Ireland

With harsh long-term consequences for the heavily indebted countries.

The post-hoc (correlation implies causation) reasons for why the initial LTRO spurred bond buying are many-fold but as Nomura points out in a recent note (confirming our thoughts from last week) investors (especially bank stock and bondholders) should be very nervous at the size of the next LTRO. Whether it was anticipation of carry trades becoming self-reinforcing, bank liquidity shock buffering, or pre-funding private debt market needs, financials and sovereigns have rallied handsomely, squeezing new liquidity realities into a still-insolvent (and no-growth / austerity-driven) region. Concerns about the durability of the rally are already appearing as Greek PSI shocks, Portugal contagion, mark-to-market risks impacting repo and margin call event risk, increased dispersion among European (core and peripheral) curves, and the dramatic rise in ECB Deposits (or negative carry and entirely unproductive liquidity use) show all is not Utopian. However, the largest concern, specifically for bondholders of the now sacrosanct European financials, is if LTRO 2.0 sees heavy demand (EUR200-300bn expected, EUR500bn would be an approximate trigger for 'outsize' concerns) since, as we pointed out previously, this ECB-provided liquidity is effectively senior to all other unsecured claims on the banks' balance sheets and so implicitly subordinates all existing unsecured senior and subordinated debt holders dramatically (and could potentially reduce any future willingness of private investors to take up demand from capital markets issuance - another unintended consequence). We have long suggested that with the stigma gone and markets remaining mostly closed, banks will see this as their all-in moment and grab any and every ounce of LTRO they can muster (which again will implicitly reduce all the collateral that was supporting the rest of their balance sheets even more). Perhaps the hope of ECB implicit QE in the trillions is not the medicine that so many money-printing-addicts will crave and a well-placed hedge (Senior-Sub decompression or 3s5s10s butterfly on financials) or simple underweight to the equity most exposed to the capital structure (and collateral constrained) impact of LTRO will prove fruitful.

Fiat Infoporn

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.

For better or worse, all of last year had Merkel and Sarkozy on the same page.  Saying whatever it took to calm markets.  They didn’t really spend a whole lot of time worrying about their own citizens.  With the elections coming up, expect more negative and potentially confusing headlines to come out of Europe. Does Germany really want to control the Greek budget process? Sarkozy wants to “unilaterally” impose a financial transaction tax in France by August. That is the problem, what the politicians have to say to appease the voters is not always what the financial markets want to hear. The EU continues to try and perpetrate the myth that Greece is unique and that Portugal is different. Portugal has the benefit of being smaller, but they are next in line for principal write-downs (or whatever they are calling haircuts now).

With a Greek default imminent, and this time ISDA having no chance to kill CDS as a hedging mechanism as the trigger event will be more than present, investors have once again jumped at the opportunity to close lucrative basis trade opportunities, as a result sending all of Europe broadly red in spread terms. Notable: Portugal CDS, which contrary to media reports elsewhere has been trading points up front for a few weeks now, just hit a record 40 pts up. And what is worse is that the 5/10s, which should be inverted for a country as distressed as this, isn't.

• Euro-Region Debt Sales Top $29B This Week (Bloomberg)
• Greek Fury at Plan for EU Budget Control (FT)
• Greek "football players too poor to play", leagues running out of money, may file for bankruptcy (Spiegel)
• After insider trading scandal, Einhorn wins the battle: St. Joe Pares Back Its Florida Vision (WSJ)
• China Signals Limited Loosening as PBOC Bucks Forecast (Bloomberg)
• China's Wen: Govt Debt Risk "Controllable", Sets Reforms (Reuters)
• IMF Reviews China Currency's Value (WSJ)
• Watching, watching, watching: Japan PM Noda: To Respond To FX Moves "Appropriately" (WSJ)
• Cameron to Nod Through EU Treaty (FT)
• Gingrich Backer Sheldon Adelson Faces Questions About Chinese Business Affairs (Observer)

You've just crossed over...

Merkel warned that Germany might be overwhelmed by its bailout efforts—a reluctance that turned Germany into a punching bag. Yet risks are staggering.

