Sovereign Debt

I recall the early days of the Greek crisis when everyone asked why Greece was so important because it is such a small country. I responded that they had a total of $1.1 trillion in debt (sovereign, municipal, corporate, bank and derivatives) and I remember the blank stares. Now, if the newest bailout goes through, they will have more than $1.3 trillion in debt and while they could not pay the initial amount they certainly cannot pay any larger amounts so that it can clearly be stated that what is going on is the central banks of Europe and the ECB/EU lending money to Greece only as a conduit to pay back their own banking institutions. If you object to my math here recall that as the private sector involvement reduces the notational amount of sovereign debt but that the Greek banks are also going to be lent money so that the decrease in sovereign debt which excludes the ECB/EIB and IMF debt is not the headline bandied about in the press. So we have the hard date of March 9 when either the threshold for the exchange is met or not, the imposition of the CAC clause or not, the next “Question” to the ISDA if the CAC is triggered asking if there has been a credit event to trigger the CDS contracts, the possible consequences of a CDS trigger, the decision on the bailout funds by the EU and finally the March 20 hard date when Greece must make its bond payments or default. Regardless of your opinion, it may now be stated precisely, that there is a lot of risk on the table and on that basis alone I would assume a quite defensive position until this all gets played out. The risk/reward ratio is now strongly slanted towards Risk.

In what should come as a surprise to nobody, German banks have announced that they will accept the terms of the Greek PSI whose outcome is due on Thursday. Because as Reuters points out, German banks already have had the time and opportunity to park the bulk of their Greek exposure with the failed German bad bank, which is explicitly funded by the government (thus making the cost to the German government even higher): "While Greek sovereign debt owned by German lenders has a face value of roughly 15 billion euros ($20 billion), in most cases they have already written down that value in their books by about three quarters. FMS Wertmanagement, the biggest creditor with an exposure of nominally more than 8 billion euros, will accept the deal, a person close to the lender said on Monday. FMS, the bad bank set up to hold the toxic assets of bailed-out former bluechip lender Hypo Real Estate, is to formally decide on accepting the debt cut later this week, the person said." German banks... German banks... where else have we seen this today? Oh yes: "Die Welt said that more than half of the 800 lenders that tapped the ECB's 3Y LTRO last week were German, consisting mainly of small savings and cooperative banks." Thank you Jim Reid - so while Bundebank's Jens Weidmann huffs and puffs about the LTRO, it is his own banks are the biggest beneficiaries, in no small part to hedge against Greek exposure. But yes - at least following the absorption of tens of billions in intermediary capital via a variety of channels, German banks can now accept a 70%+ haircut, even if they continue to complain about it in the process: "Commerzbank, which had originally invested almost 3 billion euros in Greek sovereign bonds but has written down its exposure to 800 million, said last month it had little choice but to take part in the bond swap. At the time, chief executive Martin Blessing said: "The voluntariness (of the Greek debt swap) is about as voluntary as a confession at a Spanish inquisition trial."" The Spanish Inquisition appears to have won yet again.

Analysts are questioning the "double-down effect" the ECB's LTRO exercises are creating in eurozone sovereign spreads. Citi notes a spike in the purchase of government securities since the initial take-up in December.

We are in “The Lull” which has been caused by the injection of capital by the Fed and by the ECB. This is exactly, exactly, what took place I remind you during the weeks after the subprime mess exploded. Massive injections of capital, run-ups in equities, compression in bonds, higher prices for commodities and then the reversal of course took place. When easing ends then the course back tracks and I predict a re-do of this in the coming months. It will not take some trigger event, though there may well be one, to cause this; just the easy money being placed and no more manufactured money to follow.

“As the well runs dry the throat parches and dehydration begins.”

-The Wizard

American investor (and longtime CM.com member) Erik Townsend has spent the past several years living internationally, with an eye to which countries may be good alternatives if economic crisis and/or Peak Oil start to materially impact life in the US.  His main observation as an expat? Through its misguided policies, the US has been exporting inflation to the rest of the world, raising prices all over the globe (as an example, he cites a $57 chicken pot pie from the menu at a 'working class' restaurant in Australia).  This inflation is affecting the rest of the world harshly, but is not yet being felt in the US due to our ability to export it as the issuer of the world's reserve currency. Our immunity will not last forever though, and when it ends, a massive upwards spike in prices is going to hit US markets.

Back on May 25 2010, just as the Greek fiesta was starting to unravel, we wrote the following: "Total US debt per today's Daily Treasury Statement was $12,989,095 million. Also today, the US Treasury auctioned off $42 billion in 2 Year debt. This means that as of this moment, assuming the new debt were to settle today, the US has $13,031,095 billion in debt: congratulation America - you have now passed lucky $13 trillion in total debt. But don't worry, we won't stay here for long. At the current rate of issuance, $14 trillion will be passed in 8 months, and $15 trillion in another 7. By the end of 2011, we estimate total US sovereign debt to be about $15.5 trillion. For some recent vivid examples of prosperity courtesy of runaway debt issuance, please see Argentina, Japan and Greece."  We apologize profusely, as we were off by two months.

