Credit Markets


The 'Great Stretch'

Last week the Greek government celebrated its return to the bond market, selling 3 billion euros in five-year bonds at a yield of 4.95 percent. Reportedly there was great demand for the issue, which should be no surprise given the current propensity of investors to buy all sorts of junk debt as long as it yields more than just a smidgen.

Reuters report on the backdrop that made this successful auction possible:


“Call it the Great Stretch. Two years ago, Greece's debt crisis almost brought the euro zone crashing down. Now European partners are preparing to ease Athens' debt burden without writing off their loans but by stretching them out into the distant future, extending maturities from 30 to 50 years and further cutting some interest rates, EU officials say.

Greece made a successful, if artificially engineered, return to the long-term capital markets last week for the first time since its international bailout in 2010, and just two years after imposing heavy losses on its private creditors.

But with its economy shattered, the country is still a long way from being able to fund itself unassisted in the market. The International Monetary Fund says Greece is likely to need further financial help from the euro zone over the next two years.

One reason why the sale of 3 billion euros in five-year bonds at a yield of 4.95 percent went so smoothly, on the eve of a support visit by German Chancellor Angela Merkel, was that investors are widely anticipating official debt relief.

"That has been quite substantially priced in, and the market is also expecting Greece to be quickly upgraded by the credit rating agencies," said Alessandro Giansanti, senior rate strategist at ING bank in Amsterdam.

"In a second stage, the market is also expecting a reduction in principal on official debt, and no private sector involvement (write-down) in the coming years," he said.

Whether such expectations are fully realized will only become clear later this year, when negotiations start with the euro zone and the IMF on Greece's longer-term funding, and the end of its wrenching bailout program.

But EU leaders share an interest in helping conservative Prime Minister Antonis Samaras' shaky coalition cling to office rather than seeing leftist anti-bailout firebrand Alexis Tsipras sweep to power demanding a massive debt write-off.”


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A Large Real Estate Developer Collapses

The bond default of solar company Chaori apparently was just the proverbial canary in the coal mine. As we pointed out last week, it struck us as rather troubling that analysts didn't seem to take the Chaori default very seriously. It is worth repeating a quote from a Financial Times article in this context:


Rather than billing Chaori as an alarm bell in the credit markets, many analysts see it as a trial balloon being floated by the authorities as they seek ways to cut overcapacity in certain sectors of the economy.

“The government is trying to send a signal to the market that there are risks to buying investments. They are doing it carefully,” said Christopher Lee at Standard & Poor’s. “This company is so small and in trouble anyway – even if it defaults it is not going to impact the market much.”


(emphasis added)

In view of the sheer size of China's credit and real estate bubble and the many signs pointing to a perfect storm being on its way, such comments seem quite naïve. A slightly bigger flesh wound is now about to be inflicted. According to Bloomberg:


“A closely held Chinese real estate developer with 3.5 billion yuan ($566.6 million) of debt has collapsed and its largest shareholder was detained, government officials familiar with the matter said yesterday.

Zhejiang Xingrun Real Estate Co. doesn’t have enough cash to repay creditors that include more than 15 banks, with China Construction Bank Corp. (939) holding more than 1 billion yuan of its debt, according to the officials, who asked not to be named because they weren’t authorized to discuss the matter. The company’s majority shareholder and his son, its legal representative, have been detained and face charges of illegal fundraising, the officials said.

The collapse of the company, based in the eastern town of Fenghua, adds to concern of strains in the nation’s real estate sector and comes less than two weeks after the first bond default by a Chinese company. Shanghai Chaori Solar Energy Science & Technology Co.’s inability to repay its debt may become China’s own “Bear Stearns moment,” prompting investors to reassess credit risks as they did after the U.S. securities firm was rescued in 2008, Bank of America Corp. said March 5.

“Chinese developers are extremely exposed to the easy credit that is used to finance purchases and investment,” said Patrick Chovanec, the New York-based chief strategist at Silvercrest Asset Management Group LLC, which oversees $14.1 billion in asset, by phone. “When credit is reined in even slightly, it undercuts demand. This is potentially an inflection point.”


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The First $3 Billion of a Ukraine Bailout Immediately Go to Russia

This is really too funny. Apparently, the Ukraine owes $3 billion to Russia in bonds that have been issued under UK law. One of the stipulations of the bonds is that if the Ukraine's debt-to-GDP ratio should exceed 60%, the bonds will become immediately callable.

Once the Ukraine gets funding from the IMF,  this is of course going to happen right away – its debt-to-GDP ratio will then most definitely exceed 60%, so the first $3 billion of any aid the Ukraine receives in the form of loans will right away flow into Russia's coffers.

