Anyone expecting that the events over the last 24 hours will have changed the persistently negative outlook of one of the original skeptics, will be disappointed. The SocGen strategist falls back to that old time-tested principle in complicated situations: math and logic. His summary of events released this morning: "The increasingly frenzied attempts of eurozone governments to persuade financial markets that they can draw a line under this crisis will ultimately fail – even if this week’s measures bring some short-term relief. I have minimal confidence that governments can turn this around within the confines of the eurozone project. You might be surprised though that I feel more bullish! Why? Both Dylan and I have come to the view that the ECB will be forced, by events, to monetise debt in the GIIPS and beyond. And if investors believe the governments in Spain and Italy are bust, then Germany, France, and not forgetting the UK and US, are far, far worse." To be sure, we may see a brief respite as we get the traditional post-TARP knee jerk reaction, only for markets to digest the sad reality of the situation in the proceeding 48 hours. And what will that imply? To Edwards, it will be nothing short of the realization, that even with €1 trillion (or more), the ECB will have no choice but to commence outright monetization as well. And the real question will be whether or not "Germany, will leave the eurozone after being over-ruled on the ECB (again!) and in the face of such monetary debauchery?"
Expectations of a grand plan may be on hold for a little while as the reality sets in for traders and asset managers alike this morning. Despite EUR strength, back above and holding a 1.40 handle, risk assets in general are less excited. European credit indices are opening tighter, as we would expect with higher beta outperforming. XOver -32bps and SENFIN -16bps may seem impressive but there is little follow-through in the underlying credits with most of the major European financials at best 5bps tighter (and notably BARC and LLOYD are wider). SovX is tighter by 14bps while underlying single-name Western European sovereigns are generally tighter with PIIGS unsurprisingly outperforming (though we have seen very few runs on Greece yet leaving it unch - which makes sense given the uncertainty). CEEMEA sovereigns are wider though (even if the index is compressing) as hedge unwinds seem the raison d'etre of trading desks today. Most importantly, the yield of EFSF bonds is rising (as we discussed yesterday), with the 2021s breaking back below Par. This makes sense as the sovereign risks are transferred to the supra-national EFSF entity and concentration risks are increased.
"Springtime For The Euro, Then Reality" - Citi Summarizes What Happened In Europe, And What Are The Next StepsCiti's Steven Englander summarizes last night's 4 am Eurosummit announcement, the kneejerk reaction in the all-important EURUSD, and what to expect both over the immediate future and the longer term: "We would expect the next 24 hours to be driven by how the Sarkozy call to China President Hu Jintao goes, how investors analyze the sustainability of Greek debt under this program, and the reception that the EFSF proposal will get. We are a bit surprised by the enthusiasm given the lack of detail and lack of surprise. We are also wondering how seriously investors will take the EFSF guarantees (which only apply in the event of a default), given that the banks were strongly encouraged to declare the current restructuring voluntary. Investors may fear that the EFSF - guaranteeing - governments will similarly contrive to avoid paying out on their first-loss guarantees."
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And, as expected, here is ISDA with the most farcical of decisions. From Reuters: "A new voluntary deal for holders of Greek debt to accept deeper losses is unlikely to trigger a 'credit event' that would cause a payout on default insurance, said a top lawyer at the International Swaps and Derivatives Association. Greek bondholders face losses of 50 percent under a plan to lower the country's debt burden and contain the euro zone's long-running debt crisis. The aim is to complete negotiations on the package by the end of the year. But because participation in the deal is voluntary rather than forced, it would typically not trigger payment on CDS contracts. "As far we can see it's still a voluntary arrangement and therefore we are in the same position as we were with the 21 percent when that was agreed," said David Geen, general counsel at derivatives body ISDA, referring to an original deal proposed in July that involved smaller bondholder losses. "The percentage (of losses), as far as the analysis for CDS purposes goes, doesn't change things. typically a voluntary arrangement won't trigger the CDS." Geen said the final decision on whether a credit event has occurred rested with the ISDA determinations committee, which would consider the issue when requested to do so by a CDS market participant." The fact that the decision is "voluntary" under duress from an entire political system which realizes its ponzi structure is collapsing is seemingly irrelevant. Luckily, the market is not all that stupid and the preliminary reaction is as expected, and to paraphrase Willem Buiter, "Failure to trigger Greek sovereign CDS when economic logic indicates this ought to occur would likely be detrimental to financial stability." But that's irrelevant. The EU has kicked the can down the road. Now it is literally a race for the fade to discover who is first to realize that as Zero Hedge and now RBS chimes in, "the EFSF is still too small to restore investor confidence."
- EU Sets 50% Greek Write-down, $1.4T in Debt Fight (Bloomberg)
- EU pushes banks to find extra €106bn for June (FT)
- Italy's Berlusconi Says No Plans For Early Elections (WSJ)
- U.S. Supercommittee Flirts With Failure (Bloomberg)
- Fed to wrestle with communication policy (FT)
- Investors show interest in foreclosure plan (Reuters)
- Bank's Posen says QE size about right (Reuters)
- Japan's Finance Minister Blames Yen Rise on Speculators (WSJ)
- China Nixes Rapid Yuan Rise (WSJ)
While everyone's attention today will be focused on Europe and the market's kneejerk reaction, America will announce its advance Q3 GDP print which is expected to show a modest bounce from recent lows.
