CDS

As DB notes, it appears that markets continue to steadily price in a greater probability of a December taper judging by the 2bp increase in 10yr UST yields, 1.2% drop in the gold price and an edging up in the USD crosses yesterday. Indeed, the Atlanta Fed’s Lockhart, who is considered a bellwether within the Fed, kept the possibility of a December tapering open in public comments yesterday. But his other comments were quite dovish, particularly when he said that he wants to see inflation accelerate toward 2% before reducing asset purchases to give him confidence that the US economy was not dealing with a “downside scenario”. Lockhart stressed that any decision by the Fed on QE would be data dependent - so his comments that the government shutdown will make coming data "less reliable" than might otherwise have been, until at least December, were also quite telling. The dovish sentiments were echoed by Kocherlakota, a FOMC voter next year. In other words, an Oscar-worthy good-cop/bad-cop performance by the Fed's henchmen, confusing algotrons for the second day in a row.

Bond markets may be closed today for Veterans' Day, but equities and far more importantly, FX, are certainly open and thanks to yet another overnight ramp in the ES leading EURJPY, we have seen one more levitation session to start off the week, and an implied stock market open which will be another record high. There was little overnight developed market data to digest, with just Italian Industrial Production coming in line with expectations at 0.2%, while the bulk of the attention fell on China which over the weekend reported stronger Industrial Production and retail sales, while CPI was just below expectations and additionally China new loans of CNY 506 billion (below est. of CNY 580bn) even as M2 in line, should give the Chinese government the all clear to reform absolutely nothing. That all this goldilocks and goalseeked data is taking place just as the Third Plenum picks up pace was not lost on anyone.

While today's big event is the October Non-farm payrolls print, which consensus has at 120K and unemployment rising from 7.2% to 7.3%, there was a spate of events overnight worth noting, starting with Chinese exports and imports both rising more than expected (5.6% and 7.6% vs expectations of 1.9% and 7.4% respectively), leading to an October trade surplus of $31.1 billion double the $15.2 billion reported in August. This led to a brief jump in Asian regional market which however was promptly faded. Germany also reported a greater trade surplus than expected at €20.4bn vs €15.4 bn expected, which begs the question just where are all these excess exports going to? Perhaps France, whose trade deficit rose from €5.1 billion to €5.8 billion, more than the €4.8 billion expected. Of note also was the French downgrade from AA+ to AA by S&P, citing weak economic prospects, with fiscal constraints throughout 2014. The agency added that the country has limited room to maneuver and sees an inability to significantly cut government spending. The downgrade, however, was largely a buy the EURUSD dip event as rating agencies' opinions fade into irrelevance.

 “How Can I Explain To My Clients Afterwards That We Had A Third Crash In 15 years?”

This morning US futures are an unfamiliar shade of green, as the market is poised for its first red open in recent memory (then again the traditional EURJPY pre-open ramp is still to come). One of the reasons blamed for the lack of generic monetary euphoria is that China looked likely to buck the trend for more monetary policy support. New Premier Li Keqiang said in a speech published in full late on Monday that adding extra stimulus would be more difficult since printing new money would cause inflation. "His comments are different from what people were expecting. This is a shift from what he said earlier this year about bottom-line growth," said Hong Hao, chief strategist at Bank of Communications International. Asian shares struggled as a result slipping about 0.2 percent, though Japan's Nikkei stock average bounced off its lows and managed a 0.2 percent gain. However, in a world in which the monetary tsunami torch has to be passed every few months, this will hardly be seen as supportive of the "bad news is good news" paradigm we have seen for the past 5 years.

Just as Friday ended with a last minute meltup, there continues to be nothing that can stop Bernanke's runaway liquidity train, and the overnight trading session has been one of a continuing slow melt up in risk assets, which as expected merely ape the Fed's balance sheet to their implied fair year end target of roughly 1900. The data in the past 48 hours was hot but not too hot, with China Non-mfg PMI rising from 55.4 to 56.3 a 14 month high (and entirely made up as all other China data) - hot but not too hot to concern the PBOC additionally over cutting additional liquidity -  while the Eurozone Mfg PMI came as expected at 51.3 up from 51.1 prior driven by rising German PMI (up from 51.1 to 51.7 on 51.5 expected), declining French PMI (from 49.8 to 49.1, exp. 49.4), declining Italian PMI (from 50.8 to 50.7, exp. 51.0), Spain up (from 50.7 to 50.9, vs 51.0 expected), and finally the UK construction PMI up from 58.9 to 59.4.

