CDS

If JPM, which just launched the financials earnings onslaught by first reporting Q4 results, is any indication, it will not be pretty for the financial sector which has seen dramatic moves higher in the past several weeks, because as Jamie Dimon says, Q4 was "Modestly Disappointing." The reason: a top line miss, and a continuing contraction in capital markets leading to yet another decline in Investment Banking results. Also, what DVA giveth, DVA taketh away, and with CDS tightening in the quarter, DVA resulted in a $567 million loss in the quarter. Yet even with the DVA impact exclusion, revenue, which was reported at $21.47 billion would still have missed estimates of $22.56 billion. Finally, what would a quarter be if a bank did not reduce its loan loss allowance and release even more reserves, no matter how the market is actually doing: JPM did just that in its mortgage banking division, lowering its net loan loss allowance by $230 million following a $1 billion allowance reduction in loan-losses offset by actual impairments of $770 million. Stock is down following the release.

Thanks to disappointing macro data early on and better-than-expected European auctions (and ECB not cutting), the EUR went bid early on, accelerate after the Europe close, and stayed that way for most of the day (EURUSD squeeze? or ES-EUR convergence?) ending a one-week highs. Credit markets gapped tighter around their open (thanks to Europe's early strength) but leaked back as the morning wore on. Stocks underperformed credit overall as IG and HY credit rallied into the European close and held gains - while HYG (the high yield bond ETF) significantly underperformed on the day (compressing its NAV premium further despite a modest late day pullback) which should be mildly concerning for bulls (given the size of flows and momentum behind it recently). ES (the e-mini S&P futures contract) converged with VWAP and CONTEXT around lunch then pulled higher into the close managing to tag the day-session open but broad risk-drivers did not participate so much (and we saw higher average trade size volume come in covering at the close). Oil is down 2.6% on the week (sub $99) seeing its biggest 2-day drop in a month and while Gold and Silver leaked lower from midday highs, Copper managed to hold onto its gains (now up over 6% on the week). Volume ended about average for the year in NYSE stocks and ES (though still well down from December).

Following today's increasingly more adverse news for Sears, which saw primary vendor funder CIT cut ties with the Eddie Lampert mega investment, it was only a matter of time before the market realized that the jig for the once bankrupt retailer may be up, and a Chapter 22 is the only possible option. Sure enough, the first to respond to this is the rating agency that not only is capable of forward looking activity, unlike all the other NRSROs, and also managed to get Jefferies to admit it had a far greater European exposure than the market was comfortable with (resulting in a major cut in gross and net, and a far greater transparency into its balance sheet). As of minutes ago, Egan Jones just downgraded Sears Holdings to the lowest rating just above default: C, from CC.

Even as we are drowned by yet another avalanche of lies and cow feces that the Greek private sector bailout negotiation is going well, despite everyone knowing very well by now that various hedge funds like Saba, York and CapeView are holding the entire process hostage and the culmination will be a CDS trigger, the underlying dynamics of the Greek "bailout" once again resurface, which are and always have been all about Germany and the tensions within its various political parties. And unfortunately at this point things are looking quite bad for Greece. As Bloomberg reports, "Greece will have to exit the euro area as it struggles under a mountain of debt, unable to regain its competitiveness without having its own currency to devalue, a senior lawmaker in Chancellor Angela Merkel’s party said. The comments by Michael Fuchs, the deputy floor leader for Merkel’s Christian Democratic Union, contradict the chancellor’s stance in a sign of the domestic headwinds she faces in leading Europe’s efforts to keep the 17-member euro area intact. With the debt crisis into its third year, Merkel is due to join CDU lawmakers at a two-day policy meeting beginning tomorrow in the northern German city of Kiel." The truth hurts: "For Greece, “the problem is not whether they are capable of paying their loans -- they will not, not at all, never." So, why are we optimistic on Europe again? Oh yes, because European banks issued tons of equity and now have a capital buffer to the imminent hurricane that will be unleashed once the Greek restructuring finally enters freefall mode and the country leaves the Eurozone. No wait, that's not right: only UniCredit tried that and its stock collapsed by 50%. Must be something else then - oh yes, Italy successfully sold debt maturing in one year!

