Credit Markets
JGB Rallies Back to Former Support – And Turns Down
We may just have seen what is known as a 'good-bye kiss' among technical traders in the JGB market. The JGB contract rallied back to its former lateral support at the 143 level overnight and then turned back down from there. Below is a chart illustrating the action. We hasten to add that it is still too early to call this a definitive breakdown, but it is something we are watching closely. We continue to believe that the whole world should keep its eyes glued to this market – it is the most likely source of trouble for the current 'happy consensus':
JGB, one hour chart: a classic 'good-bye kiss'? – click to enlarge.
On the long term monthly continuous chart of the nearby JGB futures contract we can see that an uptrend line that has been in force for several years has now been slightly violated. It is only a small warning sign thus far, but this market could well do the unexpected and eventually make a very big move (a non-linear hyper-volatility event is what we are thinking of here).
The JGB's price history since the bursting of Japan's bubble in 1989: the uptrend from 2006-2013 has now been violated ever so slightly – click to enlarge.
Deceptive Calm Continues
Italy finally has a new prime minister, Enrico Letta, who is expected to be supported both the center-left (its leader Bersani has recently resigned, as he was unable to get the bloc to vote for his choices for the job of president) and Berlusconi's center-right coalition. Apparently this has given fresh impetus to the buying of peripheral bonds in the euro area. Consequently, credit default swaps and other measures of systemic stress remain subdued. However, there are still technical divergences that must be considered worrisome and inflation expectations in Europe continue to plunge (this is often a precursor to credit stress). Moreover, safe haven debt continues to enjoy a good bid. We ask again, if everything is truly fine, then why is this so? Something obviously does not compute here.
Monetary Instability a la China
Mish posted an article on China's PMI data and economy yesterday in which it was mentioned that after a huge credit expansion in January, the People's Bank of China has just effected the biggest weekly drain of money from the system ever.
In order to give readers an idea about the open market operations of the PBoC (mostly bill sales and repos) here is a recent chart thereof that shows the drain Mish is referring to (the next update will be available on Thursday). The chart looks like the EKG of someone about to suffer cardiac arrest:
China: open market operations by the central bank. A positive number means liquidity is injected, a negative one indicates a liquidity draining. The index is constructed from bill sales, and repo/reverse repo activities.
The World is Still Turning…Surprisingly Enough
In mid December we issued a warning that the EU's chief living contrary indicator had piped up again – normally a sign that it is high time to batten down the hatches. We referred to him as the 'harbinger of doom' – EU economic and monetary affairs commissioner Olli Rehn, so to speak the chief central planning bureaucrat in Brussels.
Of course the economy needs neither a 'commissioner' nor a 'minister' to function smoothly. In fact, as a general rule, economies tend to function better without such people.
Hence, when Ludwig von Mises was once asked what his first offical act would consist of if he were appointed 'economics minister', his reply was:
“Resign.”
A Premature Victory Lap?
Has Draghi Won the Battle with Financial Markets? – an article at CNBC asks, expressing the hope that he has, but also a bit of unease over the possibility that more trouble may be coming down the pike. Generally the reportage on Thursday's ECB meeting and the decision to stand pat on the paltry 0.75 percent refinance rate was similarly tinged across the financial media. With the “battle against the markets” seemingly won, Draghi could now “afford” not to cut his almost non-existent benchmark rate even further toward non-existence. Instead, he could now “keep some of his powder dry”, just in case those unruly markets were to pipe up again. The mood is best exemplified by this excerpt from the CNBC article:
“Kathy Lien, managing director at BK Asset Management in New York, says investors realize that Draghi's satisfaction with improvements in financial markets means the ECB is less inclined to ramp up stimulus measures.
"With financial market sentiment improving significantly, tail risks removed and funding conditions at satisfactory levels, Draghi believes that the financial markets have now returned to normalcy," she said in a research note.
"The main takeaway from the meeting is that the ECB is no longer in crisis fighting mode because the battle with the financial markets has been won," she said.”
Selected Credit Market and Other Charts
We haven't done a chart update in quite a while, mainly because nothing particularly interesting has happened in euro-land credit markets of late. However, below is an update of a small selection of our usual suspects in order to provide some orientation - i.e., to show where things stand at this juncture.
It is still not possible for us to ascertain definitively whether CDS on euro-land sovereigns have lost their signaling function with the ban on 'naked' trading. This will only become evident once the next wave of the crisis begins, something that could e.g. be triggered by one or more of the countries that are currently on the edge missing their deficit targets next year, or unexpected political complications (Italy's upcoming election could for example be a trigger for such).
It had to happen…Moody's Strikes Back
Not a week after the EU announced new rules designed to muzzle the rating agencies with regard to issuing unsolicited ratings of tottering sovereigns in the euro area (see: “Shooting the Messenger”), Moody's has struck back.
One big problem of the euro area's bailout vehicles has always been their circularity. In this they have certain similarities with the circularity that is part and parcel of the fiat money system as such, but there is an added factor in the case of ESM and EFSF, namely that the ECB's support of their operations is not an a priori given (although it may be considered as such from a practical standpoint).
