CDS

European (like US) stocks remain in a narrow range just above the cliff of the unbelievably good NFP print of 2/3. US and European credit markets have lost significant ground since then and it seems equity investors just want to ignore this 'uglier' reality for now. The BE500 (Bloomberg's broad European equity index) is unchanged from immediately after the NFP 'jump', investment grade credit is +10bps from its post-NFP tights, crossover (or high yield) credit is around 50bps wider, Subordinated financial credit is +50bps off its post-NFP wides at 382bps, and senior financial credit is an incredible 36bps wider at 225bps (by far the largest on a beta adjusted basis). The divergence is very large, increasing, and a week old now and perhaps most importantly as we look forward to LTRO Part Deux, LTRO-ridden banks have underperformed dramatically (40bps wider since 2/7 as opposed to non-LTRO banks which are only 10bps wider) - how's that for a Stigma? Some 'banks' have suggested the underperformance of credit is due to 'technicals' from profit-taking in the CDS market - perhaps they should reflect on why there is profit-taking as opposed to relying on recency bias to maintain their bullish and self-interest positioning as the clear message across all of the credit asset class is - all is not well.

UPDATE: EURUSD back over 1.32 and TSYs +2bps on Greek loan plan news.

Credit (and vol) continue to lead the way as smart deriskers as ES (the e-mini S&P 500 futures contract) ends down only 0.5% - which sadly is the biggest drop since 12/28. The late day surge in ES, which was not supported by IG or HY credit (and very clearly not HYG - the HY bond ETF - which closed at its lows and saw its biggest single-day loss since Thanksgiving), saw heavier volumes and large average trade size which suggest professionals willing to cover longs or add shorts above in order to get filled. Materials stocks underperformed but the major financials had a tough day as their CDS deteriorated to one-week wides. VIX (and its many derivative ETFs) had a very bumpy ride today. VXX (the vol ETF) rose over 14% (most in 3 months) at one point before it pulled back (coming back to settle perfectly at its VWAP so not too worrisome). After the European close, FX markets largely went sideways with the USD inching higher (EUR weaker) as JPY strength reflected on FX carry pair weakness and held stocks down. Treasuries extended their gains from yesterday's peak of the week yields as 7s to 30s rallied around 6bps leaving the 30Y best performer on the week at around unchanged. Commodities generally tracked lower on USD strength with Oil the exception as WTI pushed back up to $99 into the close (ending the week +1.1% and Copper -1.1%). Gold and Silver ended the week down almost in line with USD's gains at around 0.25-0.5%. Broadly speaking risk has been off since around the European close yesterday and ES and CONTEXT have reconverged on a medium-term basis this afternoon (to around NFP-spike levels) as traders await the potential for event risk emerging from Europe.

Just over three years ago, Zero Hedge first pointed out some dramatically meaningless inconsistencies in one of the world's most important numbers (which also happens to be "self-reported" and without any checks and balances) - the London Interbank Offered Rate, better known as LIBOR, which is the reference rate of a rather large market. Following that, we made a stronger case that the Libor, should really be abbreviated to LiEbor in "On the Uselessness of Libor" from June 2009, which alleged that this number is essentially manipulated, potentially with malicious intent. That alone got us a very unhappy retort from the British Banker Association (BBA) which is the banker-owned entity set to "determine" what the daily Libor fixing is based on how banks themselves tell us their liquidity conditions are. Well, as has been getting more and more obvious over the past two years, our allegations were 100% correct, and have now manifested in a series of articles digging through the dirt, manipulation and outright crime behind this completely fabricated number. And yet this should be the most aggravated offence in the capital markets, because LIBOR just so happens is the primary driver in determining implicit risk as a reference rate for $350 trillion worth of financial products. That's right - that one little number, now thoroughly discredited, has downtstream effects on $350,000,000,000,000.00 worth of notional assets. That's a lot. And while we are confident that nobody will ever go to prison for LIBOR fraud, which has explicitly been leading investors and speculators alike to believe that risk is far lower than where it truly is, what one should ask if the LIBOR rate is manipulated, and with is the entire floating and interest rate derivative market, not to mention CDS which are also driven off a Libor benchmark, what is there to say about the minuscule in comparison global equity market? In other words, does anyone honestly think that with the entire fixed income market pushed around by individuals with ulterior motives, that stocks are ... safe for manipulation?