Nearly one year into the Japan's grandest ever monetization experiment, the "wealth effect" engine is starting to sputter: after soaring into the triple digits due to the BOJ's massive monetary base expansion, the USDJPY has been flatlining at best, and in reality declining, which has also dragged the Nikkei lower dropping nearly 3% overnight and is well off its all time USDJPY defined highs. But aside for the wealth effect for the richest 1%, it is not exactly fair to say that the BOJ has done nothing for the vast majority of the population. Indeed, as the overnight CPI data confirmed, food and energy inflation continues to soar "thanks" to the far weaker yen, even if inflation for non-energy and food items rose by exactly 0.0% in September. Oh, it has done something else too: that most important "inflation", so critical to ultimately success for Abenomics - wages - is not only non-existant, in reality wages continue to decline: Japanese labor compensation has been sliding for nearly one and a half years!

"We see upside surprise risks on gold and silver in the years ahead," is how UBS commodity strategy team begins a deep dive into a multi-factor valuation perspective of the precious metals. The key to their expectation, intriguingly, that new regulation will put substantial pressure on banks to deleverage – raising the onus on the Fed to reflate much harder in 2014 than markets are pricing in. In this view UBS commodity team is also more cautious on US macro...

Across the entire curve, credit spreads on JCPenney are exploding. The curve is inverted with the market indicating an almost 50% chance of default within the next 2 years (specifically in 2014 as opposed to pre-2013 Xmas). The stock price is collapsing further (though we suspect a gaggle of analysts calls to catch the accelerating knife - just as we saw last time). At $6.30, this is the lowest stock price since March 1981, on the back of yet another downgrade (this time with a $1 target) by none other than the same Mary-Ross Gilbert who proclaimed the most recent quarter a success and suggested buying the debt in just August.

The Russell 2000 made a new all-time record high and the S&P 500 gets close as rumor turned into almost news and expectations of a done deal by 11pm tonight. The rumor was bought on the back of JPY-carry surging once again, the "news" was sold - smacking the S&P down around 8 points to VWAP, and then the ubiquitous closing ramp lifted stock back near their highs. The kicking the can left USA CDS wider on the day, put a bid under T-Bills (though the Feb Bills underperformed), lifted gold and silver off their lows, and while the USD was sent scurrying lower (after an early surge), Treasury Bonds ripped lower in yield (10Y _8bps from its highs early on). Spot VIX was crushed back below 15% (down 20% - the most in 2013) and while the rest of the VIX term structure was bid, the Feb/Mar maturities were less exuberant.

We noted earlier that T-Bills have merely sloshed the risk bucket from Oct/Nov to Feb and it seems CDS markets have apparently not gotten the memo. Joking aside, either CDS traders have gotten really slow or as a result of the recent fiasco US default risk has been repriced to a permanently higher baseline, some 50% higher than where it was one short month ago.

It would appear the sad reality priced into T-Bills and USA CDS is starting to creep into stocks...

U.S. SENATE FISCAL NEGOTIATIONS SUSPENDED UNTIL HOUSE REPUBLICANS WORK OUT PLAN TO PROCEED ON DEBT LIMIT, GOVT FUNDING-SEN. DURBIN

SEN. FEINSTEIN SAYS `IT'S ALL FALLEN APART' ON BUDGET TALKS

Bills are being sold (bonds now snapping lower in yield), the USD and stocks are offered (at lows of the day) and gold and silver are well bid (at highs of day).

Understanding the complexities of the sovereign CDS market is tricky... so we are constantly bemused by the mainstream media's constant comment on it as if they have a clue. The fact is that the USA CDS market is indicating a higher risk of imminent technical default now than in 2011. As we explained in painful detail previously, you cannot compare a 71bps (+8 today) 1Y USA CDS spread to a 1200bps JCPenney CDS spread - they are apples and unicorns. Having got that off our chest, the fact that the cost of 1Y protection is at 2011 extremes (implying around a 6.5% probaility fo default) and has been higher (inverted) relative to 5Y now for 3 weeks is a clear indication that investor anxiety is very high this time (just look at T-Bills!).

With the possibility of a US government default growing day by day (1Y USA CDS rose 12bps today to 72bps) amid impasse after impasse in DC, Bloomberg's Mike McKee looks at the five possible scenarios should the debt ceiling be breached (however unlikely and ridiculous some may appear). From prioritization of payments to across-the-board cuts, 14th amendment interventions and delaying payments, McKee explains the process and implications of each. There are no good options left but we can't help but get the sense the Republicans might just be playing a longer-game here to take us beyond the Democrats' "red-line" of October 17th to highlight their fear-mongering (remember the shut-down devastation?) and potentially regain some election capital (in this increasingly twisted game of picking the worst of two evils)... and indeed, as we have long argued, until we see the market crash, nothing will be resolved.

Normally Treasury Bills are not something discussed around the dinner table or hotly debated on the business news channels. As UBS notes, the fact that the Tbill market has become the focus of attention is an ominous sign, and indicates that the stalemate over the debt ceiling could have profound effects. While TED-Spreads, and financial CDS were the key indicators in 2008, now we must watch money fund flows, and Tbill forwards. In a sense, the Tbill market is the proverbial canary in a coal mine for the US financial system. The canary is not yet back in good health.