- European leaders agreed, in principle, to boost the firepower of the EFSF to approximately EUR 1trl using a combination of a special purpose investment vehicle and a debt-insurance scheme. The leaders also struck a deal with private banks and insurers for them to accept a 50% loss on their Greek government bond holdings
- According to EU sources, the EU is to present Eurobond ideas on November 23rd
- According to a German government official, direct or indirect financing via the ECB is ruled out, adding that haircut excluded Greek bonds held by the ECB
- BoE's Fisher said that the BoE will revisit QE once the current purchase is complete, adding that there is a significant chance of a double dip recession in the UK
Yesterday we pronounced sovereign CDS dead (a proclamation which will soon shift to all corporates now that companies are less risky than countries and the vigilantes refocus their attention, as the ability of the sovereign to onboard any more private sector debt is severely curtailed). The reason: the laughable "determination" that a Greek default and 50% bond write down is not an event of default. Maybe not to ISDA's 15 committee deciders (well 14: Barclays should vote no) but it is to the market. As a result, we have seen not only the biggest tightening in IG since May 2010 (11.3 bps tighter to 114.5), but a complete collapse in the sovereign complex, now that it is obvious that in addition to not being a speculative instrument (naked position will be banned in perpetuity), CDS are no longer even a hedging one. Expect the slow, gradual extinction of sovereign CDS, which will merely make the only possible way to hedge long cash govvie position the old-fashioned one: selling.
As if the ES futures were not enough to satisfy the thirst of those seeking incredulities today, Copper - the oft-watched indicator of all that is good in the world for every Keynesian economist - has just smashed all previous records for its largest rise in a week. At over six standard deviations this is the biggest move ever and whether efficient market followers or Trichet stability hypothesis worshipers, this week's rip-fest must surely 'help' all those industrials in the world with their resource planning for the coming year/month/week/hour.
Q3 Advance GDP Prints At 2.5% In Line With Expectations; 100% Debt-To-GDP Threshold Postponed By 45 DaysAdvance Q3 was expected to print at 2.5%; it printed at 2.5%. Nothing too surprising in the constituent factors, aside from the fact that this was the biggest QoQ jump in GDP since Q4 2009. What drove it? A massive surge in PCE which increased from 0.5% to 1.72% as a portion of annualized GDP: in other words, as consumer confidence hit a near record low, and as the stock market plunged to 2011 lows, somehow Americans spent $130 billion annualized over and on top what they spent in Q2. In fact, standalone PCE was 2.4%, substantially higher than the forecast 1.9% and the previous 0.7%. Where this spending power came from, we would be delighted to know. Also notable is that the government contribution to Q3 annualized GDP was precisely 0.00% - the first time in 4 quarters in which it has not been a drag on "growth." In fact the only two growth detractors were Imports and a 1.08% drop due to change in Private Inventories, even though as we pointed out yesterday using another data series, Inventories just hit a new all time high. Probably the only actual news here is that total US GDP is now "suggested" to be $15,199 billion, up from $15,013. What this means is that the moment of 100% debt to GDP for the US has been pushed back from today, following the 7 Year auction, to a point in mid-December.
What is going on in Greek CDS is extremely important to watch, and take advantage of. Somehow CDS always attracts analogies to home insurance. It is most often written about in terms of being able to buy insurance on your neighbor's house and then set it on fire. I never thought that was a particularly good analogy, but now we have Greece on fire, and the insurance is potentially being cancelled. I remain bearish and doubt that this rally has much staying power since the plan doesn't actually fix anything, and it isn't even yet clear if it actually works in the near term. The sentiment has also changed dramatically and there are far more bulls than just a few days ago so the market is potentially now overbought. But for some long positions that play the technicals to maximum advantage I would target selling CDS where dealers are most vulnerable and the realization of what has happened in Greek CDS isn't fully priced.
We know that the latest plan for Greece revolves around a 50% haircut for private bonds (not to be confused with bonds held by the ECB, which will somehow exist in some Schrodingerian universe in which they are neither defaulted nor haircut). So far so good. It also means that very soon, the bulk of publicly traded private sector debt, of which there is about €200 billion will get a 50% cut. In the parlance of our bond times, this essentially means trading "flat" going forward, as we now have the terms of a bond transaction, and no further interest will be accrued (however this is merely speculation: there is obviously no detail). Which is why we present the entire Greek bond curve, which show that while bond maturing around 1 year from now have since jumped to just shy of the 50 cent on the dollar haircut level, bonds further down the curve are just not buying it and continue to trade in the 30s! In other words, while Europe may have convinced the EURUSD shorts that everything is fixed, Greek bondholders are certainly not convinced. Those who believe that the ECB will go ahead and carry through on its promise of a 50% haircut and no further, should be buying up the entire curve which trades below 50. We also wish them good luck. Stocks and algo driven FX may be fooled but the bond market certainly isn't. If anything, judging by prevalent values, even assuming some modest accrued interest, the bond market is expecting a final haircut of about 62%.
