The divergence between credit and equity marksts that we noted into the European close on Friday closed and markets sold off significantly. European sovereigns especially were weak with our GDP-weighted Eurozone credit risk index rising the most in six weeks. High beta assets underperformed (as one would expect obviously) as what goes up, comes down quicker. Stocks, Crossover (high-yield) credit, and subordinated financials were dramatically wider. Senior financials and investment grade credit modestly outperformed their peers but also saw one of the largest decompressions in over a month (+5.5bps today alone in the latter) as indices widen back towards their fair-values. The 'small moderation' of the last few weeks has given way once again to the reality of the Knightian uncertainty Europeans face as obviously Portugal heads squarely into the cross-hairs of real-money accounts looking to derisk (10Y Portugal bond spreads +224bps) and differentiate local vs non-local law bonds. While EURUSD hovered either side of 1.31, it was JPY strength that drove derisking pressure (implicitly carry unwinds) as JPYUSD rose 0.5% on the day (back to 10/31 intervention levels). EURCHF also hit a four-month low. Treasuries and Bunds moved in sync largely with Treasuries rallying hard (30Y <3% once again) and curves flattening rapidly. Commodities bounced off early Europe lows, rallied into the European close and are now giving back some of those gains (as the USD starts to rally post Europe). Oil and Gold are in sync with USD strength as Silver and Copper underperform - though all are down from Friday's close.
One won't find many orthodox strategists who believe that currency printing, and thus dilution, is favorable for said currency. Yet they do exist (as a reminder, this is precisely what saved the REITs back in early 2009, who came to market with massively dilutive follow on offerings, but the fact that they had market access was enough for investors to buy the stock despite the dilution). One among them is Citi's Steven Englander who has released a rather provocative piece in which he claims that as a result of reduction in tail risk, or the possibility of aggressive ECB bond buying (and implicitly, Englander suggests that what we believe is a core correlation: between the sizes of the Fed/ECB balance sheets and the relative value of the respective currencies, is not as important as we suggest), the "EUR will be stronger if the ECB compromises its ‘principles’, but succeeds in convincing investors that the sovereign risk is limited to the smaller peripherals, rather than the core." Currency stronger on central bank printing? And by implication, an x-trillion LTRO being FX positive (and thus risk-FX recoupling)? We have heard stranger things. And remember it is the bizarro market. And finally, Morgan Stanley, which won that shootout with Goldman's Stolper two months ago on the EURUSD, has just turned tactically bullish on the currency (more shortly). For now, here is how Steven Englander explains his contrarian view.
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.
We have extensively discussed the extremes to which European Sovereign spread risk has moved over the past few months. Furthermore, if we normalize by looking at a GDP-weighted credit spread across all of the members of the euro-zone, we are at all-time record wides on this measure. One question that has come up again and again is 'given the market's credit perceptions, why isn't the EUR lower?'. It appears that this is mainly due to regime shifts in the relationship as the correlation between EURUSD and European sovereign risk is extremely high when government intervention (specifically QE uncertainties and fed swap lines) is not rife. The point is that for the last four months, EURUSD and European sovereign risk have been almost perfectly correlated suggesting that as long as there is no ring-fence on risk, the EUR will continue to weaken significantly and at a minimum the EURUSD is an effective hedge against sovereign credit deterioration. Watching this relationship may provide insight into repatriation effects or government intervention as well as offer insight into how EURUSD will move given specific bond moves - a 100bps rise in Italian bond spreads alone infers a 140pip drop in EURUSD for example.
As early as July, we pointed out the increasingly likely endgame in Europe with regard to the EFSF and centralizing/concentrating credit risk. Well sure enough, sovereign risk has risen dramatically for Germany (among many others obviously) as traders realized standing on the shoulders of giants does nothing but push them further into the dirt. What is becoming more worrisome, and dramatically escalating, is the rise in sovereign CDS relative to government bond yields - or the so-called 'basis' - as it becomes ever more clear that government-bond-yield-by-mandate may not be as 'real' a measure of the risk-free rate as CDS.
