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Greece, Portugal, And LTRO





Greek debt negotiations continue. They do seem less afraid of triggering a Credit Event (and some even think it could be a good thing - as we have argued for some time). Estimates are that only EUR100bn of Greek bonds are actually in hands that will follow the IIF recommendations but it is clear that the negotiations are getting tricky (actually they have always been tricky, it’s just that until recently no one was actually negotiating).  The IMF seems insistent that they won’t provide new money without a high participation rate in an exchange with worse terms than many thought.  There are questions about whether the ECB should participate or not and this is in direct opposition to the IMF's need for very high participation and while losses could be hidden by off-market trades to the EFSF, there will be lots more political bickering if that were the case. More importantly, we think, is the Portuguese debt problem, which is much smaller than that of Greece, but should be attracting more attention as we note Portuguese debt hitting new lows (especially post LTRO) unlike the rest of Europe's exuberance.

 
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Daily US Opening News And Market Re-Cap: January 27





EU stock futures have come off the initial lows at the open today following news that EU’s Rehn expects a PSI conclusion to be reached over the weekend, however this news comes amid the IIF’s offer to private bondholders of a 70% haircut. Further Greek PSI talks are expected later in the session following a meeting between IIF’s Dallara and Greek PM Papademos in Athens at 1630GMT. Euribor 3-month rate fixing continues to decline, however the pace at which the rates are falling is slowing, showing a fall of 0.005% compared with a 0.013% fall at this time last week. The slowing speed of decline has prompted hesitancy in financial markets, pushing the Euribor strip downwards. Further evidence of this impact comes from Portuguese bond yields, which today hit record Euro area highs. Spanish and Italian spreads have tightened this morning following market talk that the ECB were buying Spanish debt through the SMP in the belly of the curve. The Italian BOT auction this morning came in well-received following strong domestic demand, with 6-month yields falling from previous auctions.

 
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Overnight Mood Mixed Following Italy Bill Auction, Greek Uncertainty





Somehow the fact that the PIIGS can issue Bills (sub 1-year debt) in an environment in which both the ECB and the Fed have made any debt investment under 3 years risk free is taken as a positive sign. But in a continent starved for even the most optically irrelevant good news, this may be all it gets, which it did last night after Italy auctioned off €8 billion 182 bills at a 1.97% rate, the lowest since May. A far more relevant question is where peripheral debt with a maturity greater than 3 years, and thus with implicit risk, would price. But for now at least some of the banks appear to be dipping their toe into a very short-term carry trade, with ECB deposits declining from €484.1 billion to €464.8 billion overnight. Whether or not this is on the back of the assumption that a Greek default is contained remains to be seen: it would be truly laughable if Europe believes things are ok and thus underutilizes the next LTRO in one month only to find itself with a several trillion euro shortfall 3 weeks later. Yet this, being Europe, is the most likely outcome. Offsetting Bill issuance optimism is the ongoing uncertainty over the outcome of the Greek PSI talks, which for now at least have stalled with the cash coupon being the straw man sticking point. The truth is that if hedge funds want a default to proceed with international litigation arbitrage, that most lucrative of hedge fund strategies, they will get a default. Everything else is irrelevant. Below is Bloomberg's summary of how the newsflow is affecting markets.

 
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Frontrunning: January 27





  • Greek Debt Wrangle May Pull Default Trigger (Bloomberg)
  • Italy Sells Maximum EU11 Billion of Bills (Bloomberg)
  • Romney Demands Gingrich Apology on Immigration (Bloomberg)
  • China’s Residential Prices Need to Decline 30%, Lawmaker Says (Bloomberg)
  • EU Red-Flags 'Volcker' (WSJ)
  • EU Official Sees Bailout-Fund Boost (WSJ)
  • EU Delays Bank Bond Writedown Plans Until Fiscal Crisis Abates (Bloomberg)
  • Germany Poised to Woo U.K. With Transaction Tax Alternative (Bloomberg)
  • Ahmadinejad: Iran Ready to Renew Nuclear Talks (Bloomberg)
  • Monti Takes On Italian Bureaucracy in Latest Policy Push to Revamp Economy (Bloomberg)
 
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Juncker Breaks Away From Propaganda Pack, Says Euro Default Will Lead To Contagion