Festive Friday fun:

• FITCH TAKES RATING ACTIONS ON SIX EUROZONE SOVEREIGNS
• ITALY LT IDR CUT TO A- FROM A+ BY FITCH
• SPAIN ST IDR DOWNGRADED TO F1 FROM F1+ BY FITCH
• IRELAND L-T IDR AFFIRMED BY FITCH; OUTLOOK NEGATIVE
• BELGIUM LT IDR CUT TO AA FROM AA+ BY FITCH
• SLOVENIA LT IDR CUT TO A FROM AA- BY FITCH
• CYPRUS LT IDR CUT TO BBB- FROM BBB BY FITCH, OUTLOOK NEGATIVE

And some sheer brilliance from Fitch:

• In Fitch's opinion, the eurozone crisis will only be resolved as and when there is broad economic recovery.

And just as EUR shorts were starting to sweat bullets. Naturally no downgrade of France. French Fitch won't downgrade France. In other news, Fitch's Italian office is about to be sacked by an errant roving vandal tribe (or so the local Police will claim).

• Greek Debt Wrangle May Pull Default Trigger (Bloomberg)
• Italy Sells Maximum EU11 Billion of Bills (Bloomberg)
• Romney Demands Gingrich Apology on Immigration (Bloomberg)
• China’s Residential Prices Need to Decline 30%, Lawmaker Says (Bloomberg)
• EU Red-Flags 'Volcker' (WSJ)
• EU Official Sees Bailout-Fund Boost (WSJ)
• EU Delays Bank Bond Writedown Plans Until Fiscal Crisis Abates (Bloomberg)
• Germany Poised to Woo U.K. With Transaction Tax Alternative (Bloomberg)
• Ahmadinejad: Iran Ready to Renew Nuclear Talks (Bloomberg)
• Monti Takes On Italian Bureaucracy in Latest Policy Push to Revamp Economy (Bloomberg)

The US market appears modestly enthused by earlier remarks from Jamie Dimon (who ironically is of Greek descent) who told CNBC that "The direct impact of a Greek default is almost zero."  Note the phrase "Greek default" because it takes us back to that long ago June of 2011 when Jamie Dimon was again giving predictions about events in Greece. In this case, the summary goes to Bloomberg, which penned a piece titled: "JPMorgan’s Dimon Says Greece Won’t Default, Australian Reports."  That's not all. He added the following, from The Australian: "I don't think they will default. I think the more likely outcome is that the European authorities and politicians will find a way to keep Greece from defaulting." It gets better: "It does reverberate because a lot of European banks own Greek debt and investors hold European bank debt. From all of the numbers I have seen, the European banks have enough capital to withstand it." We can only suppose that all the numbers probably excluded the $100 billion in FX swaps that the Fed conducted days after it told Congress it would not bail out Europe, or the OIS+100 to OIS+50 cut in interbank lending rates, because the banks had "enough capital" oh yes, and that €490 billion LTRO, that kinda, sorta indicates that the European banks did not actually have enough capital to withstand either "it" or pretty much any of the events in Q4 of 2011.

All you need to read.

• BOJ Should Be Allowed $643 Billion Fund to Buy Foreign Bonds, Iwata Says (Bloomberg)
• Banks Hoarding ECB Cash May Double Company Defaults (Bloomberg)
• China Police Open Fire on Tibetans as Protests Spread (Bloomberg)
• Sarkozy Presidential Rival Hollande Would Lower Retirement Age, Lift Taxes (Bloomberg)
• IMF takes tougher stance over Greek debt (FT)
• Iran threatens to act first on EU embargo (FT)
• PM says ‘no complacency’ on economy (FT)
• George Soros: How to pull Italy and Spain back from the edge (FT)
• Japan's NEC to slash 10,000 jobs (Reuters)
• Obama Planning Corporate Tax Overhaul (Bloomberg)

Easily the best news of the day:

GEITHNER SAYS OBAMA WOULDN'T ASK HIM TO STAY FOR A SECOND TERM - BBG

Oh well, life is tough. Surely that basement office at Goldman Sachs will have some daylight and a TruboTax manual to make post-administrative life bearable for Geithner.