The divergence between credit and equity marksts that we noted into the European close on Friday closed and markets sold off significantly. European sovereigns especially were weak with our GDP-weighted Eurozone credit risk index rising the most in six weeks. High beta assets underperformed (as one would expect obviously) as what goes up, comes down quicker. Stocks, Crossover (high-yield) credit, and subordinated financials were dramatically wider. Senior financials and investment grade credit modestly outperformed their peers but also saw one of the largest decompressions in over a month (+5.5bps today alone in the latter) as indices widen back towards their fair-values. The 'small moderation' of the last few weeks has given way once again to the reality of the Knightian uncertainty Europeans face as obviously Portugal heads squarely into the cross-hairs of real-money accounts looking to derisk (10Y Portugal bond spreads +224bps) and differentiate local vs non-local law bonds. While EURUSD hovered either side of 1.31, it was JPY strength that drove derisking pressure (implicitly carry unwinds) as JPYUSD rose 0.5% on the day (back to 10/31 intervention levels). EURCHF also hit a four-month low. Treasuries and Bunds moved in sync largely with Treasuries rallying hard (30Y <3% once again) and curves flattening rapidly. Commodities bounced off early Europe lows, rallied into the European close and are now giving back some of those gains (as the USD starts to rally post Europe). Oil and Gold are in sync with USD strength as Silver and Copper underperform - though all are down from Friday's close.
Remember back in long distant memories (from a month ago) when all the chatter was for the US to decouple from Europe as the former (US) macro data was positive and a 'muddle-through' consensus relative to the European debacle took hold. Since 12/14, European markets have significantly outperformed US markets (both broadly speaking and even more massively in financials - which is impressive given the strength in US financials). Furthermore, we saw a decoupling of correlation (de-correlating) between EUR and risk as a weaker EUR was positive for risk as USD strength showed that the world was not coming to an end (and Europe was 'contained'). Well things are changing - dramatically. EUR and risk were anti-correlated for the first two weeks of the year and since then have re-correlated. The last few days have seen EUR weakness (Greek PSI and Portugal fears) coincident with risk weakness (ES and AUD lower for instance as US macro data disappoints and a dreary Fed outlook with no imminent QE). Given the high expectations of LTRO's savior status, European financials have been the big winners (+20% from 12/14 and +15% YTD in USD terms) compared to a meager +12% and +8.8% YTD for US financials - with most of the outperformance looking like an overshoot from angst at the start of the year in Europe (which disappeared 1/9). With EUR and risk re-correlating (and derisking very recently), perhaps it is time to reposition the decoupling trade (short EU financials vs long US financials) though derisking seems more advisable overall with such binary risk-drivers as Greek PSI failure, Portuguese restructuring (yields have crashed higher), and the Feb LTRO pending (which perhaps explains the steepness of vol curves everywhere).
Amid the best start of the year for the S&P 500 since 1987, Nic Colas of ConvergEx offers some deep thoughts on how behavioral finance concepts can help us understand the dichotomy between last year's derisking and this year's rerisking in terms of market participant psychology. Between delving into whether a short-sharp or long-slow colonoscopy is 'preferable' Nic reflects (antithetically) on 10 bullish perspectives for the current rally and how the human mind (which still makes up maybe 50% of cross-asset class trading if less in stocks) processes discomfort in very different ways. Critically, while it sounds counter-intuitive to him (and us), focusing on the pain of recent volatility is actually more conducive to investors' ability to get back on the horse especially when the acute pain is ended so abruptly (intervention). As studeis have found, "subjects who actually focus on a painful experience while it is happening are more willing to immediately undergo further pain than those who performed some distracting task"
Friday was the most active day in ES (the e-mini S&P 500 futures contract) since 12/16 and today saw volume once again surge in the futures market as it tested 1300 for the first time since 7/28. However, NYSE stock volume (which managed a very late-day spurt on Friday) was dismal once again today (for instance -25% from Friday with 3 minutes to go) with another extremely late jump taking it back to 'normal' for the year so far (but still dramatically low compared to previous year 'norms'). Stocks rallied on China GDP and an optically decent Spanish auction but as we moved into the European close, risk started to leak off and accelerated in the afternoon as IMF headlines, LTRO rumors, and IIF/PSI chatter hit though more expansive ECB rumors seemed to stall losses at last night's ES re-open levels. ES is down very marginally from Friday's late-day ramp close and credit outperformed today (though HYG hung in with stock's weakness) as financials underperformed. The majors were the worst performers with Citi and BofA giving decent amount of YTD gains back. EUR stabilized post-Europe (after selling off into their close) with the USD (DXY) down 0.4% from Friday and GBP underperforming. In the face of the USD stability this afternoon, commodities were mixed with Oil spiking back over $100 (as NatGas was crushed), Copper leaking off but holding gains 2%-plus gains from Friday (China), as Silver and Gold lost their earlier gains (3% and 1.5% at best) to end around 0.75-1% better from Friday's close (still a double on USD weakness). Treasuries closed marginally lower in yield from Friday (1bps max) but were 4-5bps lower in yield from around the European close (as 2s10s30s slid also). Stocks closed well below broad risk assets as FX carry never really joined the derisking craze and oil's strength seemed divergent for now.