Despite Preemptive Gold Margin Hike In Shanghai, Gold Is Poised To Close May Near Record On Sovereign Risk WorriesSubmitted by Tyler Durden on 05/30/2011 15:50 -0400
After a near epic margin driven collapse in silver, which appears to have been largely forgotten as the metal has resumed it upward climb, it is gold which has once again regained the crown in the fiat substitute race. As Reuters reports: "The speculators are coming back, mainly driven by the European debt crisis," said a Singapore-based trader. "Gold is likely to slowly move up during the summer unless we see big headlines, such as the U.S. raising interest rates earlier than expected." Of course, where some see "speculators" others see rational investors who are already discounting the inevitable next step by the central planner cartel, which forced to deal with a slowing economy will have no choice but to inflate the global adjusted monetary base (and dilute outstanding fiat) by another several hundred billion. Elsewhere, in preparation for another gold breakout, the Shanghai Gold Exchange hiked gold and silver margins once again, this time preemptively. "The Shanghai Gold Exchange said
on Monday it will raise margin requirements on gold forward
contracts to 12 percent from 10 percent from the June 2
settlement, a move to help ward off excessive volatility in
global markets during the Dragon Boat Festival holiday on June
6. The bourse will also hike silver forward contracts to 17
percent from 15 percent. It will also set gold daily trade
limits to 9 percent and silver at 12 percent from June 3." Still, the gold fixing at the close of NYMEX trading was $1,539.1, $30 away from all time nominal highs. Incidentally, would it be too much to ask of the exchanges to provide the general public with just what the formula is that they use to make their margin hike (and, reduction) decisions? They would be amazed how quickly any allegations of collusion with the administration would disappear if only a little transparency was introduced to the "system."
Simon Black, aka Sovereign Man, who recently has been a frequent guest on the pages of Zero Hedge, was interviewed by The Daily Crux, and explains why in a world of relentless printing of credit money, and thus a surge in global sovereign debt, sovereign risk is rapidly becoming the first and foremost risk factor for investors. Courtesy of his extended travel experience, Black, who visits 50 countries each year and actually performs due diligence, summarizes his thoughts on all those pundits who base their macro views on a tourism brochure: "I spend my life trying to put my boots on the ground in as many places as possible to really see with my own eyes what's going on in the world and what the opportunities are, rather than take some idiot's recommendation on Fox Business News who doesn't know his ass from his elbow." In addition to getting some more background on Black, who is oddly low-profile in a world filled with media whores, here is one chance to evaluate key risks vicariously courtesy of a man who actually has "been there, done that."
Time to buy some peripheral European CDS - As our friends at Kerrisdale Capital point out, "There’s been a lot of talk recently about Hungary following in Greece’s footsteps and potentially defaulting on its debt. Bulgaria and Romania are two other weak economies in Eastern Europe, and the chart below shows bank exposure by country to Bulgaria, Romania, Hungary and Greece. The situation in Greece could make it difficult for Bulgaria and Romania to roll over their debt, an event which would in itself reduce the value of Greece’s assets, creating further difficulty for Bulgaria and Romania."
MarkIt reports Italian CDS has exploded by 50bps, from 200 on Monday to 250bps, a new record. The weakness is spreading globally now. A slightly delayed CMA report indicates that the biggest CDS movers are all sovereigns, and led by Korea and other Asian names. In the meantime eurodollar futures are pushing ever higher, even as Libor is still testing the temporary breaks at 0.53%. All fine and dandy, until you look at Euribor, where things are getting surreal. We will discuss this shortly.
The current system and the global imbalancing act is going to change. The nature of that change is unclear. Comparing similar pasts to the present and extrapolating future effects is one approach. However, such mean reversion doesn’t work along an established time frame. What can be counted on is that unsustainable phenomenon like current account imbalances, negative savings rates, seeming infinite asset price appreciation will change. One way or another, falling savings rates and rising deficits become rising savings and falling deficits.