Not the US Dollar of course: why would the only country to successfully overthrow the chains of banker tyranny and default in their face want to ever have anything to do with the USD, the source of all the world's problems. No, the dollar in question is that of Canada. According to the Globe and Mail tiny Iceland, "is looking longingly to the loonie as the salvation from wild economic gyrations and suffocating capital controls...And for the first time, the Canadian government says it’s open to discussing idea. There’s a compelling economic case why Iceland would want to adopt the Canadian dollar. It offers the tantalizing prospect of a stable, liquid currency that roughly tracks global commodity prices, nicely matching Iceland’s own economy, which is dependent on fish and aluminum exports." Yes, yes, there are all the fundamental reasons, but more importantly, it is a huge slap in the face of those statists (and the United States of course) who keep repeating no matter the facts that the USD will never lose its reserve status. Here's a hint: it can and it will. And so much for the thought experiment of printing endless amounts of currency in non-reserve format and getting away with everything unpunished. Finally, there is this startling dose of reality from an earlier and calmer time, when S&P, back in 2006, released its long-term baseline scenario of sovereign debt ratings. This oddly prescient table speaks for itself.

All you need to read.

The Blokes across the pond are starting to sound as bad as some of the sell side charlatans stateside. Either that or the weed over there is just that much better!

As the ECB supposedly takes it foot off the gas, and EU Summits and 'events' loom large for the careening wagon of shared sacrifice, unity, and sovereign risk, perhaps it is the nodding donkeys of Greek and Italian technocrats juxtaposed with Ireland's feistier "R" word gambit (and of course Zee German Overlords) that makes Art Cashin reflect somewhat philosophically on recent headlines. Their stereotypical interpretation has him concerned as the potential for ever-increasing culture clashes increases across the pond as sour memories and generational hatreds abound.

Dear Santa, I know Christmas is a long way off, but I was hoping that you could get me a European Bank License and another round of LTRO.   I promise to be a good boy, and borrow as much money as the ECB will possibly give me, with minimal equity, and buy as much 3 year in and in paper as I can.  I’m afraid I might not be able to bring myself to buy Spanish or Italian debt, but with the broad range of assets available against the money, I’m sure I can find something I like.  I’m not greedy, I don’t need to make 2% of carry, I would be happy with 1%, after all, I my only qualification is having a bank license, and I have no real equity in the deal (though after 3 years if all goes well, I will be a very rich man, or bank).

Silver as ever outperformed gold yesterday and traders attributed the surge to “massive fund buying” and to “panic” short covering. Some of the bullion banks with large concentrated short positions covered short positions after the technical level of $35.50/oz was breached easily. Massive liquidity injections and ultra loose monetary policies make silver increasingly attractive for hedge funds, institutions and investors. This time last year (February 28th 2011) silver was at $36.67/oz. Two months later on April 28th it had risen to $48.44/oz for a gain of 32% in 2 months. There then came a very sharp correction and a period of consolidation in recent months. Silver’s fundamentals remain as bullish as ever and the technicals look increasingly bullish with strong gains seen in January and February.

The following people are paid to have an opinion, whether right or wrong, so it is our job to listen to them. Supposedly. Reuters summarizes the professionals kneejerk reaction to the LTRO 2. Because when it comes to explaining why Europe's banks are not only not deleveraging but increasing leverage while paying an incremental 75 bps on up to €700 billion in deposits soon to be handed over to the ECB, one needs all the favorable spin one can muster.

As US markets hit their all time highs, there is nothing but bad news in EU sovereign land. What does it take for people to understand that equities have detached from fundamentals & the macro outlook?

It appears markets have re-converged in the last few days across asset classes as European credit markets have rallied to meet a modestly underperforming European equity market after quite significant drops in the former a week or so ago. In the US, equity futures have reconverged with CONTEXT (our proxy for broad risk assets) as Treasuries have weakened and FX carry has improved tone overnight while futures themselves have drifted sideways. Commodities have largely drifted also with a modest improvement in Copper and slow drift up in WTI (back over $107 now). For some perspective, GDP-weighted European Sovereign risk has improved 80bps from its Nov2011 wides (or around 23%) but remains over 200bps wide of Post March 2009 lows and over 500% higher still - back only to levels seen in August 2011. Consensus appears to be that a larger than expected LTRO is positive for risk assets with Equities and then Credit the main beneficiaries (with FX the least) and a notable divide between European traders and non-European traders with the former believing the EUR will strengthen vs USD and the latter not so much (more focused on carry trades). For now, Italian and Spanish sovereign yields are leaking higher but in general wait-and-see mode remains with anxiety high.