It seems our discussions on sovereign litigation 'arbitrage' and blocking stakes among foreign-law Greek bondholders is gathering some consensus among the smarter sell-side research shops. In a note today, recognizing the differences between Greek international-law bonds, Credit Suisse applies their rigorous game theory perspective to the EUR18bn of foreign-law bond holders and the implications on the PSI negotiations. As we have pointed out, and has been successfully traded in  the last few weeks, they expect foreign-law bonds to trade at a premium to Greek-law government bonds (just as we also noted we see increasingly in Portuguese bond dispersion) not just for blocking stake possibilities but also as better hedge-protected CDS positions. CS points out that if CACs were introduced into Greek law bonds, this blocking stake in foreign-law bonds will create a much higher chance of a hard default credit event and while UK law bonds won't be protected from a hard default they will at least have CDS trigger protection. Finally, the hope of creating a true Prisoner's Dilemma (where standing alone/holding-out singularly is a sub-optimal strategy) fails dismally as each participant is aware that others (blocking stake foreign-law bond holders) will for sure not participate. Adding to this threat is the current low stress environment, set up by the ECB and its LTRO, which could encourage more 'aggressive' behavior by any player in the game creating higher chances of a hard default by Greece as Troika-deal confidence increases the bargaining power for heavier haircuts and thus - fewer willing participants. What a mess!

Somehow the anger of the sex pistols, the sound of boots marching in the background, seem right to me today. Greek Industrial Production dropped 11.3% in December. The unemployment rate jumped to 20.9%, up from 18.2%. The charade of negotiations and a bailout can go. Some deal is likely to be announced. I’m not even sure it will be relevant by the March 20th bond maturity deadline. The economy is getting worse, fast. People are getting angry, fast. The “force feeding of austerity” and plan after plan that is really just a focus on banks at the expense of the people is getting old. While we wait for whatever plan is about to be announced, to some fanfare and some small pop in stock futures, the markets are mixed.

The last time the Fed tried to dump Maiden Lane 2 assets via a public auction in a BWIC manner, it nearly crashed the credit market. This time, the FRBNY, headed by one ex-Goldman Sachs alum Bill Dudley, has decided to go back to its shady, opaque ways, and transact in private, with no clear indication of the actual bidding process or transaction terms, and sell $6.2 billion in Maiden Lane 2 "assets" to, wait for it, Goldman Sachs, the same firm that would benefit in the first place if AIG's assets imploded (remember all those CDS it held on AIG which supposedly prevented it from losing money if AIG went bankrupt?). One wonders: does Goldman have a put option on the ML2 portfolio if the market experiences a sudden and totally impossible downtick some day? But all is well - we have assurance from the Fed that the sale happened in a "competitive process." Luckily, that takes care of any appearance of impropriety.

While hardly new to anyone who actually has been reading between the lines, and/or Zero Hedge, in the past few months, the Greek endspiel is here, and as a note by Goldman's Themistoklis Fiotakis overnight, the Greek timeline, or what little is left of it, "allows little room for error." Furthermore, "Due to the low NPV of the restructuring offer it is likely that part of this investor segment may be tempted to hold out (particularly owners of front-end bonds). How the holdouts are treated will be key. Paying them out in full would probably send a bullish signal to markets, yet it would be contradictory to prior policy statements about the desirability of high participation both in practical terms as well as in terms of signalling. On the other hand, forcing holdouts into the Greek PSI in an involuntary way would likely cause broad market volatility in the near term, but could be digested in the long run as long as it happens in a non-disruptive way (as we have written in the past, avoiding triggering CDS or giving the ECB’s holdings preferential treatment following an involuntary credit event could cause much deeper and longer-lived market damage)." Once again - nothing new, and merely proof that despite headlines from the IIF, the true news will come in 2-3 weeks when the exchange offer is formally closed, only for the world to find that 20-40% of bondholders have declined the deal and killed the transaction! But of course, by then the idiot market, which apparently has never opened a Restructuring 101 textbook will take the EURUSD to 1.5000, only for it to plunge to sub-parity after. More importantly, with Greek bonds set to define a 15 cent real cash recovery, one can see why absent the ECB's buying, Portugese bonds would be trading in their 30s: "Portugal will be crucial in determining the market’s view on the probability of default outside Greece... Given the significance of such a decision, markets will likely reflect concerns about the relevant risks ahead of time." Don't for a second assume Europe is fixed. The fun is only just beginning...

