on breaking down the mythical carry trade potential of these LTROs and mutual sovereign financing benefits since near-term (carry-trade) profit potential would be offset by additional sovereign risk - meaning that funding markets could stay closed for longer. Once again the issue of collateralization, risk-weightings, and deleveraging are front-and-center as bank 'managers' and politicians may be at loggerheads on the carry-trade-savior potential and the ECB's status on the balance sheet only serves to further subordinate existing bondholders.
Jim Reid and his team from Deutsche have produced another magnificent compendium of information and prognostication in their 2012 Credit Outlook and while their up-in-quality preference (non-financial) may not be earth-shattering strategically, their timing view is of note. Instead of viewing the looming refi-ganza among European sovereigns and financials in H1 2012 as a reason for doom and gloom, they see it as the necessary evil to drive the ECB into the markets in size only for the latter half of the year to disappoint significantly as the reality of the underlying problems rear their ugly head once more. The down-then-up-then-worse-down perspective on markets for next year hardly sounds optimistic but it is the following six scenarios away from European woes that keep them up at night. From the positivity of a US housing rebound or Election year cycle to much more extreme downside risks such as geo-political concerns and non-European sovereign risks, their views on China, QE-evolution and Inflation concerns are noteworthy.
Goldman, et. al. Suffer From The Same Malady That Collapsed Lehman and MF Global, Worlds 1st and 8th Largest Bankruptcies!Submitted by Reggie Middleton on 12/12/2011 13:48 -0400
There is NEVER just ONE roach!!!
What Mario Draghi did today is the worst of all possible worlds: on one hand he is allowing more financial risk-taking on the ECB's dime courtesy of increased liquidity and relaxed collateral requirements as well as longer LTROs, on the other he essentially killed any provisional bailout rumors, saying that the ECB will not monetize, nor lend to the IMF. The result: sovereign risk is soaring, as seen by this CDS update.