Sovereign Risk

Arbing Spot And Forward Curve Steepness

On Friday we pointed out that after nearly 9 months of straight line steepening, the Treasury curve, as depicted by the spot 2s10s, has collapsed, and has flattened from 290 to 240 bps practically overnight, in what has been an unprecedentedly rapid move in the curve, driven primarily by asset liquidations. Those with exposure to spot are panicking, and have been forced to cover what amounts to billions in levered notional positions. Some (the lucky ones) only have synthetic exposure, via Constant Maturity Swaps or other Robertson/Klarman-esque contraptions, thus limiting a downside they can walk away from. They are the minority. Yet an interesting observation, coming by way of Morgan Stanley's Jim Caron, who little by little is forced to wave the white flag of surrender not only on his 5.5% call in the 10 year by Year End, but also on his all out steepening trade, is that flattening has really only occurred in the spot curve: forward yield curves, both the 1y and 2y, have surprisingly retained their steepening bias in spite of unprecedented vol and liquidations. Why is this? Caron explains. However, more relevantly, his observation that a convergence between spot and forward curves is imminent could serve as an easy (famous last words) way to pick 100 bps.

Goldman's Tilton On European Clinical Contagion

A few days ago Tim Geithner said that any risk from Europe is isolated on the continent and there is no risk of it spreading to the US. Following a near 10% drop in the S&P we yet again have confirmation that the Treasury Secretary is a pathological liar or an idiot, or just so confused by analyzing the ever-increasing gobs of negatve data that his brain has officially switched off, we are not sure which, although either case would make him ineligible to practice the role of US Treasurer (unless to the list of permitted exemptions which currently only lists tax "avoidance", one adds lunacy). And while we await a clinical diagnosis on the SecTres' pathologies, we offer this analysis on how European contagion will come to the US from Goldman's Andrew Tilton, which, for what it's worth, is one of the better ones written on the topic.

The Definitive Incomplete Analysis Of Today's German Shock And Awe

The market’s immediate response to the ban announcement was to sell the Euro. Such a response makes sense as when faced with the inability to manage risk in debt, stock or CDS markets, participants sell what they can. And that means the Euro. But by having inadvertently further undermined the Euro, today’s actions increase the risk of failure in the entirety of the liquidity support program as the Achilles heal of the European intervention is its potential to undermine the currency. Unlike the US policy response, massive liquidity support from the ECB can create the perception (if not the reality) of a debt monetization scheme. While the US explicitly monetized the debt, it benefited from a flight to quality and worlds reserve currency status, neither of which the Euro enjoys. A precipitous decline in the Euro remains the risk to the outlook, and on display today as the Euro declines led the selloff in broad risk markets. - Jeffrey Rosenberg

Summary Of Today's Festivities From Goldman and Morgan Stanley: Run From The Euro

The whole world is still stunned from what just happened today. In essence, Germany has taken a major step to not only declaring it is the master of the European continent and all those who don't like it can just focus on their own bankrupt banks (Sarkozy), but is breaking ranks with the US, as the surprising nature of today's move was aimed not so much at European "speculators" but at Wall Street. Furthermore, knowing full well it may soon lose access to US capital markets, Germany is likely preparing to abandon the EU and EMU (to which "good riddance" is likely all it has to say). But the key implication from today is that Bernanke must now move with urgency to find a way to keep the pressure on the dollar as he is now solidly losing the currency devaluation race. The impact of this on major multinationals and on the "must do" reflation experiment could be cataclysmic. Additionally, without gobs of new domestic liquidity to prop it up, the US market will now likely collapse, further forcing Bernanke to act against the interests of the US Middle class and America's savers. We can not wait to see what he pulls out of his sleeve. With ZIRP ravaging the nation, and negative interest rates still illegal, he may just find his hands very much tied.

In the meantime, here are some preliminary shocked observations on today's events from Goldman Sachs and Morgan Stanley.

Reggie Middleton's picture

The Asset Securitization Crisis begat the Sovereign Debt Crisis at a time when many believed (and still do) that we are pulling out of a global recession with a roaring bull market. In reality, we are at the tail end of the synthetic high borne from unprecedented global fiscal and monetary stimulus, and it is time to pay the piper - world wide! Enter the final phase of the Great Global Macro Experiment, laid out for you in a analytical spreadsheet!

Reggie Middleton's picture

How many of those Greek, Portuguese, Irish and Spanish bondholders have factored the near guaranteed "additional" haircut (/scalping) they will receive having to stand behind the IMF in the event of a (probably guaranteed) default or restructuring? Do you think the investors of European banks (that includes central banks) that are holding/and currently still buying a boat load of these bonds have factored this into their valuations?

Goldman On What The Neverending [Private|Public|Global|Galactic] Bailout Means For Market Indicators

  • The European Financial Stabilization Mechanism backstops EMU public finances without distorting incentives.
  • The focus now turns to budgetary plans by individual countries, and the new rules on fiscal coordination.
  • The ECB’s ‘interventions’ in sovereign bonds have so far targeted the smaller, weaker credits.
  • Secondary trading in Spanish and Italian government bonds is slowly ailing; over time, this should help financial risk subside.
  • The dispersion of EMU sovereign spreads will remain wide going forward, reflecting greater differentiation across fiscal positions.
  • EMU GDP-weighted 5-yr government yield is now 2.4%, comparable to the US, and roughly 80% of Emu public debt is held within the Euro area (relative to only 52% in the US) 
Reggie Middleton's picture

I told you it probably wouldn't work. Now, you really have speculators lining up to put on the short trade of the a lifetime. Methinks those lines may start to get pretty long as well as I spy the Asian markets as well as the US and European futures drop like rocks in desalinated pond water. Asking 2 trillion euro, can I get a bid for 2 trillion euro, going... going... gone!

