default

Over the past month, much has been said about the recent 3 year LTRO, and its function in stabilizing the European bond market. Certainly it has succeeded in causing an unprecedented steepening in European sovereign 2s10s curves across the periphery (well, except for Greece, and recently, Portugal) as by implication the ECB has made it clear that debt with a sub-3 year maturity is virtually risk free, inasmuch at least as the ECB is a credible central bank (and if it is perceived as no longer being one, there will be far bigger issues), along the lines of what the Fed's promise to keep ZIRP through the end of 2013, and today's likely extension announcement through 2014. Yet does filling a much needed for European stability fixed income "black hole" equate to a catalyst for Risk On? Hardly, because as in a new note today Brockhouse Cooper analysts Pierre Lapointe and Alex Bellefleur explains, the LTRO is "not a catalyst for a risk-on rally as the central bank is substituting itself for funding sources that have “dried up.” Sure enough - all the ECB is doing is preserving existing leverage (especially in light of ongoing bank deleveraging), not providing incremental debt, something which could only be done in the context of unsterilized bond monetization ala QE in the US. So just over a month in, what does the LTRO really mean for Europe (especially as we approach the next 3 Year LTRO issuance on February 29)? Here is Brockhouse's explanation.

In all, the President's speech was reminiscent of George Clooney’s in Ides of March. We’ve heard it all before, maybe with slightly different words: America lost 4 million jobs before I got here, and another 4 million before our policies went into effect, but in the last 12 months, we added 3 million job. We must reduce tax loopholes, and provide tax incentives to businesses that hire in America. We must reform taxes for the wealthy (though he signed an extension of Bush’s tax cuts.) We must train people for an apparent abundance of expert jobs. We need more clean energy initiatives.  We created regulations (big sigh of relief he didn’t use the word ‘sweeping’) to avoid fraudulent financial practices. We will help homeowners. Wall Street must ‘make up a trust deficit.”   Like Jamie Dimon cares. In other words, Obama gave Wall Street a pass, while waxing populace. Don’t get me wrong. I expected nothing different. I will continue to expect nothing different, when he gets a second term, given the lame field of contenders all around.

Even as the Euro-Dollar 3 Month basis swap has contracted to a nearly 6 month low at -75 bps, on residual hopes that the LTRO will do anything to fix Europe (it won't - just compare it to the €442 billion 1 year LTRO from June 2009 which worked until it didn't for the simple reason that Europe does does not have a liquidity problem), Europe has once again reemerged as a source of risk off (not least of all because the fulcrum security benefiting from the LTRO - the Italian 2 year BTP is for the first time in weeks wider by 17 bps). Why? The same reason as always: Greece, with a touch of Portugal. As BBG observes the positive sentiment in Asia earlier was retraced in the European session, with commodities, FX, equities lower, especially after ECB demurred from accepting losses on its Greek bond holdings. What that means is that as we patiently explained over the weekend, the imminent Greek default (just listen to Soros over in Davos spewing fire and brimstone on Europe for allowing the situation to get to a place where a Greek default is inevitable) will create so many subordinated junior tranches of Greek debt it will make one's head spin. But while the fate of Greece is all but sealed, and a CDS triggered virtually factored in (note: a Greek CDS trigger, in isolation, won't have much of an impact as repeated here before - in fact it will return some normalcy to the market as CDS will be a hedging vehicle once again over ISDA's corrupt trampled corpse), it is what happens to Portugal and its bonds that has the market gasping for air. Because as Zero Hedge pointed out first, a Greek default will be impossible to be enacted in Portugal in its currently envisioned format, as stupid as it may be. In fact, due to the pervasive and broad negative pledges in most medium-term Portuguese bonds, any priming Troika bailout is impossible without providing matching collateral for everyone else under UK indenture bonds!

Former member of the Bundesbank and the ECB: The case of Greece is hopeless, a fiscal union won’t work, and they all know it.

At some point, the market will force the issue of whether or not the ECB is going to be monetizing everything or not. Germany, having already seen the ultimate outcome of monetization (Weimar) has already made it clear that it will not tolerate this.