Perhaps after today's budget miss in the Hellenic Republic it is time that the focus shift from the reality of a pending #fail for the voluntary PSI (for all the reasons we have at length discussed no matter how many headlines the markets tries to rally on) to a post-restructuring real economy reality in Greece. Whether self-imposed by devaluation or Teutonia-imposed by Troika, austerity is in the cards but there is a much more deep-seated problem at the heart of Greece - a total and utter lack of innovation and entrepreneurship. As Goldman's Hugo Scott-Gall focuses on in his fortnightly report this week "the competitive advantage of innovation is one that developed markets need to keep" and in the case of European nations that desperately need to find a way to grow somehow, it is critical. Unfortunately, Greece, center of the universe for a post-restructuring phoenix-like recovery expectation, scores 0 for 3 on the innovation front. Lowest overall patent grant rate, lowest corporate birth rate, and highest cost of starting a new business hardly endear them to direct investment or an entrepreneurial dynamism that could 'slow' capital flight. Perhaps it is this reality, one of a Greek people perpetually circling the drain of dis-innovation and un-growth, that Merkel is starting to feel comfortable 'letting go of'. Maybe some navel-gazing after seeing these three doom-ridden charts will force a political class to open the economy a little more, cut the red tape (after a drastic restructuring of course) and shift focus from Ouzo, Olive Oil, and The Olympics. We also suggest the rest of the PIIGS not be too quick to comment 'we are not Greece' when they see where they rank for innovation.

Somehow, once again, we managed to rally EURUSD (to 2 month highs) on the back of Greek deal hopes (even as Merkel stomped her feet, Hollande flexed his muscles, and Dallara/Venizelos had nothing to report) which maintained a modicum of support for equity markets (which also got a little late day push from another record-breaking Consumer-Credit expansion) as cash S&P made it to early July 2011 levels. Unfortunately, with Utilities leading S&P sectors, credit diverging wider in investment grade and high-yield, Copper underperforming (post overnight China reality checks), WTI's exuberance (relative to Brent at least), and implied correlation diverging bearishly from VIX, we can't say this was a wholly supported rally. Broad risk-asset proxy (CONTEXT) did stay in sync with ES (the e-mini S&P 500 futures contract) after the European close as Treasuries held up near the day's high yields and FX carry stabilized. Financials lagged with the majors actually underperforming for a change as we note the late-day surge in ES to new highs saw significant average trade size suggesting more professionals covering longs into strength rather than adding at the top. Volume was above yesterday's dismal performance but remained below the year's average so far. Credit and equity vol are back in line and credit has now been flat and underperforming for the last three days (even as HY issuance has been high).

The Fed is doing everything it can to push people out the risk curve, and in particular is encouraging the hunt for yield in credit products. A lot of people are arguing that “credit” is cheap.  That spreads are high and offer a lot of value.  That may even be true, but the problem is that most retail investors don’t own bonds on a spread basis, they own them on a yield basis. The ETFs are all yield based.  The mutual funds are all yield based.  The argument might be that “corporate credit spreads” are cheap, but people aren’t investing in corporate credit spreads, they are investing in corporate credit yields, and that strikes me as very dangerous. The yields are being held down by operation twist.  The treasury has anchored the short end and continues to shift money to the long end, keeping those yields low, for now.  What happens when that ends? And keep in mind that credit almost always grinds tighter and gaps wider with little to no warning.  When the shift from concern about not getting enough yield to concern about how much notional I can lose always seems to catch the market by surprise.

Prudent institutions aren't waiting around until the dominoes fall--they're buying the underlying assets so they can meet their CDS obligations. That's the only way not to topple into insolvency when the default causes CDS to be recognized as due and payable. In this light, it's no wonder stocks have been rising. If even a modest percentage of CDS are tied to stock indices, then those deleveraging their derivatives positions must acquire the underlying assets. They can no longer count on all counterparties paying off as promised, and so they are raising cash and buying the underlying assets needed to make good their obligations. The whole thing is a farce, just like The Producers. The moment the default is recognized, then all the CDS become due and payable, and it will only take handful of failed counterparties to bring the entire system down. No wonder the Eurocrats and central bankers are twisting everyone's arms to accept a 70% loss--the alternative is a Greek default and the collapse of the banking cartel's profitable scheme. It is beyond absurd--what is a 70% loss but default? When banana republics default, their bondholders don't necessarily absorb a 70% loss. yet now, to "save" the despicably parastic shadow banking system and the "too big to fail" financial institutions, a default cannot be called a default: it is a "voluntary haircut." Greece, please do the world a favor and openly default--right now, today. Declare a default and pay nothing. Force the shadow banking system to recognize a default and bring down the entire rotten heap of worm-eaten corruption.

