Earlier in the week we noted the spike in the cost of protecting against a technical default on US Treasuries. While well below "record" wides of 2011, a very interesting event has occurred. The cost of 1Y protection has surged higher than the 5Y protection - something we have only seen in the summer of 2011. However, this time it's different as the inversion is even greater than in 2011 - although not the most liquid instrument in the world - implying a greater chance (albeit a small probability) of a postponed payment in US Treasuries. As we noted previously, there is a way to trade this away from CDS-land.
As we head for the fateful FOMC announcement on September 18, US data have continued to moderate. Accordingly, the consensus seems to be converging on a $10-15 billion initial reduction in monthly purchases (mostly focused on the Treasury side and less so on MBS) with any 'tightening' talk tempered by exaggerated forward-guidance discussions and the potential to drop thresholds to appear more easy for longer, since as CS notes, assuming Fed policymakers have learned anything in the last four months, they must know that the markets view “tapering” as “tightening,” even though they themselves for the most part do not. Thus, they are going to need to sugar-coat the message of tapering somehow. But as UBS notes, political risks have grown and there is little clarity on the Fed's thinking about the housing market. This leaves 3 crucial surprise scenarios for the FOMC "Taper" outcome.
Something is way off: either the unemployment data is very much wrong and the real unemployment rate is far higher especially when normalized for the collapsing labor participation rate and the surge in part-time and temp workers, or the GDP calculation is incorrect and the economy is growing at a 4%+ rate. (It isn't). The scarier implication is that in addition to all other seasonally adjusted economic data points which have become painfully unreliable, daily Treasury tax receipts must also now be added to the docket of meaningless and corrupt data points. The question of just how the Treasury could explain a massive (and deficit boosting) cash discrepancy could only be answered if somehow the Fed is found to be parking cash directly into the Treasury's secret basement.
Earlier this morning the BoJ introduced a comprehensive change to its monetary policy framework. The asset purchasing program will be merged with the outright JGB purchase program (rinban), and JGB purchases will be expanded to include all maturities, including 40-year bonds. The pace of JGB purchases by the BoJ will be accelerated to ¥7trn per month from just under ¥4trn currently (on a gross basis), and purchases of ETFs and J-REITs will also be increased. The main operating target for money market operations was changed to a monetary base control (a quantitative index) from the uncollateralized overnight call rate.
Hey, this was cuddle time-week! A big Hug for everyone: Bonds, Equities, Periphery, ah, Periphery bonds! Greece…
As Super Mario said himself on Friday, albeit in a different context: “We were living in a Fairy World”. Cute way of spelling it out.
Fairies, rainbows, wonderful world… Let’s put IZ on the case!
"Somewhere Over The Rainbow" (Bunds 1,38% -6; Spain 5,30% -30; Stoxx 2580 +1,1%; EUR 1,301 +50)
In a world where flow is the new QE, this week is an alignment of the stars for long-end US treasury traders.
Today is the 2nd of the long-end UST auctions for the month of November. 16bln 30yrs will be sold to the market at 1pm...largest single DV01 event of the monthly cycle. Can we game the US Govt??
Will 24bln more 10yr notes be enough to satisfy this Risk Off demand? Enquiring minds want to know...
Romney's selection of Paul Ryan as his veep clarifies the policy debate (forcing typically middle-of-the-road voters to become more polarized to the size of government) into the November election and materially changes the odds of the fiscal cliff's resolution. As Morgan Stanley's Vince Reinhart notes, "by tying one side to an explicit plan for fiscal consolidation, the Ryan selection makes it much more likely that the campaign will focus on the appropriate role of the government. That is, the debate will be about the right level of federal expenditure relative to national income, the progressivity of the tax system, and the extent to which family incomes are protected on the downside by Washington, DC." Although theoretically the Ryan pick raises the chance of a benign, before-the-election resolution to the fiscal cliff 'issue', it also worsens the likely outcome if the legislative stand-off continues into 2013 - which the odds suggest is the case.
A week ago we brought you Elliott Management's summary opinion on US paper: "We Make This Recommendation To Our Friends: If You Own US Debt Sell It Now." Today, Bill Gross doubles down.
Gross: The #Fed is where bad bonds go to die. Today it was 10-years. Tomorrow 30-years. Stay short my friends.