Successive plans to restore confidence in the euro area have failed. Proposals currently on the table also seem likely to fail. The market cost of borrowing is at unsustainable levels for many banks and a significant number of governments that share the euro. In three short sentences, the Peterson Institute for International Economics' (PIIE) Simon Johnson introduces the clear and present danger that Europe has become in a comprehensive article on the deepening European crisis. The circular nature of the realization of sovereign credit risk realities and the subsequent effective insolvency of banks exacerbates a credit crunch and exaggerates problems in the real economy - most specifically in the periphery. Johnson outlines five measures that are needed to enable the euro area to survive but the big bazooka of up to EUR5tn just for the PIIGS is what the PIIE senior fellow fears as the ECB is pushed down a dangerous path. The coordination of 17 disaparate nations leaves the former IMF man greatly concerned as the unique nature of this crisis leaves "four economic, social, and political events as possible causes of systemic collapse with each at risk of occurring in the next weeks, months, or years and these risks will not disappear quickly." As European sovereign bonds are now deeply subordinated claims on recessionary economies, it is no surprise that Johnson ends by noting that Europe's economy remains in a dangerous state.

I warned on Greece 2 years ago, and it seems to have come to fruition. This is who's next....

Just a week over the last time S&P said Greece would likely default any second, it reminds us once again why we should care.

• GREECE IN ALL LIKELIHOOD WOULD QUALIFY AS A DEFAULT: CHAMBERS
• S&P'S CHAMBERS SAYS IT'S NOT GIVEN THAT GREECE DEFAULT WOULD HAVE DOMINO EFFECT IN THE EURO ZONE

Perhaps just as irrelevant if notable is that S&P basically said just that back on May 9, 2011. As for Greece, it is a given that if the country proceeds with CACs it will default. Period. And yet that is just what will happen. However a far bigger question, as we touched on yesterday, is what happens next, when Portugal decides to follow the same framework of "deleveraging" only to find that courtesy of having strong creditor protection bonds it can't? Or when the Troika figures out that due to strong negative pledges, the country's balance sheet can not be primed and thus subordinated, and thus is ineligible for secured financing. And what happens when Europe realizes that Portugal is ineligible for saving in the conventional sense? Or Spain? and so forth.

There was a time, about 4 weeks ago, when the overnight session was assumed by default to mean lower futures just because it was "the time of Europe." Then markets took one glimpse at the ECB's balance sheets and realized it had grown by more in 6 months than the Fed's during all of QE2, and decided that the central bank will not let the continent fail, and despite how ugly the European interbank market continues to be, Europe was ironically a source of optimism, no matters how ugly the actual news. In other words, a carbon copy of January 2011. Alas, January 2011 ended, and so is the currency phase of Risk On on everything European. Which explains the shift in overnight sentiment. As Bloomberg explains, the First Word Cross Asset Dashboard shows sentiment retracing from early European session rise, with commodities, FX, equities lower after Greek debt negotiations hit snag, according to Bloomberg analyst TJ Marta. EU finance chiefs balked at private investors’ offer of 4% coupon for new Greek bonds; EU wants lower; IIF’s Charles Dallara to hold press conference at 8:30am EST; EU equity indexes lower, led by OMX -1.6%; U.S. futures moderately lower, led by S&P -0.5%; US$ outperforming on risk aversion; Commodities generally modestly to moderately lower. Finally both Portugal, and thus Spain, are once again back on the radar screen. Only this time the Greek "deleveraging" model will not apply, as Zero hedge first noted, and as MUFJ picked up on in its overnight note: "It would likely be more difficult for “Portugal to restructure its private-sector debt than for Greece,” Bank of Tokyo-Mitsubishi UFJ’s Lee Hardman says, without necessarily noting where he got the idea. A higher share of Portugal’s outstanding debt is governed by English law which offers greater protection to creditors vs 90% of Greek government bonds covered by local law. Finally, Hardman says that Eurozone lacks a credible firewall to ensure contagion from eventual default in Greece. That may be the case until the ECB does some gargantuan LTRO on February 29, as those in the know already expect.