Though Shalt Not Sell Toxic Rembrandts
Apparently a few banks weren't aware of this commandment and went ahead and sold those Rembrandts anyway. Unfortunately these weren't works of the renowned Dutch painter, which would probably have proved to be a reasonably good investment for the buyers.
In this case we are talking about 'structured notes' that went from 'AAA' to 'toxic crap' in a split second during the financial crisis. The widely derided ratings the big three credit rating agencies so liberally granted to 'senior tranches' of CDO's backed with sub-prime debt and other complex derivatives based on their models (the 'even under the worst possible scenarios these senior tranches will always be safe' type of models) are these days belatedly meeting with the displeasure of the courts. Both the credit agencies and the banks/financial services companies that sold the paper are now on the hook for losses they inflicted on investors. An adverse decision in such a case comes to us from Australia, and it could lead to major changes:
“Standard & Poor’s misled investors by giving its highest credit grade to securities whose value plunged during the global financial crisis, an Australian judge ruled. The ratings company said it will appeal.
S&P was “misleading and deceptive” in its rating of two structured debt issues in 2006, Federal Court Justice Jayne Jagot said in her ruling released today in Sydney. The Australian municipalities that brought the case are entitled to damages from S&P and two other defendants, ABN Amro Bank NV and Local Government Financial Services Pty., she ruled.Twelve Australian councils claimed they lost more than 90 percent of the A$16 million ($16.6 million) they invested in so- called Rembrandt notes rated AAA by S&P and linked to credit- default swaps on investment grade companies. The repackaging of debt into securities with top rankings from S&P and other rating companies contributed to more than $2 trillion in losses and writedowns as Lehman Brothers Holdings Inc. collapsed in 2008 and the world fell into recession.
“This is the first time that a ratings agency has been held liable for their opinion in this way,” said Harald Scheule, as associate professor of finance at the University of Technology Sydney. It may spur efforts to move the industry toward a model in which consumers instead of issuers pay for credit opinions, he said.
The 1,459-page ruling is a “major blow to the ratings agencies, which for years have had the benefit of profiting from the assignment of these ratings,” Amanda Banton, a partner at law firm Piper Alderman, which represents the councils, said in an e-mailed statement. It will promote transparency in the ratings process, she said.
Defections from PASOK begin
We recently voiced our hunch that the Greek government would find it difficult to keep all MP's in line on the labor reform vote. The first defection from PASOK was indeed announced yesterday:
„Greek lawmaker Michalis Kassis quit the co-ruling Socialist PASOK party on Thursday in protest at austerity measures, adding pressure on the governing coalition before an important parliamentary vote next week on contested reforms[…]
Kassis's departure was the latest setback for PASOK, beset with infighting since being thrashed in the June national election. PASOK has seen its support among voters sink to all-time lows over its support for unpopular austerity steps.
"I am now an independent member of parliament. I do not belong to PASOK," Kassis was quoted as saying by the semi-official Athens News Agency.
His exit cut the majority held by PASOK and its ruling partner New Democracy to 159 in the 300-seat house. It came a day after the two parties narrowly pushed through a privatization law after several PASOK deputies voted against it.“
Credit Market Charts
Below is our customary update of credit market charts: CDS on various sovereign debtors and banks, bond yields, euro basis swaps and a few other charts. 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 Friday's close.
The Moving Target Keeps Moving At Breakneck Speed
To no-one's surprise, non-performing loans in Spain's banking system expanded by a huge 0.60% in just one month, to a new record high of €178.6 billion, or 10.5% of all outstanding loans.
This highlights one of the problems with the cost of the putative bailout of Spain's banking system that we have frequently highlighted: it remains a moving target – and a fast moving one at that. As WBP online remarks on this:
„Analysts cannot agree on the adverse-scenario likelihood, as the Bank of Spain says its probability is 1%, while analysts at Nomura and Citigroup say spending cuts and economic conditions mean the worst-case outcome already looks feasible.
“You can’t attach a 1% probability to a scenario that already looks realistic,” said Silvio Peruzzo, a European area economist at Nomura in London, in a telephone interview with Bloomberg on Wednesday.
The European Commission estimates Spain's gross domestic product (GDP) will shrink 1.8% this year and remain in contraction in 2013 with the GDP dropping 0.3%. A deeper recession raises the risk that banks will have to find more capital to cover losses.“
A Signal Loses Its Significance
As a friend recently reminded us, the charts of credit default swaps (CDS) on sovereign debt in the euro area that we are regularly updating in these pages may no longer be indicative of the underlying reality of market perceptions.
This is so because the EU's bureaucrats, in their ongoing attempts to manipulate markets, have issued a ban on so-called 'naked' trading in CDS. This means that speculators are no longer allowed to buy and sell CDS contracts to merely express their opinion. Unless one holds the underlying bonds, one will no longer be allowed to trade these credit instruments from November 1 onward.
