It is hard to find fiscal situations that are worse than Japan's. The gross government debt/GDP ratio, at more than 200%, is the worst among the major developed economies. Yet yields on Japanese government bonds (JGBs) have not only been among the lowest, they have also been stable, even during the recent deterioration during the European debt crisis. This apparent contravention of the laws of economics is both an enigma for foreign investors and the reason for them to expect fiscal collapse as a result of a sharp rise in selling pressure in the JGB market. As Goldman notes, the European debt crisis has led to an increase in market sensitivity to sovereign risk in general and questions remain on when to expect the tensions in the JGB market and the fiscal deficit to reach a breaking point in Japan. In the following 14 charts, we explore the sustainability of fiscal deficit financing in Japan and Goldman addresses the JGB puzzles.
What do USD money markets have to do with gold? Money market funds invest in short-term highly rated securities, like US Treasury bills (sovereign risk) and commercial paper (corporate credit). But who supplies such securities to these funds? For the purpose of our discussion, participants in the futures markets, who look for secured funding. They sell their US Treasury bills, under repurchase agreements, to money market funds. These repurchase transactions, of course, take place in the so-called repo market. The repo market supplies money market funds with the securities they invest in. Now… what do participants in the futures markets do, with the cash obtained against T-bills? They, for instance, fund the margins to obtain leverage and invest in the commodity futures markets. In summary: There are people (and companies) who exchange their cash for units in money market funds. These funds use that cash to buy – under repurchase agreements - US Treasury bills from players in the futures markets. And the players in the futures markets use that cash to fund the margins, obtain leverage, and buy positions. What if these positions (financed with the cash provided by the money market funds) are short positions in gold (or other commodities)? Now, we can see what USD money markets have to do with gold! Let’s propose a few potential scenarios, to understand how USD money markets and gold are connected...
Measuring the 'contentedness' during this summer of total comfort is tricky. With equities at the year's highs in nominal prices in the US and breaking multi-month highs in Europe, how do we 'know' the relative richness or cheapness (or hope or despair) that is priced into stocks and what the 'fall' ahead looks like. We may have found a way. Europe's economic and implicitly market performance is very much based on the explicit belief that the EMU remains in tact and that Draghi's recent 'promise' will enable sovereigns to go about their economic business (austerity and growth) without the hindrance of those nasty speculating long-only fixed income managers repricing cost-of-funds and eating into the nation's growth. In the US, it's all about multiples - P/E expansion (in the face of lower 'E') has maintained the hope; and so it is in Europe. The following chart shows the extremely high correlation between European equity P/E (hope multiples) and European Sovereign risk. At the end of LTRO2, European stocks were exuberant only to fade away; currently, European stock multiples are once again back to those exuberant 'hope' heights. Trade accordingly.
While it is probably not surprising that so many decided to focus on those few words of relevance to an implicitly self-aggrandizing crowd of long-only risk-takers and commission-makers; the truth is that, as UBS notes, "Draghi was stating a fact, not changing a policy". Putting the fateful sentence in the context of the rest of his speech/interview is critical and most importantly, we agree with UBS' Justin Knight's opinion that Draghi did nothing more than make a technical observation on an impairment in monetary policy transmission (as we discussed here). Regardless, if our interpretation is correct, then the rally in peripheral bonds should unwind quickly. The size of the move probably has knocked many shorts out of the market.
It's about time for Frances funding rate to feel a little pressure, no?
Things are getting a little 'strange' in Europe. European equity markets (and voatility) have disconnected from the reality of European corporate, financial, and sovereign credit. As the massive bifurcation in sovereign yields continues - with Spain near record-highs and Swiss/German at record-lows - equities are still significantly higher post the EU-Summit (and vol massively so) as credit of any kind is dramatically wider. Specifically, 1) Europe's broad equity index is massively outperforming credit post EU Summit; 2) Europe's broad equity index Vol is majorly disconnected from XOver credit; and, 3) Europe's broad equity index is in-line with GDP-weighted sovereign risk BUT dramatically dislocated from Italian and Spanish risk (that is reflective of the core of the stress). Just as we have seen in the US, the method of choice for 'pumping hope' into equity market valuations is through the levered selling of volatility - it seems some-one/-thing with very deep pockets is getting awfully brave as Europe's VIX drops to near pre-crisis levels (and its steepest in months as short-term complacency surges).
EURUSD has tumbled hard following the FOMC minutes as the much-hoped for 'we promise to print USD to infinity at the next meeting no matter what we see' phrase was missing. Two months ago, when the EURUSD was at 1.30, we asked if a 1000 pip move lower, based on relative central bank balance sheets, is in the cards. Today, we are 80% of the way there, with the Euro having tumbled 800 pips against the dollar as NEW QE gets priced further and further out - now implying a 20% likelihood of getting a new USD printing from the Fed within the next 3 months.