Of course there may be litigation first, but as Greek bondholders have found out, all those who held bonds issued under UK law were actually paid in full, while everybody else had to accept the 'PSI' and could basically go pound sand.

Of course it was all 'voluntary', but funny enough, the holders of Greek bonds issued under UK law didn't turn out to be as altruistic as all the other ones. At least we have not heard of any 'voluntary' contributions made by them. It seems rather doubtful that Mr. Putin will be eager to become a voluntary contributor to bailing out a government which he deems illegitimate. Instead he's going to take his money and run – or alternatively, make as-of-yet unspecified demands.

According to NBC:


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Rising Interest Rates Spoil the Party

I originally wrote this in September 2013. It is just as relevant now in December.

The big news in America is that the rate on the 10-year Treasury bond has risen dramatically from around 1.6% to over 2.9%. This is 130 basis points from a starting point of 160, or an increase of more than 80%!



Keith chart-1Via Bloomberg – click to enlarge.


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Euro Area Credit Markets Remain Calm, But …

Below is an update of the usual suspects, CDS on sovereign debt, euro basis swaps and a few other charts (keep in mind that 4-in-1 charts use different scales, which are identified by colors).

No-one seems to be worried in euro-land at present, in spite of the continued increase in various sovereign debtbergs.  There is however a small degree of concern visible in Slovenia, which is going through a political crisis. As Reuters reported last week:


“A dispute over the leadership of Slovenia's ruling party erupted on Wednesday, posing a threat to the euro zone state's four-party coalition government and its efforts to avert an international bailout.

The mayor of Slovenia's capital Ljubljana, Zoran Jankovic, announced he would run for the leadership of the center-left Positive Slovenia (PS), the main ruling party, in a move that prompted dismay among the other coalition parties. Jankovic, who set up the PS in 2011, resigned from its helm in February, enabling his successor, Alenka Bratusek, to form a coalition government with the three other parties and to become prime minister of the tiny Alpine country.

The parties had refused to join a coalition if Jankovic remained PS leader. They cited a state anti-corruption commission report which said in January Jankovic could not explain the origin of a big part of his income in past years. "I decided to be a candidate for the president of Positive Slovenia. This was a difficult decision. I will explain my reasons… at the congress," Jankovic told a news conference, referring to a party gathering planned for October 19. Bratusek has said she will seek re-election as PS leader.

"This is not good for Slovenia. Jankovic has a better chance of winning and if that happens the government will collapse," said Meta Roglic, a political analyst at daily Dnevnik.”


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SPX Retakes 50 dma

Yesterday's move in the SPX back above the 50 day moving average bore a very close resemblance to the last occurrence in early July. As the chart below shows, both the price movements prior to the break, MACD and the relative position of the 20 day moving average looked almost exactly similar:



SPXSPX: regaining the 50 day moving average in a similar manner as in early July – click to enlarge.



Different Levels of Bullishness Displayed in Positioning/Sentiment Data

What is different are a number of ancillary data. For instance, there is far more enthusiasm about this move in the option pits than there was last time around, but there is less bullishness detectable in sentiment surveys. This may be partly due to the relative strength in technology shares, which never really corrected much. The options of many big cap tech stocks are quite heavily traded.


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A Little Goosing of the Money Supply and the World is Alright Again

We have pointed out for several months in these pages that the increase in the euro area's true money supply (+8% year-on-year) would likely produce further improvements in PMI data and other measures of economic activity in the euro zone. See for instance our June 5 article Euro-Area PMI Data Improve as Money Supply Growth Accelerates”.

This is not rocket science to be sure, but we have noticed that very few economists actually look at these data. In fact, if they look at monetary developments at all, most of them employ money supply measures that are essentially useless, as they include components that are not money. This is why they are continually 'surprised' when economic data are released.


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An Update of Selected Charts

We haven't done a chart update of this sort for quite some time, so in order to quickly show the most important recent developments, here is one. Below are charts of CDS on various sovereign debtors and banks, bond yields, euro basis swaps as well as a few other charts of interest. Charts and price scales are color coded (readers should keep the different price scales in mind when assessing 4-in-1 charts). Where necessary we have provided a legend for the color coding below the charts. Prices are as of Tuesday's close.


The Eerie Calm

A brief comment: in the euro area, the eerie calm continues (as we noted previously, the euro area may just be resting a moment to catch its death). Exceptions are Portugal and Slovenia, both of which have seen their 5 year CDS spreads spike recently, although they are already drifting lower again from their recent highs. However, both countries obviously still have problems, even if the markets are  not overly worried about them at the moment. Edward Hugh recently remarked in an e-mail exchange that he believes the highest risk in the periphery is now of a political nature, a point which we have frequently stressed as well and which has briefly come to the market's attention when two ministers resigned abruptly from Pedro Passos Coelho's cabinet in Portugal. 

