The markets seem to think we live in a largely riskless world. Are risk assets now riskless assets or are they risk assets disguised as riskless?
Another day, another melt up overnight wiping out all the post-Moody's weakness, this time coming courtesy of Europe, where following the French downgrade, the EURUSD filled its entire gap down and then some in the span of minutes following the European open, when it moved from 1.2775 to 1.2820 as if on command. And with the ES inextricably linked to the most active and levered pair in the world, it is is no surprise to see futures unchanged. It appears that the primary catalyst in the centrally planned market has become the opening of said "market" itself, as all other news flow is now largely irrelevant: after all the central planners have it all under control.
As we warned here first, and as the sellside crew finally caught on, while the key macro event this week is the US presidential election, the one most "under the radar" catalyst will take place in Greece (currently on strike for the next 48 hours, or, "as usual") on Wednesday, when a vote to pass the latest round of Troika mandated austerity (too bad there is no vote to cut corruption and to actually collect taxes) takes place even as the government coalition has now torn, and there is a high probability the ruling coalition may not have the required majority to pass the vote, which would send Greece into limbo, and move up right back from the naive concept of Grimbo and right back into Grexit. Which is why the market's attention is slowly shifting to Europe once more, and perhaps not at the best time, as news out of the old continent was anything but good: Spain's October jobless claims rose by 128,242, higher than the estimated 110,000 and the biggest jump in 9 months, bringing the total number of unemployed to 4,833,521, a rise of 2.7%, according to official statistics released Monday. This means broad Spanish unemployment is now well above 25%. In the UK, the Services PMI plunged from 52.2 to 50.6, which was the lowest print in nearly two years or since December 2010, and proved that the Olympics-driven bump of the past few months is not only over, but the vicious snapback has begun.
From Egan-Jones, which downgraded the US for the first time ever last July, two weeks ahead of S&P: "Up, up, and away - the FED's QE3 will stoke the stock market and commodity prices, but in our opinion will hurt the US economy and, by extension, credit quality. Issuing additional currency and depressing interest rates via the purchasing of MBS does little to raise the real GDP of the US, but does reduce the value of the dollar (because of the increase in money supply), and in turn increase the cost of commodities (see the recent rise in the prices of energy, gold, and other commodities). The increased cost of commodities will pressure profitability of businesses, and increase the costs of consumers thereby reducing consumer purchasing power. Hence, in our opinion QE3 will be detrimental to credit quality for the US."
Speculation that the ECB might, as part of its proposed bond-buying programme, announce an interest rate target (or band) for short-dated peripheral government bonds has sparked a further rally in Spanish and Italian bonds in the past week. Such an 'unlimited' move is a complete volte face from past policy, but Daiwa's research team believes hopes that the announcement of an interest rate or spread target would spare the ECB the pain of having to intervene in the markets at all are flawed in our view. For the ECB to credibly communicate an interest rate or spread target requires it to quantify the excess risk premia. Given the inherent inaccuracy (or falsehoods) of the forecasts underlying these estimates, the ECB would risk having to review these targets regularly, leaving markets uncertain about their permanence. The success and the sustainability of any future ECB interventions will ultimately depend on the peripheral governments’ ability to meet the conditionality required - and we know how that has ended up - always and every time.
Peugeot, Its Record High Default Probability, And A Brief Primer On Corporate Viability Under SocialismSubmitted by Tyler Durden on 07/17/2012 12:41 -0500
With central bankers dominating the airwaves, and the only thing that matters is who prints where and how much, most can be forgiven to have missed one of the more important micro developments in the past few weeks: namely the case study of emblematic French automaker Peugeot, which just happens to be Europe's second largest, and its Credit Default Swaps, which have doubled in the past 4 months, to a record high spread of 813 bps, which means the probability of default for the company has nearly doubled from 29% to 52% in a few short months. Yet what is it about Peugeot that is interesting - well the fact that the biggest spike in its default risk has taken place in the last few days, which have seen a nearly 100 basis point spike. The catalyst: "French President Francois Hollande, elected in May after pledging to block a “parade of firings,” said July 14 he would lean on Peugeot to rework the plan intended to stem losses and trim production capacity. The government will report the findings of a review later this month, as well as measures to prop up the French auto sector." The problem is that this type of state intervention into corporate viability and profitability is precisely what precipitates wholesale bankruptcy. And this is precisely what the bond market has reacted to. Because while Hollande is doing all he can to pander to populism, and to recreate America's epic failure involving GM, the reality is that by enforcing what he thinks is "right" and "fair" dooms not only Peugeot and its 200,000 employees, but millions of upstream and downstream workers.
And so, the little rating agency that could, just gave Spain the triple hooks, downgrading the country from B to CCC+, negative outlook. As a reminder, the Uganda credit rating is B: it sure is no Spain.