Back on December 30, we noted that a little known name in the US, but very well known in Europe, PetroPlus is having significant solvency issues as banks froze a $1 billion revolver. Less than a month later the situation has proceeded to the next evolutionary step, as Europe's largest refiner by capacity has announced it will file for bankruptcy protection. And while operations should not be impacted, the fact that this comes just as Europe imposes an oil embargo on Iran, virtually guarantees that the continent's gasoline prices, already among the highest in the world are likely to set off even higher, paradoxically even as end-market demand is at lows. The bankruptcy will also guarantee that European initial jobless claims will plunge, especially if the BLS opens a Brussels office and applies its own very unique brand of "logic" to Europe.

Remember when Europe was fixed, if only for a few weeks? Those were the times, too bad they are now officially over. EURUSD is back under 1.30 in thin volume because even as we "shockingly" find that, no, Greece did not have the "upper hand" since Greek bondholder negotiations just broke down (and that over the matter of a cash coupon delta between 3.5% and 4.0%, which implicitly means that from a bondholder IRR perspective, when taking a 15 cent EFSF Bill into consideration, the hedge fund community fully expects the country to be in default even post reorg in at about two years). But it is that "other" European country which was recently junked by S&P (causing the 10 year to soar to new records), that is now the focus point of (re)bailout concerns. Reuters reports: "The euro nudges down some 20 pips to $1.2995 in thin, illiquid trade with Tokyo dealers citing renwed fears Portugal may need a second bailout. Undermining the glow of Lisbon's achievements in reforming the country's labour market is the rapidly rising market concern that it is the next potential candidate to default in the euro zone after Greece -- a point that is fast becoming clear as Athens approaches the end of its debt restructuring talks." And here is the paradox: if Greece succeeds in persuading the ad hoc creditors to accept a 3.5% coupon, which it won't absent cramdown and CDS trigger, Portugal will immediately if not sooner proceed with the same steps. There is however, a problem. Unlike Greece, where the bulk, or over 90%, of the bonds are under Local Law, and thus have no bondholder protections (a fact about to be used by Greece to test the legal skills of asset managers who can retain the smartest lawyers in the world and generate par recoveries on their bonds in due course), in a generic Portuguese Euro Medium Term note Programme prospectus we find the following...

Hank Paulson started the extortion racket. Greek prime ministers practice it weekly. Now Christine Lagarde jumped in too. Taxpayers please step up to the plate. Or else—

Amid the lowest NYSE volume of the year (-24% from Friday - OPEX) and pretty much the lowest non-holiday-period volume in 9 years based on Bloomberg's NYSEVOL data, ES (the e-mini S&P 500 futures contract) ended the day almost perfectly unchanged underperforming 5Y investment grade and high-yield credit indices on the day as both moved to contract tights (their best levels since early August last year) even as their curves flattened. There has been lots of chatter about how the steepening of the short-end of the European sovereign bond markets (Italian 2s10s for instance) is a sign that all-is-well in the world again, well unfortunately the flattening of the short-end of US IG and HY credit markets sends a rather less positive signal than headlines might care to admit (as jump risk in the short-term remains 'high' relative to bullish momentum in the medium-term). At the same time, vol markets are showing extreme levels of short-term complacency as 1m VIX is almost at record low levels relative to 3m VIX (and diverging today from implied correlation). Broadly speaking , risk assets rallied into the US day session open only to sell off into the European close (with Sovereigns leaking back the most). The afternoon saw risk rallying as the path of least resistance appears to be up all the time there is no news. Stocks ended well off their highs of the day, in line with broad risk assets, as TSY yields rose 3-4bps higher, Oil and Copper 1.5-1.75% higher (outperformed) while Silver and Gold hugged USD weakness at around a 0.5% gain from Friday's close.

So… are stock investors smarter than everyone else… or are they just gunning the market on low volume yet again regardless of reality? We’ll find out this week once we get past the Fed FOMC and Europe’s decision on Greece.