Instead, trading in them now takes place only 'by appointment', as every trade must be sanctioned by the EU's bureaucrats. A buyer or seller of CDS must now be able to “prove that a CDS position is a hedge, showing correlations (both quantitative and qualitative)”.
Not surprisingly, liquidity in the CDS markets is evaporating as a result of these new regulations and we can probably no longer rely on these markets to give us relevant signals (we will however continue to keep an eye on them to see what develops).
5 year CDS on the sovereign debt of Portugal, Italy, Greece and Spain – with hedge funds no longer able to trade these instruments unless they hold the underlying bonds, liquidity in these markets is drying up and the quality of their price signals comes into doubt.
Credit Market Charts
Below is a selection of our customary update of credit market charts: CDS on various sovereign debtors and banks, bond yields, euro basis swaps, plus a few other charts. 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 Friday's close.
Bailout Application Expected by November
Markets are allegedly 'disappointed' that Spain hasn't asked for a bailout yet. Reuters for instance reports that the fact that it didn't do so over this weekend was a reason for the euro to drop in early Asian trading. Yeah, right. At the time of writing the drop had somehow magically reversed, although still no bailout application had been lodged – not least because it was still nighttime in Spain.
Nevertheless, many observers apparently agree that the application will come by November at the latest. There are a few obstacles to consider however: Read the rest of this entry »
PIK Toggle Bonds Are Back – Batten Down the Hatches
You can't keep a bad idea down, especially not when the central bank is promising to stuff gobs of freshly printed money into the economy at the pretend cost of zero for as far as the eye can see.
Readers are probably well aware of the massive 'hunt for yield' that has been in train since the panic lows of 2009. Retail investors have shifted enormous amounts from equity into bond funds, a process that is ongoing at breakneck speed according to the latest ICI fund flow data.
Unfortunately these fund flows are only broken up into 'taxable' and 'municipal' types at ICI's site, so we cannot ascertain from the data how much money is rushing into junk, but it is probably fair to assume that it is a sizable percentage of the total. There is certainly heavy trading volume in representative ETF's like JNK, although this particular vehicle hasn't really gone anywhere in some time:
A long term chart of JNK – lots of churning, but essentially no capital gains since 2010 (the fund does pay a sizable dividend yield of 6.94% at present) – click for better resolution.
In the short term the ETF has seen a good rally, joining other 'risk assets' in anticipation of more 'QE', but ever since the latest iteration of money printing has been announced it has stalled out, once again in sympathy with other 'risk assets'. Given that Ben Bernanke has made explicit that the support of asset prices is one of the goals of 'QE' (an interesting widening of the ambit of the Fed's mandate as it were), we can regard the most recent version of it as a failure thus far – from the point of view of the planners that is (that may of course still change). If an unmentioned subsidiary goal was to saddle the economy with large dollops of dubious debt, then the policy is an unqualified success.
JNK has rallied quite a bit since the May low, but has stalled out since 'QE3' was announced – click for better resolution.
Euro Area – The Issue of Compliance
A topic we have frequently discussed in this pages has now made it into the mainstream press: namely the question in what way the new 'fiscal compact' is actually different from the Maastricht treaty when it comes to enforcing compliance. It turns out, there really isn't any difference, and it is for the very same reasons that stood in the way of countries respecting the Maastrich treaty's limits.
Der Spiegel reports:
„The EU plans to enforce its rules by imposing tough penalties in the future. But experience suggests it won't be able to gets its way against major EU countries. Even the much-vaunted fiscal pact pushed through by Chancellor Angela Merkel to underpin the euro is at risk of being watered down. When it comes to publicly urging greater integration, most European leaders aren't to be outdone.
"We need more Europe, not less," says German Chancellor Angela Merkel. "We don't need less Europe, but rather more intelligent integration," contends Luxembourg Prime Minister Jean-Claude Juncker. And French President François Hollande says: "We realize that the euro zone must have a common economic policy."
Herman Van Rompuy appears to take these affirmations literally. At next week's European Union summit, the EU Council President intends to present a bold concept to fundamentally restructure the monetary union. According to this proposal, the European Commission, the EU's executive, would gain the right not only to recommend amendments to national draft budgets, but also to enforce them. If a government resists, the Brussels-based institution would have the power to impose fines.
In many European capitals, though, Van Rompuy's reform plans are controversial. Indeed, many politicians have been put off by the numerous rules and regulations that Brussels has already used to intervene in the economic policies of crisis-stricken countries. Until now, the threat of EU sanctions has mainly been confined to smaller member states.
For instance, early this year the Commission threatened to suspend subsidies for Hungary. Shortly thereafter, the nationalist Hungarian prime minister, Viktor Orbán, gave in to Brussels' demands. After all, 97 percent of all public investment in his country is financed to a significant degree by the EU.
By contrast, large countries such as Spain, Italy and France have so far had little to fear. Olli Rehn, the European commissioner for economic and monetary affairs in Brussels, knows better than to antagonize certain countries by imposing sanctions.“
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