Bottom line - while a 3% rally in stocks and the best performance day in IG and HY credit since 5/27 hide what we think is going on under the covers. Breadth was much more mixed in single-names and the unwinding of index overlays and single-name longs (bonds or CDS) that was evident today seem to signal a risk-off sentiment from the top-down (with technicals dominating index moves today). The increasing correlation (and again we are careful to avoid using the term dependence) between stocks, credit indices, and carry currency crosses appears to be getting tighter (with EURJPY and ES_F hardly leaving each other's side today) but for the third day in a row, stocks have outperformed credit.
IG is at its widest (on-the-run adjusted) since 5/28/09 today (and we note that the last time IG was here, HY was over 1000bps) - but different portfolios make the comps a little tricky. Across the broad universe of credit, 5Y was pretty much unch on aggregate as 3Y underperformed with APC, RIG, and HAL the worst performers on a DV01-adjusted basis (along with UAL and CONTI). No clear ratings-related theme today as cohorts were very mixed as we saw bond volumes low once again but underperforming where we did see them (smells like Monty Python's Holy Grail - investors bringing out the dead as markets show any appetite for risk). FINLs and Energy were the worst performing sectors by far today with Utilities and Capital Goods the best performers. One day to go til the greatest sporting event in the world (aside from my eldest daughter's U10 Soccer matches) and we have started to prepare ourselves - bets placed (in my home country of course or that would be illegal) and Fantasy Squad selected. Ennngggeeerrrrlaaannnddd.
The most recent "it's time for risk on" note from Morgan Stanley is pure comedy defined. Jim Caron is now openly fishing to try to get any last remaining greater fools into the HFT shark infested swimming pool. The punchline: "front-end risk metrics remain stable, as 3m Libor sets slightly higher at 0.537, which is actually lower than was expected on Friday. Tactically, as a result, I think the time is ripe to put on risk right now." The salvage attempts by the TBTFs are becoming a surreal Lewis Black skit. Oh well, one always needs to goal seek "better then worst case data" to fit with the imminent risk on reversal. Looks like gold longs got the memo and saw right through it.
As a reminder, for anyone considering this a buying opportunity (other than for a swing trade) based on rebalancing or mean-reversion should note two things: fund outflows are picking up for risk assets, and, even more importantly in our view, risk budgets will mean that allocations will be materially lower (in their wondrously pro-cyclical manner) as we note IG's three-month realized vol is its highest since NOV08 and HY's three-month realized vol is its highest since OCT07 (higher still if we adjust for intraday vol)!
All-in-all a very weak close to a worrisome day (especially given month-start rebalancing hopes). Even the positive ECO prints were questionable on the basis of regime-change a month ago and anything more recent was showing a disappointing trajectory. Weakness was evident across all sectors and industries in credit but the stress in the ENRG space are clearly particularly notable (especially given their somewhat safe-haven status that may have hurt so many recently). Levels to consider in IG are 109.5bps as next support with 118.75bps as a decent short-term pivot. HY held above its pivot of 645bps today with next stop 587bps (large range due to recent vol) and a target of 702bps in the short-term.
The EURJPY has now pushed back below the 110 support even as stocks, which nobody except a few computers, trades any more, fight tooth and nail to give the impression there is buying interest. Hopefully, readers have been prudent enough to stay out of the market since when it broke down terminally, some time in April of 2009, and ridiculous equity moves such as today's will not matter. What should matter, is the ongoing flatenning in the 2s10s, which, as we have claimed previously, is a far more troubling phenomenon, and indicates that between the unending FX carry unwinds, and the Treasury steepener selloffs, liquidations are continuing. That these are not spilling over into the now completely irrelevant stock class is not at all important: stocks are now just for administrative window dressing, and to push the Obama propaganda just how good the economy is, which as everyone knows, is nothing but a lie.
The most ominous sign for US bank P&L continues to not relent: the 2s10s curve, which is the primary source of "revenue" for the hedge funds formerly known as US banks until a bunch of idiots came along and repealed Glass-Steagall, has just gone inside 240 bps. As before, we view this as the primary margin call threat, as billions, if not trillions, of wrong-way bets on curve steepening move further out of the money with every passing basis point. Once the first major repo counterparty blinks and demands a trand unwind, this trade will snap and we could see an even faster flattening, which would lead to some scary consequences for every other asset class.
Spreads closed the day weaker after clinging to gains until mid-afternoon and outperforming stocks. A slow-and steady decline in FINLs finally cracked the low activity rally in risk assets but we note IG underperformed HY as stocks sold off helped by the EUR stalling. Cash underperformed synthetic single-name credit once again but the late-day rush for protection suggests investors once again covering with macro overlays - not a good sign for bonds.