Now Is The Time To Prepare For The (Next) French Bailout Of Their Banking System & Potential Bailout Of FranceSubmitted by Reggie Middleton on 06/28/2012 10:42 -0400
So who's big enough to bailout France? How do you spell "No One" in French? This banking thing is about to get uglier than most comprehend!!!
Europe faces three systemic risks: Sovereign (GRExit vs. GERxit), Liquidity (unsustainable refinance rates and foreign capital outflows), and Banking (insolvency and under-capitalization). All of these can fundamentally be traced back to an era of excessive over-indebtedness, which as Pictet notes, leads to required deflationary policy responses that are incompatible with developed market government targets (of re-election, Keynesian pro-growth fiscal policy, and satisfying financial market's expectations). While LTRO did indeed address liquidity risk in the very short-term, it is now painfully clear (just look at European bank stock prices) that financials are driven by sovereign risk (not so much liquidity risk) at the margin. The following three charts provide a roadmap to Nirvana or Samsara (hell). With the Summit underway, Pictet's path to catastrophe roadmap (tactical and strategic) is critical to comprehend.
Italy Pays More For 6 Month Debt Than America Pays For 30 Year, As LTRO Claims Its First Bank InsolvencySubmitted by Tyler Durden on 06/27/2012 07:02 -0400
Today Italy had a rather critical Bill auction in which it sold €9 billion in debt due six months from today. Obviously, since the maturity is well inside of the LTRO, the auction itself was rather meaningless from a risk standpoint. Still, the good news is that Italy managed to place the entire maximum amount targeted. The bad news: it cost Italy more to raise 6 months of debt, or 2.957%, than it costs the US to borrow for 30 years (2.70%). Not only that but the average yield 2.957% was the highest since December when the Italian 10 Year was north of 7%, and nearly 50% higher compared to the 2.104% at auction on May 29, or less than a month ago. The Bid/Cover of 1.62 was unchanged compared to the 1.61 at the May 29 auction. From Reuters: "Today's bill sale points to the sovereign getting this supply away but at yield levels sufficiently elevated to leave a niggling doubt at least as to the medium-term sustainability of the country's public finances," said Richard McGuire, a rate strategist at Rabobank. On Tuesday, Spain paid 3.24 percent to sell six-month bills. Madrid is seen at risk of having to ask for more aid after formally requesting a European rescue for its banks this week. But doubts are also growing on Italy's ability to keep funding its 1.95 trillion euro debt, which makes it the world's fourth-largest sovereign debtor. Domestic appetite has so far allowed the Treasury to complete 56 percent of its 445-billion-euro annual funding plan."
The long anticipated downgrade of the recently bailed out Spanish banking sector has arrived. Moody's just brought the hammer down on 28 Spanish banks. Also apparently in Spain banks are now more stable than the country: "The ratings of both Banco Santander and Santander Consumer Finance are one notch higher than the sovereign's rating, due to the high degree of geographical diversification of their balance sheet and income sources, and a manageable level of direct exposure to Spanish sovereign debt relative to their Tier 1 capital, including under stress scenarios. All the rest of the affected banks' standalone ratings are now at or below Spain's Baa3 rating." Can Spain borrow from Santander then? They don't need the ECB.
We have no doubt that everyone is tired of bad news, but we are compelled to review the facts: Europe is currently experiencing severe bank runs, budgets in virtually every western country on the planet are out of control, the banking system is running excessive leverage and risk, the costs of servicing the ever-increasing amounts of government debt are rising rapidly, and the economies of Europe, Asia and the United States are slowing down or are in full contraction. There's no sugar coating it and we have to stop listening to politicians and central planners who continue to downplay, obfuscate and flat out lie about the current economic reality. Stop listening to them.
While we discussed the definitive new world geography last week, it appears the CDS market has decided to add a new parallel for us, Germany is now Chile (in terms of 10Y restructuring and devaluation risk). As a reminder, Germany's credit risk has risen by almost 50% in the last 3 months to record highs, and has converged higher towards Europe's GDP-weighted average sovereign risk in the last 2-3 weeks.
I’m sure many of you may be asking yourselves, “Well, how likely is this counterparty run to happen today?”Submitted by Reggie Middleton on 06/14/2012 07:48 -0400
As Predicted Last Year, The French and the Greeks Are In A Race For The Biggest Bank Run! Each stock showcased has led the drop as well...