Equities underperformed credit once again as macro protection was in demand (in all asset classes) and some rotation from macro-to-micro protection in equities ended a day which was very ugly open-to-close despite what headlines will yell.
Only a very few names managed gains in both equity and credit today (an interesting bunch - MAR, TOL, HOT, DHI, PEP, and SVU) as homebuilders were interestingly near the tope on the list of better performers in credit (which we suspect was related to the underperformance of the CMBX and ABX tranche markets as well as the higher beta exposure in some of the credit indices). Every sector was in agreement between credit and equity with a deteriorating move today as we note financials, leisure, and media were the worst beta-adjusted in credit relative to stocks on the day. Capital Goods, Utilities, and Consumer Noncyclicals performed the relative worst in stocks versus credit. The up-in-quality theme in credit is increasingly leaking into vol as we saw much less impact higher in vols in better-rated credits than in lower-rated credits. This was also the picture in credit though we did see the very highest rated names underperforming (financials?). This picture was somewhat different in equity-land where BB-rated and below names saw their stocks drop far less than A- rated and above names - once again we think this is to do with both financials dominating performance as well as the typical ratings/momentum correlation unwind.
Contextually , credit and vol were much clearer about their directional view today (deteriorating) than stocks (mixed) . Financials saw modest vol compression but the rest saw vol increase on average at the sector level. Tech, Energy, and Media were the worst (risk-adjusted) performers in credit while Financials and Media were worst on average in stock land (risk-adjusted). Interestingly equity outperformed credit (divergently - as in equity rose and credit widened on average) in Basic Materials, Consumer Noncyclicals, Energy, Healthcare, Tech, Telecoms, and Utilities and the fact that Utes and noncyclicals were the best risk-adjusted performers in stock land suggest less rotation out of stocks and more rotation across sectors today.
It is no secret that since the start of QE2 in November, the US Treasury has issued a gross $890 billion in debt in the form of various Bond, Bill and TIPS. This is cash that the US received in exchange for promises to pay interest and principal at maturity on various series of bonds. At the same time, over the past 5 months, there was $291 billion in debt maturity paydowns, or cash leaving the Treasury and going to those who are lucky enough to receive principal on US debt at maturity. That leaves a net of $589 billion in debt that was issued between November 1 and March 31: money used to fund the ongoing operations of the United States. This is all perfectly public and well-known. After all, every single auction is loudly announced by CNBC at 1 pm Eastern on auction days, with a breakdown between Direct, Indirect and Primary Dealer takedowns. Note that the Fed does not feature in this list of primary issuance bidders as that would be illegal, and would be monetization beyond even any semantic argument that the Fed does not, in fact, monetize. What is less known is that the true action in US Treasurys occurs in the secondary market, or that dominated by the Federal Reserve. Here is where the daily POMO takes place, where as we have noted on many, many, many occasions Primary Dealers promptly flip bonds purchased during a primary auction right back to the Fed. This is where the real source of Treasury funding comes from. And what many may not be aware of is that since the start of QE2, the Federal Reserve has purchased $491 billion of Treasurys in the Open Market (and $556 billion since the start of QE Lite). This $491 billion in indirect monetizations ultimately ended up funding government cash needs. In other words out of $589 billion in net issuance, the Fed has been responsible for 83.4% of the money needed to fund government transfer payments (among many other uses of funds) and keep the US consumer "strong", not to mention funding US defense, education, healthcare and every other aspect of US day to day cash needs. QE2 is supposed to end in precisely three months. During that time the Fed will fund another $400 or so billion in US cash needs. What happens after, nobody knows.
Earlier today, JPMorgan made waves by claiming, some would say rather uncouthly, that Portugal's government is about to keel over and die (even if it is undisputed- after all, on Wall Street no one can hear you speak the truth). Never one to be left wanting, here comes Citi with some charts of "parabolic" moves in the Irish 2 Year bond, and some even scarier claims. As expected any research report that starts with the words: "Oh dear...The picture on Irish interest rate markets is taking a very grim turn" - well, it is clear where it is going from there. In summary, Citi now believes that Ireland is essentially done for, or as Tom Fitzpatrick ever so more diplomatically puts it "things are about to get ugly", and recommends going long CDS since the entire short end of the curve has gone parabolic, now that Europe seems set to watch the island country explode, 2s10s has inverted in the past few days, and overall the Emerald Isle is now a dead man walking in the dumbest game of chicken since the creation of the euro. Too bad neither side is willing to back out, which will ultimately end with the eventual destruction of the eurozone and the euro.