Bernanke's recognition of his penalizing savers with low rates as an 'issue for people' sparked an interesting note from the WSJ on how sensible and stoic savers are being herded (unsafely) into risky investments. Bernanke's insistence that "our savers collectively have to hold all the assets of the economy and a strong economy produces much better returns in general" must be juxtaposed with comments from a money manager that "I don't think that's a fair-trade" for money intended to be invested safely. By removing the last shred of hope for a rise in savings rates anytime soon, the Fed is once again creating the potential for major unintended consequences as the 30% drop in interest income for US savers from the 2008 peak forces them to extend duration (TSYs), lower quality (corporate bonds), and/or increase leverage/risk (equities). One only has to look at Treasury yields, Muni yields, investment-grade bond yields, and now high-yield bond yields for how tempted investors (retail and professional 'insurance/pension' assets) have become to take their safest net worth asset (low risk liquidity) and expose it to the business/credit cycle and all its myriad event risks. While reducing the rate of savings might seem sensible for the short-term from the Fed perspective, it leaves a wholly unsustainable recovery (or bubble in who knows which asset class next) and as Nordea notes this week, based on their models, a considerably higher savings rate will be needed going forward (for any sustainability) even as 'saved money' is rotated into risk or spent on quality-of-life maintenance. Perhaps it is time for many to listen to the sensibilities of the WSJ's last (75 year-old) interviewee who notes "At my age, I can't be a risk-taker anymore" as maybe it is time to consider the reality of the recent good US data in relation to coinciding elements such as inventory build-up, plummeting household savings, and lower gas prices when adding to that risky investment.

Three weeks ago, Zero Hedge was the first to bring the world's attention to the legal (and explicit trading/risk) ramifications of European sovereign bonds. We noted the ECB/IMF's subordinating impact on unsuspecting sovereign bond holders but much more explicitly showed the huge gap in market perception between domestic- and foreign-law bonds (and the fact that they have very different ramifications given the rising tendency for retroactive CACs or simply local-law changes to accommodate restructurings). The arbitrage of "dumping all weak protection bonds and jumping to the 'strong' ones" which we preached is indeed occurring and now three weeks later, JP Morgan is suggesting its clients take advantage of this same arbitrage strategy (citing the very same thesis and legal justifications as we did) as domestic law bonds offer significant advantages to the sovereign (and therefore implicit disadvantages to the lender or bond holder just as we said) relative to foreign law bonds. While we are flattered that our analysis is deemed worthy of mainstream sell-side research regurgitation, we caveat the celebration with the concern that perhaps JP Morgan already took advantage of the information a 'fringe blog' provided to the world (as we know many funds did given the requests for more explicit bond details) and is now looking to unwind the profitable (though modestly illiquid) positions it has been accumulating for the past three weeks.

Oops?

Something quite notable has shifted in recent weeks in Europe, and it originates at the European paymaster - Germany. While in the past it was of utmost importance to define any Greek default as voluntary (if one even dared whisper about it), and that the money allocated to keep the Eurozone whole would be virtually limitless, this is no longer the case. In fact, reading between the headlines in the past week, it becomes increasingly obvious that Greece will very soon become a new Lehman, i.e., a case study where the leaders are overly confident they can predict the outcomes of letting a critical entity default, and manage the consequences. Alas, this only proves they have learned nothing from the Lehman case, and the aftermath is still not only unpredictable but uncontrollable. But that's a bridge that Europe will cross very shortly. And what is truly frightening is that this crossing may happen even before the next LTRO hits the banks' balance sheets, thus not affording Euro banks with sufficient capital to withstand the capital outflow and funds the unexpected. In the meantime, here is UBS summarizing the palpable change in European outlook over Greece, and over the entire "Firewall" protocol.