On Friday we pointed out that after nearly 9 months of straight line steepening, the Treasury curve, as depicted by the spot 2s10s, has collapsed, and has flattened from 290 to 240 bps practically overnight, in what has been an unprecedentedly rapid move in the curve, driven primarily by asset liquidations. Those with exposure to spot are panicking, and have been forced to cover what amounts to billions in levered notional positions. Some (the lucky ones) only have synthetic exposure, via Constant Maturity Swaps or other Robertson/Klarman-esque contraptions, thus limiting a downside they can walk away from. They are the minority. Yet an interesting observation, coming by way of Morgan Stanley's Jim Caron, who little by little is forced to wave the white flag of surrender not only on his 5.5% call in the 10 year by Year End, but also on his all out steepening trade, is that flattening has really only occurred in the spot curve: forward yield curves, both the 1y and 2y, have surprisingly retained their steepening bias in spite of unprecedented vol and liquidations. Why is this? Caron explains. However, more relevantly, his observation that a convergence between spot and forward curves is imminent could serve as an easy (famous last words) way to pick 100 bps.
A couple million force-liquidating shares in Amazon or a few billion shorts covered in EURAUS, all those, while painful, are manageable. Yet the biggest positional unwind ongoing currently, which has trillions of dollars behind it, and that few are talking about is the unprecedented flattening of the Treasury curve, as seen in the 2s10s. With every hedge fund, most notably Julian Robertson, and bank (Morgan Stanley), either actively buying or pitching curve steepeners, virtually all market participants are now on the wrong side of the trade, which has collapsed from 290 a month ago to 242bps today, and it appears we will take out the September low of 230 bps shortly. Zero Hedge has long been warning that curve flattening is the biggest squeeze danger out there, courtesy of massive groupthink, which always without fail (anyone remember Volkswagen) cause massive pain to all those who instead of thinking independently, rush into a trade just because "everyone else is doing it." Well, the trade now is collapsing, and with leverage in the hundreds if not thousands, all those who have steepeners on are forced to liquidate whatever else holdings they have, further pushing the long-dated side of the curve lower, thereby reinforcing the liquidation pressure. Look for the 2s10s to continue collapsing, and for MS to change its tune on the steepener trade shortly.
Spreads ended the day notably wider (HY wider than 'flash-crash' close) with stocks managing to slightly underperform on a beta-adjusted basis as broad-based selling in single-names and indices made today feel a little more 'real' than recent swings. There are a few signals of regime change today that make us nervous even with potential clarity from Germany and FINREG due very soon. After some midday covering on EUR (eh hem intervention), the cloture vote triggered more selling and that weakness gathered pace and stocks and credit closed considerably weaker. ES_F closed at the lows of the day and while credit was weak, equity's beta-adjusted performance was notably worse than credit's on the day. HY, which traded over 690bps intraday (shy of the intraday wides of 706bps on 5/6), closed wider than the 'flash-crash' day's close taking it back to end NOV09 wides. IG was weak but remained inside of the 5/6 closing levels. HY-IG decompressed further and we hop those clients who followed us into this trade move those stops up to at least breakeven now (with a target of 600bps).
Spreads rallied today with HY outperforming IG but neither IG nor HY able to get down to Monday's tightest levels as we note 3Y continuing to underperform 5Y (albeit both compressing today) as risk seems to be dragged nearer-term and credit is definitely less Utopian than equities.
Spreads ended the day wider in the US with HY underperforming IG and US underperforming Europe but the tale of the tape was 3s5s flattening and FINL underperformance. After opening notably gap wider this morning, credit markets rallied most of the morning with Main and XOver dramatically so as we sense some exaggeration by correlation desk hedging. HY never made it into positive territory today and even IG only managed a small compression at its best levels.
Morgan Stanley Capitulates, Sees No Rate Hike Until 2011, Pushes Back Call For 4.5% On 10 Year By Two QuartersSubmitted by Tyler Durden on 05/10/2010 15:43 -0500
The one biggest bond bear since December 2009, Morgan Stanley, has just thrown in the towel, and instead of expecting 4.50% on the 10 Year by June 30, the firm has now pushed back its target by 2 quarters. Which means that its longer 5.50% Target on 10 Years has been scrapped. The firm's strategists have also adjusted their call on Fed hikes (now expected to occur no sooner than 2011 instead of September 2010). Lastly, the firm's most vocal call, one for a substantial 2s10s steepening to 325 bps has also been moderated from Q2 to Q4. We also include the latest Rates Strategy slide deck from MS.
Spreads were broadly wider today with breadth very negative as single-names caught up to the index underperformance from yesterday. Despite what appeared a better-than-expected jobs print, derisking was rife once again and European financials led the way. High beta single-names underperformed low-beta dramatically and curves generally flattened at the short-end and steepened at the long-end (though liquidity out from 5Y was less than average).
As an aside, it may be time for IG accounts to take a look at NRUC again. May be getting ready to blow again