That Europe has been unable to do the simplest thing, and come to a conclusion in its negotiation with Greek creditors, now running into its six month, is not very surprising. After all this is Europe, where nothing gets done before the deadline, only in the case of Greece the deadline also means the risk of runaway contagion. And as of today there are about 53 days left before the March 20 Greek D-Day. Yet the one thing European should at least be able to do is to have their story straight on what happens once Greece defaults. If nothing else, to show solidarity for optics' sake. Alas, it can't even do that. Because just overnight we have two diametrically opposing stories hitting the tape. On one hand we have Spanish economic minister Luis de Guindos telling Bloomberg TV in Davos that the euro region could withstand a Greek default. This is very much in line with the Jamie Dimon line of thinking that there will be limited fallout. Yet on the other hand, it is that perpetual bag of hot air, Europe's very own head propaganda master Jean Claude Juncker, who ironically told Le Figaro that a Greek default must be avoided at all costs as it would lead to Contagion (read tipping dominoes all over the place). Too bad that both Fitch and S&P said that a Greek default at this juncture is inevitable. And while Juncker's statement in itself is absolutely true, the fact that discord is appearing at the very core of European propaganda - the one place it can afford to stay united until the very end - is troubling indeed. Especially since Juncker also told Le Figaro that Germany can not be asked to do everything alone. Is that a quiet request for the Fed to keep bailing out Europe since the ECB apparently has no interest in doing so?

 
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Guest Post: Gold Bonds: Averting Financial Armageddon





It seems self-evident. The government can debase the currency and thereby be able to pay off its astronomical debt in cheaper dollars. But as I will explain below, things don’t work that way. In order to use the debasement of paper currencies to repay the debt more easily, governments will need to issue and use the gold bond. The paper currencies will not survive too much longer. Most governments now owe as much or more than the annual GDPs of their nations (typically far more, under GAAP accounting). But the total liabilities in the system are much larger. The US dollar game is a check-kiting scheme. The Fed issues the dollar, which is its liability. The Fed buys the US Treasury bond, which is the asset to balance the liability. The only problem is that the bonds are payable only in the central bank’s paper scrip! Meanwhile, per Bretton Woods, the rest of the world’s central banks use the dollar as if it were gold. It is their reserve asset, and they pyramid credit in their local currencies on top of it. It is not a bug, but a feature, that debt in this system must grow exponentially. There is no ultimate extinguisher of debt. In reality, stripped of the fancy nomenclature and the abstraction of a monetary system, the picture is as simple as it is bleak. Normally, people produce more than they consume. They save. A frontier farmer in the 19th century, for example, would dedicate some work to clearing a new field, or building a smokehouse, or putting a wall around a pasture so he could add to his herd. But for the past several decades, people have been tricked by distorted price signals (including bond prices, i.e. interest rates) into consuming more than they produce. In any case, it is not possible to save in an irredeemable paper currency.  Depositing money in a bank will just result in more buying of government bonds.  Capital accumulation has long since turned to capital decumulation... I propose a simple step. The government should sell gold bonds. By this, I do not mean gold “backed” paper bonds. I mean bonds denominated in ounces of gold, which pay their coupon in ounces of gold and pay the principal amount in ounces of gold. Below, I explain how this will solve the three problems I described above.

 
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On Jamie Dimon's Track Record Of Predicting Greek Outcomes





The US market appears modestly enthused by earlier remarks from Jamie Dimon (who ironically is of Greek descent) who told CNBC that "The direct impact of a Greek default is almost zero."  Note the phrase "Greek default" because it takes us back to that long ago June of 2011 when Jamie Dimon was again giving predictions about events in Greece. In this case, the summary goes to Bloomberg, which penned a piece titled: "JPMorgan’s Dimon Says Greece Won’t Default, Australian Reports."  That's not all. He added the following, from The Australian: "I don't think they will default. I think the more likely outcome is that the European authorities and politicians will find a way to keep Greece from defaulting." It gets better: "It does reverberate because a lot of European banks own Greek debt and investors hold European bank debt. From all of the numbers I have seen, the European banks have enough capital to withstand it." We can only suppose that all the numbers probably excluded the $100 billion in FX swaps that the Fed conducted days after it told Congress it would not bail out Europe, or the OIS+100 to OIS+50 cut in interbank lending rates, because the banks had "enough capital" oh yes, and that €490 billion LTRO, that kinda, sorta indicates that the European banks did not actually have enough capital to withstand either "it" or pretty much any of the events in Q4 of 2011.