Following this morning's near terminal posturing by JC Trichet, who almost, but not quite, is about to hike rates any minutes now, we promise, which saw the EUR surging to near 1.40, a far more troubling side effect is the accelerating flattening of the Bund yield curve. As can be seen below, the German 2s10s has dropped from a high of 210 bps in December to 156 bps, a nearly 25% contraction. Luckily, it has another whopping 14 points to take out the September lows, which back then resulted in deplorable European data, indicating how much more sensitive the continent is to the fluctuations in the yield curve. Furthermore, as March is when the calendar festivities in Europe start for real, German banks are rightfully cursing JCT to hell following his failed attempt to secure his ECB legacy as a hawk on the way out. Should the ECB indeed follow through with an April tightening, look for the iTraxx Senior Financials index to start the slow grind wider as risk in European banks come back with a vengeance.
The "correction" is over. The last time silver was here, the 10 Year was at 12.45%, the 2s10s was inverted -210 bps, and gold was $600.
Why Contrary To The Chairman's Lies, A Record Steep Yield Curve May Be The Most Bearish Indicator AvailableSubmitted by Tyler Durden on 02/09/2011 16:38 -0400
The most important characteristic of current capital markets, aside of course from now completely irrelevant stocks, which there is no point in even discussing any more as the Russell 2000 has become nothing more than a policy tool for Bernanke in pitching idiot Congressmen how "successful" his failed monetary policy has been when all it indicates is how good he is at manipulating stock prices, is the record steepness of the yield curve, as we have been pointing out month after month (oddly the topic never gets boring as it hits a new record wide with each passing month). And while to Ben the steepness is simply more good news to regale his questioners, who have no idea what the difference between a bond price and yield is, with, it is just as easily the most bearish indicator available. Nick Colas explains why "the bears also have more fodder from the steep yield curve than an Alaskan salmon run: the long end of the curve could be blowing out over inflation fears, persistent government debt issuance, or even a future downgrade of U.S. sovereign debt." But don't worry- the Chaircreature will never acknowledge that there is a yang to every ying. Especially not when the ying has to be so well priced, that Bernanke's midichlorian count has to be off the charts to get his liquidity extraction timing perfectly and avoid either a hyperdeflationary or hyperinflationary collapse.
Goldman's John Noyce once again lays out all the main charts to keep a track off in the coming week, with a particular focus on the EURUSD, EURUSD 2 Year swap spreads, USD 2 and 10 Year swap spreads, but most interesting are Noyce's observations about the 2s10s treasury curve, which he believes Noyce is set to resume flattening from record steep levels: "Putting all the pieces together; the aggressive weekly moving average setup and triangle like consolidation on 2-year swaps, the relatively less aggressive weekly moving average setup on 10-year swaps and the current extreme level of the 10-year/2-year curve, it seems the market is at a juncture where a break higher in short-end yields would be very significant both in specific yield related terms and also due to the USD’s +ve correlation to short-end U.S. yields in a number of currency pairs."
As we have highlighted over the past week, one of the best performing asset classes in trecent days has been rice. And judging by the just released CFTC Commitment of Trader data, the speculators are waking up to the possibility that rice has along way to go higher. The Non-Commercial Net Speculative positions in Rough Rice (per CBOT), have jumped to 5,811 in the week ending February 1, and are now the highest they have been in over a year. They are also double where they were less than 4 weeks ago. Of course, with increasingly more popular speculative positions, the concern that profit taking rallies will appear should be widely anticipated. We expect at least one-two broad selloffs in rice in the coming days, following which distribution the path for continued moves higher in the grain should be wide open.
Today's NFP data has sent the treasury complex in a tizzy: the 30 year has now lost its support levels and the yield is up 6 basis point to 4.72%. And since this move would have been expected in the case of a huge NFP beat ('economy improving' rhetoric), but not on today's atrocious result (and if the BLS needs the services of snowy apologists, like DB'a LaVorgna whose only job lately is to explain why economic data are subpar due to the motion of celestial bodies, perhaps it needs to refine its seasonal adjustment to account for snowfall in, gasp, winter), this is merely yet another indication that the long-end vigilantes are once again making a push for an outright QE3 announcement, a development which was predicted by Zero Hedge at the time QE2 was launched.