Following yesterday's extravaganza in European credit markets, which saw XOver (European high-yield credit) surge to highs year-to-date (wiping out a week's worth of leaking wider in one fell swoop), today's open suggested some follow-through but as macro data combined with France downgrade rumors (denied rapidly) sovereign and corporate credit markets sold off quite rapidly into the close. Interestingly, financials (senior and sub debt) managed to hold gains from yesterday's close as XOver and Main (Europe's investment grade credit index) along with the broad stock market lost ground to close near their lows (though well off yesterday's open still). EURUSD (holding under 1.27 at the EUR close) weakened fairly consistently after Spanish industrial output and German GDP did nothing to inspire and while sovereign spreads (Spanish and Italian mostly) were outperforming, as the French rumors hit, they sold off rapidly (France and Italy back to unchanged). As usual into the close there was a modest risk rally and sovereign spreads leaked modestly tighter (by around 6-9bps) with France underperforming but we did not see that bounce in corporate credit. The weakness in 'cheap-hedge' investment grade credit suggests risk appetite is not returning and decompression trades are back in vogue after yesterday's snap and perhaps a growing realization that no PSI agreement is looming anytime soon.
The S&P 500 closed practically unchanged today - recovering from decent selloff to a late-Europe-session low - amid volume that was over 30% lower than at the same time last year. Investment grade credit, the high-yield bond ETF HYG, and broad risk assets in general kept pace with ES (the e-mini S&P 500 futures contract) but high yield credit (tracked by the HY17 credit derivative index) outperformed considerably - moving to its best levels since late October. This disconnect appeared as much driven by technicals from HY-XOver (Long US credit vs Short EU credit) and HYG vs HY17 (a high premium-to-NAV bond ETF vs relatively cheap high yield spread index) trades as it was a pure risk-on trade. Elsewhere, the USD retraced only marginally the earlier gains of the day (with EUR hanging under 1.2950 by the close) as Treasury yields jumped 5-7bps more (30Y +14bps on the week now) as we can't help but notice the correlation between TSY weakness and EUR strength for a few hours this afternoon (repatriation to pay up for tomorrow's French auction?). Commodities were very mixed with Copper sliding notably (decoupling from its new friend Gold which rose and stabilized this afternoon over $1610) as Oil pushed higher all day (over $103) on Iran news and Silver leaked back this afternoon (under $29.5).
High yield credit spreads were the first to show signs of disappointment this morning but this seemed more due to technical relationships in the CDS index market as HYG stormed ahead with stocks. Commodities had notably cracked early on this morning and were trending lower already as we broke the FT rumor of broad S&P downgrades in euro sovereigns. All markets reacted instantly, no questions asked, and while IG, HY, and the S&P dropped together, it was the drops in commodities as the USD strengthened that were optically of the highest magnitude. TSYs also instantly reacted and were another major outperformer - drastically beating Bunds on the day. ES (the e-mini S&P 500 futures contract) was much less volatile than broad risk assets overnight but as Europe opened markets started to move closely together in a positive risk mode. CONTEXT (the broad risk basket) was less positive that ES in the US morning session but as we sold off and closed they were closely in sync once again as every member of the basket was contributing to risk aversion. Financials outperformed but were well off their intraday highs as a sector with the majors closing mixed (e.g. BAC near lows and MS near highs) but we note that financials were the most net sold (especially the majors) in corporate bond land.
Some late day covering lifted 30Y TSY yields and EUR strengthened against the USD (European banks repatriating ahead of their open?) helping CONTEXT and elevating ES into the close. ES was on its own relative to credit though as it tore back up to try and regain VWAP.