For those who have not been following, ISDA has released their updated Q&A on whether a 'voluntary' gun-to-my-head haircut of 50% is not a credit event. Nothing really new here but it clarifies much of what we have said with regard to their 'determinations' process and how they will defend their decision against a lot of very upset basis traders (who by the way were most supportive of both new issues and secondaries in the European sovereign market - well until now that is). And some persepctive: I don't believe that this "solution" has done that much and too many people are looking at sovereign CDS as a sign. I think as the news is digested, real details come out, Sovereign CDS will continue to gap tighter, bonds of Germany and France will continue to be weak, Italian and Spanish bonds will give up some of their gains, and CDS in MAIN and XOVER and IG will drift wider in response to moves in bonds rather than moves in sovereign CDS.
While this was surveyed before the earth-changing discussions last night, Bloomberg's Consumer Comfort Index hits its lowest level in over a month. We have pointed to the stable and low levels of consumer confidence/sentiment/comfort many times recently but today also sees expectations (a much more powerful indicator of potential spending) drop to its lowest since March 2009 and the current state of the economy at its lowest since Feb09 (which was the only print EVER lower than current). Of course the man-in-the-street will be overjoyed at the efforts of the EU and this will jump to meteoric levels next week - or perhaps it won't?
With actual economic data now largely irrelevant, and why should it be : "got a recession? There's an EFSF for that" it is hardly worth noting that the third notable economic data point of the day, the first being GDP which came in line on an inexplicable surge in consumer spending in Q3 despite an epic collapse in consumer confidence, and a drop in the market to 2011 lows; the second being the nth consecutive print in initial claims over 400, which was the pending home sales update from the NAR which printed at -4.6% on expectations of an increase of 0.4%, and down from last month's -1.2%. This is the third consecutive monthly slide in sales data, and merely adds to yesterday's near record drop in median home prices, once again simply confirming that the biggest source of US "wealth" housing still has a long way to drop. And while we ridicule him all the time, even the NAR's Larry Yun has figured out that operation twist and monetary policy in general is a failure: "The Federal Reserve evidently has been attempting to lower mortgage rates, yet more consumers are faced with taking out jumbo loans that carry higher interest rates." Speaking of Jumbo loans, PrimeX jumped earlier today on the European news, and has since been drifting lower. It will continue doing so once some semblance of rationality returns.
And So They Line Up At The Concessions Trough: "Irish Spy Opportunity" In Greek Debt Blue Light SpecialWhen sharing our kneejerk reaction to yesterday's latest European resolution, we pointed out the obvious: "Portugal, Ireland, Spain and Italy will promptly commence sabotaging their economies (just like Greece) simply to get the same debt Blue Light special as Greece." Sure enough, 6 hours later Bloomberg is out with the appropriately titled: "Irish Spy Reward Opportunity in Greece’s Debt Hole." Bloomberg notes that Ireland has not even waited for the ink to be dry before sending out feelers on just what the possible "rewards" may be: "Greece’s failure to cut spending and boost revenue by enough to meet targets set by the European Union and International Monetary Fund prompted bondholders to accept a 50 percent loss on its debt. While Ireland won’t seek debt discounts, the government might pursue other relief given to Greece, including cheaper interest payments on aid and longer to repay it, according to a person familiar with the matter who declined to be identified as no final decision has been taken." There is one very important addition here: "While Ireland won't seek debt discounts" yet. And seek it will: after all, all Ireland needs is for its economy to mysteriously resume its deterioration. Purposefully. Impossible you say? Well, maybe. Or maybe the tricky Irish statistical bureau can just pull a page from their Greek colleagues on just how this is done. And Ireland is just the beginning. Very soon, and by that we mean 24-48 hours, every country in Europe that is undergoing "austerity" (which in Italy's case means increase the retirement age by 2 years over the next 15 years, or 49 days per year), will see its striking (and rioting) fringe elements demand just the same that Greece got, and probably far more. Which then goes right back to the question: yes, French exposure to Greek banks is limited. But what about Irish, Portugues, Spanish and finally Italian exposure? Will that be something to be a little more worried about?
In the original, July 21st proposal, the IIF assumed a 3.8% discount rate on the 30 year zero, and a 9% discount rate on the Greek flows. According to my little spreadsheet, that created an NPV of 78.9% - pretty much what they said. So that is how they calculated a 21% haircut. So what would the absolute most egregious way to say they are taking a bigger discount? If they ran the NPV with a rate of 4.25% for the zero (French 30 year zeros were trading at 4.1% yield yesterday according to Bloomberg) and they ran the Greek flows at a "less normalized" 20%, then guess what, the same bonds as July 21 would have an NPV of 50%.