I am not an economist, but as a strategist I believe there is a case for a multi-year period of weak growth in the US, which could be magnified by an EM slowdown as the EM bloc diverges policy to deal with its own domestic positive output gaps, domestic inflation problems and domestic asset bubbles. The obvious problem is that the US has an excess debt problem and a central bank that seeks to solve asset bubbles that burst by creating new asset bubbles. This policy has been proved a failure. Remember that debt does not equal wealth, that asset bubbles do not equal wealth, that more liquidity does not equal money but instead equals more debt, and that liquidity does not equal capital.
The MBA reported the results of its weekly mortgage applications survey earlier and the leading indicators for the housing price collapse continue coming fast and weak. After rising by 5% in the prior week, the market composite index plummeted by 12.9%, a major reversal, which confirms that as we have been saying, no matter the record 2s10s spread, few if any are taking "advantage" of surging mortgage yields and refinancing. Indeed, the Refinance index decreased by 15.3%, hitting the lowest level since January 2010, while the Purchase Index is at the lowest since October 2010. And so, in addition to global rioting, add the complete collapse in the housing market as the natural offset to a market meltup inducing QE 2. As such, the tradeoff becomes: debt monetization and Russell 2000 at 36,000 (bankers win) or a complete housing market wipe out and accelerating global food price revolutions (middle class is not eradicated). We take the former any day.
EUR Shorts Crucified, And The Fun Is Not Done Yet As Specs Expect Food Price Surge To Persist, Further Curve SteepeningSubmitted by Tyler Durden on 01/21/2011 17:44 -0400
Last Friday, following the disclosure that net commercial EUR short positions has surged to -45,182, nearly a double from the -24,201 the week before, we expected a massive short covering squeeze, which would bring the EURUSD far higher. Today, the CFTC released its weekly update of non-commercial futures exposure. As expected, the covering rally was fierce and intense, and is likely still ongoing: net non-speculative long positions surged by 49,291, in line with the highest one week move in recent years, the biggest of which was recorded in June 2010 when net shorts collapsed by 49,585. The net result pushed net spec positions from -45,182 to 4,109, and resulted in a move in the EURUSD from 1.33 last Friday to 1.3621 at last check. We believe the short covering rally is now over. This is further corroborated by the drop in USD longs in the past week from 10,057 to 5,210. Other currencies were not surprisingly quiet in the past week, with little notable action in either CHF, GBP or JPY net spec exposure.
Over the past week, one of the less noticed and more notable developments, was that the 2s10s quietly climbed back to just short of all time record wides: at 273 bps, the curve is just 13 basis point away from the all time record 286 bps achieved on February 2, 2010. For those who still don't understand how this most recent gift to the banks by the Fed and the government works, the math is that for every 100 bps in spread widening, banks make profits by borrowing free at the 2 Year and lending out at the 10 Year spread (on a Price x Volume basis, although as we will discuss momentarily while the price (i.e. spread) may be there the volume is missing), even as home prices decline by about 12% for each percentage point. In other words, in the past year the entire double dip in home prices can be attributed to the spike in long-term rates, which have in turn caused mortgage rates to jump to year highs. All of this has been predicated by increasing concerns that the Fed will allow runaway inflation, as a result pushing 10 and 30 Year spreads (and gold) ever higher. And while traditionally, a steep curve implies substantial bank profits, this time it is really is different, as demand for mortgages, by far the biggest bank product beneficiary from rising LT interest rates, is non-existent - recent new and refinancing mortgage applications are plumbing 15 year lows, meaning that even if banks make exorbitant profits on a spread basis, there is just not enough of them to go around, which in turn means that banks once again have to rely on accounting gimmicks such as declining reserve provisions to pad their books. And unfortunately for the banks, every incremental basis point increase from here on out only means accelerating home price deflation (regardless of how many days in a row cotton, wheat and whiskey closes limit up), which will wreak havoc on myth of any "recovery." This is in fact the most salient point of Scott Minerd's of Guggenheim latest letter: while the bulk of his latest thoughts is focused on Europe, we believe that the critical part if really that dealing with US interest rates. As he concludes: "The story in housing remains a compelling reason yields on the 10-year note above 4 percent are simply not sustainable at this juncture." We complete agree, which also means that the strawman of higher bank earnings due to the yield curve is now dead and buried. Alas for all the bank bulls, from this point on the only direction the curve can go is down... Unless of course the Fed really loses control of the long end in which case all bets are off and QE3 is sure include purchases of MBS.