CDS

The European Union failed to approve a law or plan to bank naked shorts on sovereign CDS.  Their focus on CDS trading started over 18 months ago when the Greek Finance Minister said that all the short sellers would lose their shirts. There have been a multitude of rumors that it would be banned, but there are many better ways to control the CDS market. In all likelihood, the politicians will remain intent on banning CDS.  I think they will be disappointed with the impact and realize that CDS is not the root of all evil and Europe will still have a sovereign debt crisis, without the benefit now of some short covering and additional price discovery.

Judging by the futures one may be forgiven to assume that sovereign default risk in Europe has moderated today. One would also be 100% wrong. It's contract roll day and Italy downgrade day (first of many: Moody's on deck) not to mention algo ES futures ramp up ignore day, and as a result everything is wider across the board, and Italy 5 Year hit 520 earlier, a new all time record.

As S&P futures head back towards their lows, they remain notably above commensurate credit-inferred levels as the credit and TSY complex is showing stresses far more than equities so far (and we know how that has ended recently). Europe is very ugly again with the major credit indices all significantly wider. Financials are losing grip on any hope as we now start to see not just PIIGS spreads widening but the core spreads crack as risk transfer is priced into the overall euro-area balance sheet. Non-financial European corps are also notably weaker as transmission mechanisms drag the real economy down and that is implicitly crossing the pond to drag IG and HY spreads wider over here.

Some may find it odd that afer all the measures taken to resolve the threat of a Greek bankruptcy and Eurozone explusion, it is just Greek CDS that are actually wider on the day. We suggest those "some" forget about reality and enjoy the latest massive short covering squeeze which will end only when it does and not a moment sooner.

While the market continues to trade purely on rumor, counter-rumor and refutation of a refutation, the facts demonstrate that Europe is ugly and getting worse. Today's now daily update focuses on continuing deterioration in both liquidity and solvency. First, the usage of the ECB Deposit Facility soared to €198 billion on Monday from €182 billion on Friday. This is a massive €118 billion increase in the past month alone. As the chart below demonstrates, a good word to describe the chart is parabolic. Furthermore, USD Libor continues to rise and has now risen nearly 40 days in a row. While not nearly parabolic, it is time to shift attention away from Credit Agricole, which is still the most "funding challenged", and focus on CSFB which once again rose by 0.01%, and threatens to overtake the troubled French bank in pole position. Time to refocus the shorts from France to Switzerland? Lastly, the CDS are ugly across the board.

Even as stocks surge on the back of the latest rumor that yet another perpetually wrong Medley report has been released and states that the Fed may cut the IOER to zero in addition to Operation Twist (we have not seen the report nor have any interest in putting any faith in a "think tank" work product), someone has apparently forgotten to tell Europe it is all filed. Here is the CDS rerack, which unfortunately shows that this latest stock ramp is to be faded, especially since QE3-666 are already priced in, and will all eventually fail.

Just when one thought Wall Street could not become more full retard, here comes David "Kermit" Bianco who, perfectly oblivious of the world ending one broke European country at a time, has just released the following: "S&P 500 2011 year-end target remains 1400, 12-month target raised to 1450 from 1400 12-month target raised on time value and conviction in 2012 EPS being ~$100 barring recession." Barring recession? Has this "strategist" even looked at a TV in the past three months, let alone exited the island of lunatic asylum that is Manhattan? But wait, the humor continues, although we are 100% confident this joke of a snake oil salesman will be on CNBC any minute. As a reminder, Bianco had an S&P price target of 1650 until October 6, 2008, or after the Lehman bankruptcy. He would end up being off by only well over 100%.

As we speculated on Friday, Europe has opened, and it is ugly. In fact, Europe has never been closer to a bank and market holiday than it is right now. Why? Let's go down the list...

Cue popular REM song...