Today saw NYSE trading volumes at their 3rd highest of the year and ES (the e-mini S&P 500 futures contract) saw its second highest volume of the year (though both still well below recent averages) as stocks managed marginal gains, outperformed handily by high yield credit. For the sixth day of the last seven ES closed only a smidge from where it opened but average trade size was dramatically higher (its highest since 8/31) which historically has suggested a short-term top (and certainly seems odd heading into tomorrow's European bond auctions). In a similar manner to yesterday, HY17 (the high yield credit index) surged (absolute and relative to ES and HYG) from the European close to US day session close (index RV to Europe and Index arbitrage seems much more of an effect than rerisking. The major Financials were among the best performers today once again (as XLF managed +1.13%) with BofA now up an impressive (if not ridiculous) 24% YTD (and Citi +19%). Perhaps of note is the fact that the major financial CDS rally stalled today with MS, GS, and JPM all leaking a little wider into the close. Treasuries continued their ain't-no-decoupling rally as the 10Y auction went well (beige Book mixed/weak) leaving longer-dated TSY yields near day (and year to date) lows and ES near day highs (sell EUR, buy anything USD-denominated?). The dollar is practically unchanged on the week now as EUR 1.27 (and GBP more so) weakness dragged it up (even as AUD rallied - helping stocks). Copper outperformed among the economically sensitive commodities as Gold gained modestly (slight beat of Silver) and Oil slid back to $101 and remains down on the week as Silver holds over 4% gains. As an aside, from the 12/30/11 close, Gold is up 4.95%, the S&P 500 is up 2.77%, and the Long Bond is down 0.65%.

Over the weekend, and before it became a popular topic in the mainstream media and an issue of political debate, UBS first among the "non-fringers" discussed the topic of not only a coercive Greek restructuring (i.e., one in which there is no "agreement" of the bondholders) but that it is, in fact, imminent. Since then, the din over this issue has escalate with reports over the past two days, that Greece may enforce collective action contracts as well as force bondholders into a deal, since various hedge fund hold-outs have been holding Europe hostage, a development foreseen here in mid-2011. Unfortunately for Europe, which apparently has no idea what is going on, and whoever is advising it financially is certifiably an idiot, the coercive path is precisely what the end outcome may end up being. Naturally, while this is preciseley what should have happened long ago (and saved taxpayers everywhere hundreds of billions in Greek bailout funds), the fact is that it goes contrary to everything the imploding status quo and collapsing ponzi house of cards is doing to prevent an all out catastrophe, as a coercive transaction actually will have unpredictable and adverse spill over effects in virtually every aspect of European financial markets, which in turn will migrate to the US. The good news is that CDS, despite the constant attempts of the crony and corrupt ISDA otherwise, will once again become an instrument of hedging, which ironically in the long run will be stabilizing. But not before some serious short-term fireworks. UBS explains.

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.

Payback sure is a bitch. After being demonized for everything from the tiniest tick down in the EURUSD, to blowing out spreads in CDS, to plunging stocks across the insolvent continent, hedge funds, long falsely prosecuted for everything, even stuff they patently did not do, are about to have their day in the sun, precisely in the manner we predicted back in June of last year when we posted: "Greek Bailout #2 Is Dead On Arrival: A Few Good Hedge Funds May Have Called The ECB's Bluff, And Hold The Future Of The EUR Hostage." Back then we wrote: "we may suddenly find ourselves in the biggest "activist" investor drama, in which voluntary restructuring "hold out" hedge funds will settle for Cheapest to Delivery or else demand a trillion pounds of flesh from the ECB in order to keep the eurozone afloat. In other words, the drama is about to get very, very real. And, most ironically, a tiny David is about to flip the scales on the mammoth Goliath of the ECB and hold the entire European experiment hostage..." Sure enough, we were right yet again. Ekathimerini writes: "Hedge funds are taking on the powerful International Monetary Fund over its plan to slash Greece's towering debt burden as time runs out on the talks that could sway the future of Europe's single currency. The funds have built up such a powerful positions in Greek bonds that they could derail Europe's tactic of getting banks and other bondholders to share the burden of reducing the country's debt on a voluntary basis." Oh no, they will let it happen, but first Europe will pay, with real interest, for every single incident of hedge fund bashing and abuse over the past 2 years. We estimate the final tally, to US taxpayer mind you, will be about $20 billion, to remove the "nuisance factor" of hold out hedge funds. Congratulations Europe - you have proven to be a continent full of idiot "leaders" once again.

