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.