 
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Rumors Start Early: Greek Creditors "Ready To Accept" 3.75% Cash Coupon But With Untenable Conditions





As a reminder, the primary reason why the Greek PSI deal "officially" broke down last week, is because the European Fin Mins balked at the creditor group proposal of a 4%+ cash coupon. So now that creditor talks, which incidentally don't have a soft deadline so they can continue indefinitely, or until the money runs out on March 20, whichever comes first, have resumed we already are getting the first totally unsubstantiated "leaks" that negotiations are on the right path. As various US wires reported overnight, including DJ, BBG and Reuters, citing completely "unbiased" and "unconflicted" local Greek media, "Greece's private creditors are willing to improve their "final offer" of a four percent interest rate on new Greek bonds in order to clinch a deal in time to avert a messy default, Greek media said on Thursday without quoting any sources. With time running short ahead of a major bond redemption in March, private creditors are now considering an average coupon of around 3.75 percent on bonds they will receive in exchange for their existing investments, the newspapers wrote." All is good then: the hedge funds will make the proposal to Europe and Europe will accept, right? Wrong. "Another daily, Kerdos said participation of public sector creditors including the ECB in the swap deal was a pre-condition for that offer, which it said could bring the average interest rate to about 3.8 percent." And that as was reported yesterday is a non-starter. So in other words, the latest levitation in the EURUSD started at about 4am Eastern is nothing but yet another rumor-based attempt to ramp up risk. Only this time the rumor is actually quite senseless, which probably explains why even the market which has been completely irrational lately, has seen the EURUSD drop from overnight highs. That said, expect this rumor to be recirculated at least 5 more times before end of trading.

 
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Market Now Pricing In $770 Billion Increase In Fed Balance Sheet





As we have pointed out previously, the primary if not only driver of relative risk returns (because in a world of relative fiat value destruction, it is all relative, except for gold which is revalued relative to all on a pro rata basis), will be who of the big two - the Fed and the ECB - can print more. And up until now, at least since the end of December when the market "suddenly" realized that the ECB's balance sheet has soared to unseen records, the consensus was that it was the ECB that would be the primary source of easing. Especially when considering that there is another ~€500 billion LTRO due on February 29. Yet today's rapid reversal in the EURUSD, driven by Bernanke's uber-dovish comments suggest that something has changed and that the Fed is now expected to ease substantially. How much? For that we look to the latest balance sheet cross-correlation, where if we go by simple correlation, the market is now pricing in (based on the EURUSD cross ratio) that the relationship of the two balance sheets will rise from a multi year low of 1.08 as of a few days ago to 1.15, at least based on the rapid move in the EURUSD higher as can be seen in the chart below. Indicatively, the actual value of the two balance sheets is €2.706 trillion for the ECB and $2.92 trillion for the Fed (or a 1.08 ratio). So now that the EURUSD has risen as high as it has, it implies that the pro forma "priced in" ratio is about 1.15. But wait: one should also factor in the fact that the ECB's balance sheet will rise by at least another €500 billion in just over a month, which will bring the ECB's balance sheet to €3.2 trillion. Which means that to retain the 1.15 cross balance sheet relationship, the Fed's own balance sheet will have to rise to $3,687 billion, or a whopping $767 billion increase!

 
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Less Than Two Months Ahead Of The Greek D-Day, Rogoff Says "Europe Is Clearly Not Ready For A Greek Default"





It is less than two months until the Greek March 20 D-Day past which there is no more can-kicking? Check. Creditor negotiations which are going "so well" they may collapse at any given moment, have had their deadline extended indefinitely just because, and in which hedge funds now have every option to put the country into bankruptcy? Check. You would think Europe is prepared for this contingency right? Wrong. Per Ken Rogoff (who together with Simon Johnson are two former IMF chief economists who have become some of the biggest bears in the world - what is it about not being shackled to one's salary, that allows one to speak the truth), Europe is "clearly unprepared for a Greek default", less than two months from the day when it very well may finally occur. He adds: "there's going to be an endgame to this and it's not going to be pretty.... If you are just printing money and you are not making fundamental change you either lose money and you will have to recapitalize with the ECB or you will get inflation." And it gets worse: "it's not just Greece. You are going to see other restructurings before this is over." He ends with what we have been saying since mid-2011: "Once you set the precedent then say Portugal are going to say 'hey, look how much you gave Greece. How come we don't get the same?'." Unfortunately, the fact that Portuguese bondholders are far more protected than Greek ones will make an in kind restructuring virtually impossible. Which is something else for Europe to ponder as it prepares for the only key catalyst event between now and March 20 - the February 29 LTRO, which as Credit Suisse already suggested could be up to a ridiculous €10 trillion to firewall not only Greece and Portugal, but all the other PIIGS. Intuitively, this does make a lot of sense.

 
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Why The LTRO Is Not A "Risk On" Catalyst





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.

 
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Guest Post: President Obama's State of the Union: Ten Skirted Issues





 

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.

 
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European Stress Reemerges As Risk Off Epicenter Following Portugal Admission It Needs €30 Billion Bailout





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!

 
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