As we have pointed out in our most recent missive on Greece, there are a few initial signs that the peripheral countries are seeing a smidgen of light at the end of the tunnel, but progress is very slow and the social strains continue to be severe. Not only that, what progress there has been could be easily wiped out again by an intensification of the problems experienced by the banking systems in these countries, especially Portugal's and Spain's.

Note that there is some movement now in Ireland, where banks after a long period of tolerating 'strategic defaults' by homeowners are beginning to initiate foreclosures at an accelerated pace. Once again, this could prove politically explosive.

Lastly, we continue to believe that the markets are way too sanguine about Italy. Contrary to the remaining 'PIGS' (Portugal, Ireland, Greece and Spain), Italy has seen no improvement in its unit labor costs.  Its public debt continues to rise, even while the government resorts to cosmetic and almost comical measures such as slightly reducing the car fleet of its ministers (don't get us wrong, it is certainly a good idea, but it represents not even a drop in the ocean of Italy's public debt). In Italy the political situation is also not exactly stable now that the Cavaliere is under growing pressure to quit.



On to the charts:


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Political Risk Threatens to Reignite Crisis in Europe

It couldn't come at a more inopportune moment: the crisis that is increasingly engulfing Mariano Rajoy, and the mounting legal troubles besetting Silvio Berlusconi, the realization that Portugal's crisis remains intractable and Greece  careening toward another summer of discontent (even as the tourism industry is recovering slightly), as civil servants and their unions gear up to fight the latest troika-imposed cuts. The moment is so inopportune because Olli Rehn and others have to once again fear for their summer vacation. Euro area crises  have an odd habit of flaring up in the middle of the summer.

Rajoy's troubles, as some speculate, may actually be the result of a kind of palace coup: apparently there are factions within the PP that want to be caliph instead of the caliph. No-one ever doubted that Spain's politics were riddled with corruption, so the main question should actually be: 'why is it all coming to light all of a sudden'? After all, if former PP treasurer Louis Barcenas is to be believed, the particular scams he and his buddies were engaged in went on for 20 years running. Former prime minister Jose Maria Aznar has been mentioned as a possible culprit, but he too is on the 'Barcenas list' of receivers. Others suspect that the Most Excellent Countess of Bornos, Esperanza Aguirre y Gil de Biedma, the former president of Madrid, may have a hand in the proceedings, since she isn't implicated and is loudly calling for a clean-up of the party.



Somewhere in the PP, there is an Iznogoud lying in wait.

(Tabary, Goscinny)


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Abe Seeks 'Redemption'

Shinzo Abe, father of the latest attempt to 'reflate' the Japanese economy by devaluing the money issued by the BoJ and by government spending even more money it doesn't have, is said to be seeking 'personal redemption' by winning the upcoming upper house election.


“Japanese Prime Minister Shinzo Abe is a man with a mission: to erase the bitter stain of defeat and attain personal political redemption with a victory in a national election this month.

With his Liberal Democratic Party-led coalition (LDP) back in power since December and all but assured of a handsome win in a July 21 poll for parliament's upper house, Abe might forgiven for slowing his pace a bit. But allies and critics agree the 58-year-old heir to an elite political family will not rest until the votes are counted and his ruling bloc is in control of the chamber, reversing a humiliating defeat that led to his resignation six years ago.

"I guess history is a turn of Fortune's wheel. The LDP led by Prime Minister Abe suffered a crushing defeat in the last (2007) upper house election, which led us to lose power," Abe's close ally Chief Cabinet Secretary Yoshihide Suga told a news conference last week as the official campaign commenced. "We must resolve the split in parliament through this upper house election. By doing so, Prime Minister Abe can finally get his revenge from the defeat of six years ago."

Upper house lawmakers serve six-year terms and half the seats are contested every three years, so the seats to be filled in the coming election are those that were at stake in 2007.

When he succeeded popular Prime Minister Junichiro Koizumi in September 2006, Abe – then aged 52 – had high support ratings. Ten troubled months later, his popularity eroded by scandals in his cabinet and public outrage over lost pension records, Abe led the LDP to its worst election defeat since it was founded in 1955.

He clung to power for another two months before suddenly quitting in the face of a deadlock in parliament, where the opposition-controlled upper house was blocking a key bill, and ill health due to a flare up of his chronic ulcerative colitis.

Two years and two more LDP prime ministers later, the LDP lost power to the novice Democratic Party of Japan in an historic 2009 lower house poll.

"The setback then has been deeply embedded in my heart," Abe told a news conference after parliament ended its session late last month. "I cannot lose the upper house election."