What would a Collective Action clause achieve? Let’s say they institute a 75% agreement clause, so that if at least 75% of the holders of anyindividual bond issue, agree to the terms, then all bondholders are forced to accept the new terms.  Will adding a Collective Action Clause make investors agree to the changes?  I don’t see why that would happen.  If you didn’t agree to the plan being proposed by Greece now, why would you agree to the plan if all they have done is institute a Collective Action Clause.  You wouldn’t, so you would still have the same group of holdouts. What happens if a bond doesn’t get 75% agreement?  Then those that agree get the new bonds, and those that don’t agree keep the old bonds.  Same as now. But if it is the same as now, why bother?  Maybe they need to make it 50% agreement?  Or 10%?   In any case, there may be individual bonds that don’t meet the Collective Action threshold.  For those bonds, it is exactly the same as it is now – except that the government changed the rules retroactively and jammed it down your throats (but more on that later). What happens if 80% of the holders of a particular bond agree?  Then all bondholders are subject to the agreement.  Well, guess what, that is a Credit Event! 

If there is any one more vivid confirmation of Mayer Rothschild words "Let me issue and control a nation's money and I care not who writes the laws" then we have yet to find it. Today Hungary, which had "valiantly" defied Europe and the IMF in ignoring pressure to make its central bank more "malleable" finally folded, following a recent explosion in its bond yields, a surge in CDS to records, and a collapse in its currency. And to think how easy it is to subjugate a state to slave status in our "globalized" days without shedding one drop of blood. Reuters reports: "Hungary's government is ready to consider modifying disputed legislation if the European Commission deems it necessary, Foreign Minister Janos Martonyi told the bloc's executive and European Union partners. "We fully respect the authority of the European Commission, the guardian of the EU treaties," Martonyi wrote in a letter dated January 6 and published by his ministry on Tuesday. "We stand ready to consider changing legislation, if necessary."" As Rothschild foresaw so effectively over 200 years ago, selling out your sovereignty only takes a few pieces of (paper) silver.

Money continues to come into the market based on “decoupling” and the “muddle through” scenario. I do not believe that “muddle through” is an option. The entire system in Europe has become so interconnected that “muddling through” doesn’t seem realistic. The situation in Italy remains bleak (bond yields are higher again in spite of massive amounts of central bank support). The situation in Greece is reaching a peak. A voluntary resolution seems less likely by the day, but that leaves open the ECB’s positions, and also opens up the question of what to do with all the Greek Government Guaranteed Bank Bonds (affectionately known as ponzi bonds) that the ECB is financing to keep Greek banks alive? The ECB will have to change their rules yet again to let formerly guaranteed debt still be pledged as collateral? I think that issue is just as important as the CDS settlements and changes in collateral requirements that are likely to result from a Greek default.

Life goes on, so does the stock market. 