The late day collapse in financials (thanks to Fitch's comments that seemed to wake up a sleeping equity market to the reality that credit has been screaming for weeks) helped drag equities (and HY debt) significantly lower. Most notably, amid a much higher than average volume day today, the dislocations of the last few days - that we have highlighted - have converged very rapidly this afternoon. ES significantly underperformed a broad basket of risk assets (CONTEXT) into the close as copper and oil gave back some of the day's gains. TSYs closed at low yields for the day - and 2s10s30s dropped significantly - as we warned it would have to sustain any sell-off as EURUSD tracked back towards its lowest levels of the day dragging DXY up to almost unchanged on the day (+1.7% on the week). On a longer-term basis, HY markets are priced for an S&P around 1190 currently but as HY also collapses wider, we will rapidly see the 'expected' S&P level drop further. Credit Anticipates and Equity Confirms is often cited by old-school credit market professionals - it seems once again that it is true. What is more evident, and discussed by Peter Tchir of TF MArket Advisors, is the morphing of the sovereign crisis into a banking system crisis as TPTB are unable to achieve anything of note.
So much for that Greek bailout plan. Greek CDS are now back at fresh all time highs as the market seems set on not only testing the EU's rescue resolve, but determined to get a fresh new bailout plan entirely. At last check CDS was just shy of 1,000 bps. The immediate catalyst is a Fitch report that says Greece risk has gone up and that the country will need further consolidation in 2011 and 2012. The broader catalyst is that the entire Greek credit market is completely dead (noi cash liquidity) and momentum trading has now arrived in CDS, which is the only place left to express a bearish stance on Greece. Should the spread onslaught continue, we expect all of Europe to follow Germany's example and immediately ban naked CDS shorts across the continent. Luckily, both China and India are now set to open CDS trading of their own.
Primary Dealers Net Treasury Long Positions Spike To 2010 Highs, Is There A Major Derisking Occurring In PD Portfolios?Submitted by Tyler Durden on 04/02/2010 23:55 -0400
The FRBNY has disclosed that Primary Dealer bond holdings have surged to 2010 highs, with net Coupon holdings of nearly $20 billion, and all Treasuries (including Bills) accounting for $36 billion. Contrast these holdings with the lows recorded in late January in which Coupons were a net short position of ($24) billion. Bills have also surged by $32 billion from ($15) billion on February 17, to $17 billion on March 24. Incidentally the accumulation has occurred even as recent Bill and Coupon auctions have been very week over the past two weeks. Are PDs becoming unable to offload auction allocations? After all this is capital that the Primary Dealers would much rather use to gun the stock market than be locked up in instruments yielding virtually nothing. Alternatively, if PDs are accumulating Treasuries, could this merely be an indication that they are reallocating capital away from equities and to USTs? Furthermore, Corporate bond holdings have dropped to near 2010 lows - is there a major shift away from risk (yes, that includes stocks) occurring under the surface? Altogether, PDs have spent $33 billion to cover shorts and accumulate fixed income instruments (including Agency and MBS) over the past month, and $60 billion Year To Date.
While the logic of how a US economy equates to a weaker dollar escapes those who think before pushing buttons and chasing trends, a glance at intraday currency performance indicate a substantial divergence in then Yen relative to the global "short-dollar" complex. Even as the euro, cable and OZ are powering higher, the yen has been caught in a weak zone, and has been declining all day long despite a stronger than expected US economy (yes, it does make sense...but don't think about it too hard). The oddity in the FX market is compounded when juxtaposed with Japan CDS levels: as of several minutes ago, Japan CDS was trading around 63 (white line on the chart below): a level last seen in April. This begs the question: what does someone know about Japan, and will this weakness translate into weaknesses for other non-US currencies?
It appears the market now only acts sensibly on big volume selloff days. The chart below is what one would expect, and what one would never see over the past 6 months.
Analyzing CDS open interest data since the March 6 lows demonstrates a troubling trend: there has been over half a trillion in net derisking across various industries, with financials leading the pack with over $130 billion. The global tightening in the CDS universes across all sectors is one direct consequence of this substantial shift to derisking.
Spreads were broadly wider in the US as all the indices deteriorated. Indices generally outperformed intrinsics (as we see high beta shorts selling index protection as hedges) with skews widening in general as IG's skew decompressed as the index beat intrinsics, HVOL outperformed but widened the skew, ExHVOL outperformed pushing the skew wider, XO's skew increased as the index outperformed, and HY's skew widened as it underperformed.