— PIMCO (@PIMCO) August 14, 2012
With all eyes firmly planted on Spain, the little-Escudo-that-could has quietly slipped off the heading-into-the-abyss list of the mainstream media. Little was made this week of the fact that 10Y Portuguese bond yields dropped to seven-month lows - except by us of course where we explained that this is almost entirely due to the CDS-Bond basis trade 'arb-du-jour' that has placed a technical bid under Portuguese bonds. Between the help from LTRO and the fact that ISDA is under-pressure to improve/amend CDS rules to 'honor the spirit of the CDS contract to the fullest extent' which implicitly reduces the massive 'event' premium uncertainty between CDS and Bond risks for distressed-names (thanks to the ECB's actions in Greece), every bond in the short- to mid-term maturity of Portugal appears notably rich - with only the longest-dated bonds reflecting the crisis that remains. As we described in detail here, the real Debt/GDP of Portugal is around 140% (notably higher than the EC estimates of 111% once contingent liabilities are take account of) and the issues that face this small nation are entirely unresolved with bank recapitalization needs of at least EUR12bn and a highly indebted private sector. The bottom-line is that optically-pleasing bond improvements recently have been entirely due to synthetic credit arbitrage and, as Morgan Stanley notes, the nation remains mired in the three risks of contingent liabilities, bank recap needs, and a grossly indebted private sector; leaving a second bailout very likely by September 2012 and the challenging debt dynamics likely to mean a restructuring.
We have been rather vociferous in our table-pounding that even if a Greek PSI deal is achieved (in reality as opposed to what is claimed by headlines only to fall apart a month later), then Greece remains mired in an unsustainable situation that will likely mean further restructuring in the future. JPMorgan's Michael Cembalest agrees and notes that Debt/GDP will remain well above 100% post-deal but is more concerned at the implications (just as we noted earlier in the week) of the process itself including ECB preferred credit status, retroactive CACs (law changes), and CDS trigger aversions. In his words, the debt exchange is a bit of a farce and we reiterate our note from a few days ago - if this deal is so close, why is the 1Y GGB (AUG 2012) price trading -8.75% at EUR 28.75 (or 466% yield) and while longer-dated prices are rallying (maybe bear flattener unwinds), the moves are de minimus (-17bps today on a yield of 3353bps?) as selling pressure is clearly in the short-end not being rolled into the long-end as some surmise.
The slippery slope of lower volume continued today in the NYSE (cash/stock trading markets) despite ES (the e-mini S&P futures market) seeing its 2nd highest volume since 12/16 as that futures market has only seen 1 day of the last 11 with a negative close-to-close change. Driven seemingly by yet another rumor that the Greek PSI deal is close (yet GGBs are lower?), risk assets broadly went into overdrive and while ES held 1300 (on very large average trade size and volume as broke that stop-heavy level), the shifts in commodities, FX, and Treasuiries all helped sustain the euphoria into the close where we stabilized at yesterday's pre-market highs. Copper, Silver, Gold, EURUSD (and all FX majors aside from JPY), Treasury yields (and 2s10s30s) all closed at their highs of the day and while oil dropped early (around the Keytsone news?) it also limped back higher to $101 by the close. Equity markets were slight leaders on the day but credit caught up into the close. We do note that while the high-yield credit index has rallied dramatically but worry that the optical compression of spreads (bullish) is hiding the bear flattener in 3s5s that is seemingly dominating flow for now (relative to underlying credit).
Morgan Stanley's Jim Caron Apologizes For Wrong Call On Bonds, In 180 Degree Move Now Recommends A 10s30s FlattenerSubmitted by Tyler Durden on 08/20/2010 14:37 -0500
One of the biggest economic bulls, and correspondingly bond bears, of the past year, has been Morgan Stanley's Jim Caron, whose earlier estimate of a 5.5% in the 10 Year has cost many a bond investor much money. Today, Caron appeared on Bloomberg Radio with Tom Keene, apologizing for his call, and following up on his latest release in the MS Interest Rate Strategist, which started off: "We got our rates call wrong and missed a great opportunity to be long bonds this year. The market is currently rife with tactical relative value opportunities and that’s what we will focus on going forward. We’re shifting gears and will become more tactical, playing for rate moves in either direction in shorter timeframes, rather than having our ideas hinge on longer-term macro themes." Indeed, relative value, in the form of various divergence and convergence trades, is where it is at, and where Zero Hedge has been focusing over the past year.