Morgan Stanley Capitulates, Sees No Rate Hike Until 2011, Pushes Back Call For 4.5% On 10 Year By Two Quarters

The one biggest bond bear since December 2009, Morgan Stanley, has just thrown in the towel, and instead of expecting 4.50% on the 10 Year by June 30, the firm has now pushed back its target by 2 quarters. Which means that its longer 5.50% Target on 10 Years has been scrapped. The firm's strategists have also adjusted their call on Fed hikes (now expected to occur no sooner than 2011 instead of September 2010). Lastly, the firm's most vocal call, one for a substantial 2s10s steepening to 325 bps has also been moderated from Q2 to Q4. We also include the latest Rates Strategy slide deck from MS.

Chris Pavese's picture

It is important to note that in the near term, the contraction in private sector credit combined with the threat of fresh credit concerns ahead, will likely keep a lid on inflation pressures. This view is perhaps where we differ most from today’s consensus thinking, where many expect an immediate and permanent increase in inflation levels.

Summary Of The Biggest Bail Out Ever: Even Keynes Is Spinning In His Grave

The race to the currency devaluation bottom is now in its final lap. And gold is the only alternative to the now imminent collapse of the fiat system: the world had a chance to take writedowns on losses, punish those who took risk and failed, and refused to do so. There is now no risk left, but it only means that eventually all the risk will come back and lead all capital markets to zero. The result will be the end of Keynesian economics as we know it. Do not trade in this broken market, do not hold your money in a bank as they are all now one hour away from a terminal bank run - buy and hold real, FASB mark-to-myth independent assets.

Here Are The Critical Credit/Liquidity Indicators To Keep A Watch For In The Coming Week

Call it Lehman 2.0, sovereign risk flare up, or plain old money run, the liquidity crunch from last week almost killed the US equity market, has generated an unprecedented swing in FX pairs, and is starting to move into key credit indicators and spreads. The "big bail out" from the weekend has come and gone (unless Trichet is preparing to release something at 5:59pm Eastern tomorrow), and if Goldman is correct will have no material impact on markets... Which means that the downward path of least resistance will continue. And with equity markets not only decoupling from the rest of the world, but from the credit market as well, as they migrate to a plane of existence of their own, replete with unicorns, rainbows and spittoons full of hopium, keeping an eye out on early stress indicators from the credit markets is critical - credit is and has always been a far better early warning of market health, or lack thereof, than the HFT controlled, rebate-driven trading action in the shares of C, FNM, FRE, AIG, and other bankrupt pennystocks which account for up to 40% of daily trading volume. Earlier today, we touched upon some of the key early warning indicators to watch for in determining if the European contagion is going airborne. Below, we share a presentation from Morgan Stanley's Jim Caron, Measuring Risk: Extracting Market Sentiment from the Interest Rate Markets, in which the credit strategist provides a much more detailed framework of what critical credit signals are and how to interpret them. We recommend that all those still trading, either with their own, or other people's money, familiarize themselves with this 27-page overview.

Surging Libor-OIS And Cross Currency Basis Swaps Indicate Europe's Response Is Too Little Too Late

Even as the immediate factor for the 1000 point drop in the Dow is investigated for the next several months by the SEC, a process which will likely not come to any reasonable market structure regulatory recommendation before the SEC is forced to analyze the next subsequent (and even greater) crash, the one primary fundamental cause for the sell off in stocks this week was the ever deteriorating situation in Europe. As the euro tumbled on Thursday afternoon, which we noted 20 minutes before the stock market crash began in earnest, as implied correlation algos went berserk, and as viewers were witnessing the near-warfare in Athens live, things just got too real for speculators (investors is so 20th century). Various computerized trading platforms merely kicked on (or rather, off) after the initial panic had already set in, and liquidity evaporated, leading to the implosion in the market. And the primary reason for the initial market pessimism early on Thursday was the fact that even as the whole world was listening to Jean-Claude Trichet to say soothing words after the ECB's rate decision, the central bank president once again did not realize the gravity of the situation. And to speculators, long habituated to Bernanke's endorsement of infinite moral hazard and speculative mania, the fact that someone refused to play "ball" and leave open the possibility that failure is still permitted in our day and age was the last straw. Now, 48 hours later, we learn that the rumors, which we reported about the ECB preparing a bailout fund, were indeed true. Our sense is that at this point the ECB's action is "too little, too late" as contagion fear has already crept deep within the fabric of various overt and shadow funding/liquidity mechanisms. Additionally, the world is now convinced that Europe can only deal with problems retroactively, and who knows how big and unfixable the next problem will be: the ECB, which has lost most of its credibility after "inviting" the IMF to do a heavy part of the bailout, is about to become the laughing stock of global central banks. Trichet is seen merely as a powerless bureaucrat, caught between Merkel's electoral struggles and Bernanke's demands for contagion interception and implicit Fed supremacy over Europe. The contagion from the "isolated" Greek fiasco is rapidly spreading. Here are some of the ways in which markets are about to be affected.