Peripheral country bond yields (and CDS) continue to rise unwaveringly towards the endgame where European leaders are forced to actually do something as opposed to paper over gaping cracks with piecemeal solutions that are seen through by market participants within hours of release. Greece 5Y CDS rose 210bps to 3235bps (running equiv.) Portugal 5Y CDS rose 50bps to 1110bps. Perhaps more worryingly Germany 5Y CDS rose 3bps to 81bps as we see similar risk transfer transmissions as were evident during the US (private to public) crisis three years ago. EUR just broke through the mid-July lows of 1.3837, taking it back to mid-March lows.

A tale of two Europes:

• PORT 1030/1070 +25
• IRELAND 812/840 +6
• ITALY 420/428 +2
• GREECE (pts) 51/55 +2
• SPAIN 380/390 -2

• BELGIUM 262/272 flat
• FRANCE 164/168 -8
• AUSTRIA 126/131 -5
• ENG 74/76 -1
• DEUTSCHE 76.5/78.5 -1

There are those who may be surprised to find that China is not completely insulated from the latest fun in Europe, America, and all those other places where the ponzi is imploding. To those same people we suggest a casual reading of the following two articles by Bloomberg and MNI - frankly we are too lazy to summarize. As for the market: it already knows whats up. Below is the nth consecutive drift up in most Asian CDS as once again credit predicts and idiots momos react, and after losing a shitload of money, confirm.

Add the CDS market to the list of participants that is ignoring the biggest development out of Europe in two months: the failure of the second Greek bailout.

We wish we had some good news to report this morning.... But we don't.

Following yesterday's plunge in the German ZEW investor confidence reading, today we got yet another confirmation that Germany's economic in freefall, after the IFO Business Climate survey printed at 108.7, the lowest in more than a year, down from 112.9, and a big miss to consensus of 111.0. The 4.2 drop was the highest since November 2008, when it plunged by 4.2. In summary, today’s disappointing Ifo data, if repeated in coming months, points “at least to sharp deterioration of growth, perhaps even recession,” Ralph Solveen, head of economic research at Commerzbank says." And unlike America, where hope is the only thing pushing investors forward, in Germany it is the inverse with the expectations component dropping belopw the 10 year average of 100.5, for the first time since July 2009, while the current assessment component is still above the 102.7 long-term average. Should this collapse in hopium consumption jump across the Atlantic, watch out America. Furthermore, while as was noted before, Merkel's continuing refusal to adopt Eurobonds is nothing new, today we got a new kink after German president Wulff questioned the legality of ECB bond purchases during a conference at Lindau, claiming that bond buying damages the ECB's independence. Wulff cited an article in the European Union's fundamental treaty, which prohibits the ECB from buying bonds directly from governments. "This ban only makes sense if those responsible don't circumvent it with comprehensive purchases on the secondary market," he added. "What independence?" might add anyone who has seen the global printing cartel in action over the past 3 years. Yet the recent expansion in the SMP, which has bought about €40 billion in Spanish and Italian bonds, is the only thing keeping Europe afloat now: if this were taken away, it is the beginning of the end. Another complication to any sustained EUR rally, is that the Finnish government announced overnight it is sticking to its collateral side deal with Greece, a move that apparetly has Germany fuming. Expect headlines as  Finland’s govt will meet this afternoon to discuss Germany’s rejection of collateral agreement the cabinet struck with Greece on Aug. 16, newspaper Helsingin Sanomat reported on its website without saying where it got the information. This may well be worth 200 pips in the EURUSD... to the downside. And lastly, the cherry on top is that Greek 2 Year bonds, just soared above 40% for the first time ever! So much for bailout #2. Time to star pricing in the 4th iteration as the 3rd one is now a certainty. All this means that iTraxx Fins Senior is now at an all time high of 255, +4 bps, while the Sub Index is also at a record of 453, +9bps. Look for a resumption in the serial close of trade of all Italian banks before Europe shuts down at 4:30 pm local.