Bank Regulatory Capital has been in the news a lot recently - between the $1+ trillion Basel 3 shortfall, the Spanish banks with seemingly their own set of capital issues, or JPM's snafu. There has been a lot of discussion about Too Big To Fail (“TBTF”) in the U.S. with regulators demanding more and banks fighting it. After JPM's surprise loss this month, the debate over the proper regulatory framework and capital requirements will reach a fever pitch. That is great, but maybe it is also time to step back and think about what capital is supposed to do, and with that as a guideline, think of rules that make sense. Specifically, regulatory capital, or capital adequacy, or just plain capital needs to address the worst of eventual loss and potential mark to market loss. Hedges are once again front and center. The only "perfect" hedge is selling an asset. This "hedge" is also a trade. The risk profile looks very different than having sold the loan and the capital should reflect that.
Even as the SEC is hell bent on destroying Egan Jones as a rating agency, in the process cementing its status as an objective, independent, and honest third party research entity, the firm is just as hell bent on milking its still existing NRSRO status for all it's worth. Because while Egan Jones was the first entity to cut Spain two weeks ago, only to be followed by Spain, it just did so again minutes ago.
One of the big stories of the week was that Morgan Stanley “reduced” its exposures to Italy by $3.4 billion mostly by unwinding some swaps they had on with Italy. Morgan Stanley booked profit of $600 million on the unwind. The timing couldn’t have been worse coming on the heels of the “Darth Vader” resignation at Goldman Sachs, attracting more attention to profits on derivatives trades was the last thing the investment banks need. Much of the outrage seems misplaced though. In this case, don’t blame Morgan Stanley, blame Italy, and be very afraid of what else Italy has done.
Unlike other, more humorous instances, such as Byron Wein and his 10 endlessly entertaining year end forecasts, some banks take the smarter approach not of predicting what will happen, because only idiots think they have any clue what tomorrow may bring with any sense of certainty, especially under global central planning - a regime that is by definition irrational, but instead of stating what would be a surprise to a base case forecast. And with "surprise" now the new normal, it would be prudent to anticipate what to the status quo may represent as fat tails in the coming year. Especially since even UBS now mocks the Wall Street consensus, and the traditional upside biad: "Let’s face it: Bottom-up consensus earnings forecasts have a miserable track record. The traditional bias is well known. And even when analysts, as a group, rein in their enthusiasm, they are typically the last ones to anticipate swings in margins." Which is why, with that advance mea culpa in hand, we bring to readers the Ten Surprises for 2012 from UBS' Larry Hatheway: "At the end of each year, in our final strategy note, the global asset allocation and global equity strategy teams join up to consider possible surprises for investors in the year ahead. Inside, we briefly describe ten such outcomes, and also provide a review of how last year’s surprise candidates fared." For those pressed for time, here is the full list: i) The consensus of bottom-up earnings estimates is right; ii) Financials outperform; iii) The euro rallies; iv) Oil prices fall below $70/barrel; v) Sovereign default outside the Eurozone; vi) Rising Treasury yields; vii) An Italian sovereign upgrade; viii) EU or EMU disintegration; ix) Fewer than five governments switch hands and, last but not least, x) Britain does Great at next summer’s Olympics. Let's dig in.
As investors proceed happily through the forest that is this week's potentially epic fail, Nomura asks the question on every European is asking - What's in my wallet? Investors holding EUR-denominated assets and obligations face potential redenomination of contracts into new currencies. Based on the current misalignment of the real exchange rate and future inflation risk estimates, the fixed income group sees very material depreciation risks in most of the periphery and one surprise but critically the research enables risk-reward trade-offs on intra-European trades. This potential 'fungibility' issue is exactly what we described last week as a potential driver of stress and Nomura's work provides a framework for quantifying that relative stress. That said, Nomura adds the usual disclaimer: "For full disclosure, we are not regarding the break-up scenario as our central case." But... there is always a But. "But it has become a real risk over the last few months, and a possibility for which investors should now plan."
Are The Conservative Dutch Immune To Contagion? Are You Safe During An Earthquake Because You Keep You Keep Your Shoes Tied?Submitted by Reggie Middleton on 11/17/2011 15:35 -0500
This collapse will come in waves, and the CRE wave hasn't even started yet. When it does come, it will crash against the Sovereign defaults and rate storms to combine with a derivative malaise that will collapse much of the banking system. Ok, now for the bad news...
Last time when Jefferies' (which is not MF Global although it is just as a big question market in the TBTF category, and as a reminder is not a Bank Holding Company, being the last pure play investment bank left out there) stock had a $9 handle, it triggered a -20% circuit breaker and forced a short covering squeeze. This time it is far more methodical. At this time Leucadia is underwater on both of its recent purchases, all past and future Jefferies press releases have been priced in and will be irrelevant in the future, and Handler only has half of his original gross sovereign book left to sell (into a bidless market and thus generating more major P&L losses).
Unless something changes in the next 24 hours, I expect we will hear more and more talk about default, not only of Greece but of other countries and of banks. Just in case that happens, here is some information that may help you make good decisions. There will be lots of chatter about the “likelihood of default” the CDS market is implying, but although it can be a useful statistic, it can also be very misleading. Before jumping into trades based on erroneous assumptions, it is worth spending a few minutes reading this. If all it does is confuse you, maybe that is a good thing in itself, because you won’t take a headline about default probability as fact.