UBS, which has been issuing ever gloomier forecasts over the past few months, with the sole intent of getting someone to bail out the European financial system, which despite the current stay of execution is increasingly more brittle (because solvency crises only get worse with time, never better), has just come out with its magnum opus. In a report released overnight, the firm's Global Rates Team has just jumped the shark, with a prediction that things in Europe are literally about to implode: "we anticipate that the crisis will deteriorate further than the stressed levels of late November. We do not believe that Greek PSI will take place in a “voluntary” fashion but instead expect coercive restructuring of Greek debt either before or soon after the March redemption, triggering CDS contracts. Greece is not likely to decide to leave the euro area in 2012, though the risks of that happening have certainly increased." And as we well know from previous UBS reports, a departure of a country from the Eurozone would lead to a mass splurge in purchases of guns, spam and gold. So is this merely a last ditch call for a bailout from someone, anyone: either Fed or ECB will do? Most likely. Because if while the general market continues to ignore Europe, and European banks are out there literally screaming the end is nigh, then the truth is surely somewhere inbetween. Especially, if as Reuters reports, Greece is just the beginning. "One of Portugal's most prominent business leaders has moved his family holding company to Holland partly because of uncertainty over whether the country will remain in the euro, Alexandre Soares dos Santos said in a newspaper interview on Saturday. Soares dos Santos, who is chairman of the board of Jeronimo Martins, caused a stir in Portugal this week when it emerged that his family holding company that controls the country's second largest retailer had moved to Holland...."I also don't know if Portugal will stay in the euro. And if it leaves, it will be to the escudo," Soares dos Santos told Expresso, referring to the escudo currency used by Portugal before it adopted the euro. "I have a right to defend my property."" So while everyone continues to expect the best, those who really matter are planning for the worst.

Equities traded their lowest volume of the week (-19% from yesterday alone). The NFP print this morning provided ammunition for some vol early on but as we drifted into the European close, risk assets in general were pushing lower. Unlike the last few days the circa-Europe-close dip-and-rip only occurred in the equity market today as the USD stayed near its highs and TSYs near their low yields of the day (and high yield credit near its wides of the day) as stocks took off back into the green and meandered either side of VWAP for the afternoon. It seems odd that the afternoon's divergence between TSYs and stocks was not accompanied by Gold or USD weakness (QE hopes) and in fact as we got into the last few minutes, stocks started to push back lower on much larger average trade size but was trapped between VWAP and unchanged on the day. Gold outperformed on the week (+3.4%) just inching out Silver and Oil as they appeared to converge on a 3x beta of the USD 'appreciation' of around 1.2% this week. Treasuries rallied 4-6bps and the curve flattened overall as we saw duration reduction in corporate bonds (with highest quality names (Aaa-Aa3) being net sold). DXY stayed above 81 as the EURUSD scrambled back above 1.27 (down an impressive 1.85% on the week). AUD was the only major to gain relative to the USD on the week (and very marginally). Finally, we saw VIX dropping and stabilize and implied correlation diverged and rose this afternoon which combined with the divergence in risk assets suggests stocks are short-term overdone at best.

According to Bloomberg's First Word Cross Asset Dashboard, sentiment rose modestly in European session and into U.S. open, with EU and U.S. equity indexes as well as Bunds and Treasury yields modestly higher, Bloomberg analyst TJ Marta writes in following note:

• Payrolls est. 155k; market possibly expecting upside surprise after yesterday’s ADP 325k vs est. 178k
• After most Asia equity indexes fell moderately, EU equity indexes, U.S. futures modestly higher; S&P futures +0.7%
• Treasury yields modestly higher ~1bps; Bund yields modestly to significantly higher, led by 2-yr +3.6bps
• FX, commodities, EU sovereign yield to Bund spreads mixed in mostly modest ranges
• In Europe, Hungarian bonds jumped by the most in 6 weeks following hope that talks between the Premier, Central Bank Chief and Ministers would resolve the IMF rescue impasse. The meeting was concluded with Orban saying that Hungary wants IMF aid and is ready to support central bank - in other words Hungary just caved to the banking status quo. CDS declined modestly from all time records.
• Germany November factory orders collapsed by 4.8%, on expectations of a 1.8% drop - biggest drop since September 2008 - the recession has now firmly moved into the core.
• ECB deposit facility usage rose to a new record of €455.3 billion.
• Liquidity conditions are measured by Swap Spreads improved modestly, and are now at early November levels: the 3M EURUSD basis swap rose 6.8 bps to -102.25, highest since November 7; the 3M Euribor/OIS dropped to 0.93, lowest since November 25