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Prominent Victims

Hegde fund legend Ray Dalio among other things runs a big fund that is called the 'All Weather Fund'. Its appeal is based on the idea that by holding different investments that will either profit from rising or falling inflation, it will deliver positive returns no matter what happens.

What the fund's managers obviously didn't expect was the scenario that has actually unfolded lately: inflation expectations are collapsing, and bond yields are shooting higher anyway. And so the 'All Weather' portfolio is now suddenly under the weather:


“A $70 billion portfolio managed by hedge fund titan Ray Dalio's Bridgewater Associates and widely held by many pension funds to survive stormy markets is emerging as a big loser in the recent selloff in global markets.

The Bridgewater All Weather Fund is down roughly 6 percent through this month and down 8 percent for the year, said two people familiar with the fund's performance.

The All Weather Fund is one of two big portfolios managed by Bridgewater and uses a so-called "risk parity" strategy that is supposed to make money for investors if bonds or stocks sell off, though not simultaneously. It is a popular investment option for many pension funds and has been marketed by Bridgewater and Wall Street banks as way to hedge market turmoil.

Bridgewater created a portfolio based on two of the four basic economic scenarios: rising growth, falling growth, rising inflation, falling inflation. Different types of assets do well in each of these scenarios and the all-weather portfolio contemplates spreading its risk evenly.

But money managers familiar with the strategy said it does not perform when both stock and bond prices tumble, as global markets have experienced in recent weeks.


The All Weather fund invests heavily in Treasury inflation protected securities, or TIPS, which have lost 4.5 percent in June and over 8.26 percent year-to-date. In fact, the All Weather fund, launched in 1996, was a leader in investing in inflation-protected bonds.

Rick Nelson, chief investment officer for Commonfund, with $25 billion under management for endowments and foundations, said his firm has avoided putting clients into risk parity funds because there are better ways to manage risk.

He said risk parity funds tend to "use a great deal of leverage on the fixed income side" and that can magnify losses. Nelson was not commenting specifically on All Weather because Commonfund has no money with Bridgewater.”


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Greek Disturbance

Apparently, the PASOK and DIMAR parties, the junior coalition partners in Greece's government, are pondering whether early elections would be preferable to being seen as complicit in shutting down the State-owned television station, which has proved to be a rather unpopular decision.

According to To Vima, the 'government is in jeopardy' (this follows on the heels of earlier denials by Venizelos):


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CDS Spreads Increase Along with Yields

In recent days some CDS spreads on euro area sovereigns and neighboring countries have begun to rise a bit. In recent months all such bounces have proved transitory, but there is always a chance that this changes  again – not least as euro area governments recently insist that the faux 'austerity' period is over. Middle Eastern countries and Turkey have experienced a small increase in CDS spreads as well, presumably on account of the recent unrest in Turkey. A small selection of CDS and other data is below.


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Yields Begin to Rise

Over the past two weeks, treasury note yields have risen rather vigorously from a higher low. As a side effect of this, mortgage rates are now increasing in spite of Bernanke's truly massive purchases in that sector. Note that the Fed is not only adding $40 billion in mortgage related debt to its balance sheet per month, it is also replacing debt that matures. As a result, the purchases have exploded. In fact, the year-to-date purchases of agency debt amount to  $345 billion so far, which is a monthly run rate of $69 billion. Together with its treasury debt purchases, the Fed has therefore bought securities amounting to $113 billion per month this year (of course the replacement purchases do not increase the money supply, unless the old purchases were from banks and the new ones are from non-banks).

In any case, there has been a strong increase in yields, in spite of the fact that market-based 'inflation expectations' continue to decline in both the US and Europe.



10 year treasury yield, daily – click to enlarge.



10 year treasury note yield, weekly – click to enlarge.




Inflation expectations in the US (orange line) and euro-land (measured by comparing nominal yields to yields on 'inflation protected' bonds): apart from a small recent uptick, they continue to fall in both regions, and yet, nominal yields are now heading higher anyway – click to enlarge.


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Spending on Social Security and Debt Service Soars

We recently wrote about Shinzo Abe's desire to beef up Japan's military and alter the pacifist constitution to do so. Apart from the fact that this will divert scarce resources into wasteful lines of production that do little more than increase the probability of war,  an important question is: how will he pay for it? Consider the recent trends in government spending in Japan. We have discussed this topic before, but have recently found a chart that illustrates the central fiscal problem nicely.





Japanese government expenditures

The growth in Japan's government spending per category since 1960 (source: Japan's MoF). The two largest and fastest growing items are spending on social security and debt service. Defense spending is fairly small slice of the overall spending pie, and now Abe wants push its rate of growth up as well – click to enlarge.


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