James Grant: The Fed Manipulates Rates All the Time

Saturday, July 14th, 2012

The Federal Reserve and other central banks manipulate interest rates every day, James Grant of Grant’s Interest Rate Observer told CNBC’s “Closing Bell” on Thursday. “The Fed is in the business of trying to manipulate markets, the macro economy, interest rates, unemployment and inflation through various monetary means, including the twisting around of yield curves and interest rates,” Grant said. Grant added, “The Federal Reserve fixes rates on principle. They have ‘operation twist’ that manipulates the credit markets. They have quantitative easing that manipulates bond yields.”

Tags: Bond Yields, Central Banks, Closing Bell, Cnbc, Credit Markets, Federal Reserve, Grant Federal, inflation, Interest Rate Observer, Interest Rates Unemployment, James Grant, Macro Economy, Principle, Quantitative Easing, Yield Curves
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David Rosenberg: “Despair Begets Hope”

Sunday, May 20th, 2012

Presenting the best weekly self-contrarian segment from everyone’s favorite Gluskin Sheff-based skeptic – David Rosenberg:

DESPAIR BEGETS HOPE

… Over half of the 2012 price advance has been reversed in barely over a month as the broad market drifts down to its lowest level since February 2nd. The Financial Times makes the point that the 10-day relative strength index at 29.2 is deeply into oversold territory. The Canadian TSX index is officially in bear market terrain, having declined 21% from its cycle high (posted in April last year) and is back to levels prevailing on October 2011.

Fading risk appetite is also underscored in the credit markets where BB-rated corporate spreads have widened to 450 basis points from the recent low of 420bps. Until we see some resolution to the latest round of euro area angst, one can reasonably expect spreads to widen further, but we would look at this as a nice buying opportunity as the link between the problems there and corporate default rates here is extremely loose. The fact that gold and other commodities are slipping while core government bond markets — gilts, bunds and Treasuries — are rallying strongly suggests that deflation risks are getting repriced into various asset classes. Greek bonds are trading at pennies right now and implicit probabilities in peripheral bond markets are highly discounting exits from the monetary union by year-end. Spanish bond yields have blown through 6% (Italy getting closer too) and 10-year spreads off Germany have hit a new record high of 485bps.

This is where the LTRO has proven to have actually been a dismal failure. Domestic banks used the program as a carry trade to play the yield curve and are now choking on losses on the sovereign government bonds they were enticed to buy. So thanks a lot, Mr. Draghi — ECB policies are at least partly responsible for why it is that euro area bank shares have sunk all the way back to March 2009 lows. Non-domestic investors have been dumping the peripheral government bonds just as the Italian and Spanish banks have been loading up — these foreign entities, we see in the FT, have been net sellers of Italian government bonds to the tune of 200 billion euros in the past nine months and 80 billion of Spanish debt over the same time frame. And guess what? They can unleash even more supply damage because they still own roughly 800 billion euros worth of combined bonds of both basket-case countries.

The most bizarre quote we have seen in quite a while came from a strategist in the FT. Get this:

We can take comfort from the fact that while the Greek electorate are against austerity, the support for staying within the eurozone is even stronger”.

I can replace that with this real-life comment:

We can take comfort from the fact that while my three sons are against doing their homework, the support for getting a passing grade is even stronger”.

How utterly lame.

If the Greeks want to stay in the eurozone, it’s probably because they know they can continue to suck at the teat of the Troika. More bailouts please and on easy terms since “austerity” is the new dirty nine-letter word globally.

The best lines actually came from the FT Lex column:

“All balled-out eurozone countries will ultimately have to decide whether they can make the fiscal adjustments and achieve economic growth more quickly in, or outside, the euro. That is where Greece now finds itself.”

Now that is a thoughtful comment.

There was another really good zinger in the Markets and Investing section. To wit:

“it’s naïve in the extreme to think you can limit the knock-on effect. As soon as Greece leaves or defaults, contagion will pass like a cannon going off in Spain”.

That was from an executive at a U.K. bank.

Arvind Subramanian penned a truly brilliant piece in the FT as well, titled Why Greece’s Exit Could Become the Eurozone’s Envy. In a nutshell, Greece’s challenge is that it is woefully uncompetitive and as such needs wages and prices to adjust sharply lower. You either do that organically or you devalue the currency — which then sharply boosts exports and fosters import substitution. Of course, the initial impact is recessionary and deflationary, but only for one to two years, if history is a guide, followed by a boom. This is exactly what happened to Asia a decade ago. As Arvind concludes, “the ongoing Greek tragedy could yet turn out not too badly for the Greeks. But tragedy it might well be for the eurozone and perhaps the European project”.

Indeed, the cost estimates I have seen published for the euro area would be in the neighbourhood of 400 billion euros — in terms of immediate direct financial losses. Second round impacts are far more difficult to assess, but would be enormous. While there are a myriad of legal complexities surrounding a Greek departure, it is not an impossible task. The bigger issue would be how the ECB would manage to ring-fence the banks in Portugal and Spain and prevent a contagion.

But let’s talk about what we do know with some certainty.

The Greeks voted against the status quo. It isn’t working for them. An election is likely around mid-June, and the party in the lead is dead-set against the initial bailout terms. The government, meanwhile, runs out of cash by early August when a bond payment comes due and that could well be the trigger for default and exit. It is tough to see this process being orderly — confusion, turmoil and volatility all come to mind. But if we do get a cathartic event, we will be able to buy assets for our client base at excellent prices. There always is a silver lining. You just have to find it.

We also know that Angela Merkel this far is not being swayed by her party’s recent electoral setbacks — at least that is the indication we are getting from her latest rhetoric.

Tags: Bond Yields, Broad Market, Bunds, Carry Trade, Credit Markets, David Rosenberg, Default Rates, Dismal Failure, Domestic Banks, Domestic Investors, Draghi, Financial Times, Gilts, Government Bond Markets, Government Bonds, Greek Bonds, Relative Strength Index, Risk Appetite, Sovereign Government, Yield Curve
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Flight From Risk: Treasury Plummets To Record Low Yield As Gold Surges

Thursday, May 17th, 2012

Now its getting interesting. 30Y yields fell the most in 5 months today back to 5 month lows, 10Y yields crashed to all-time closing lows, and Gold surged by its most in 4 months (and 2nd most in 7 months) as stocks started to accelerate lower. Gold is unch on the week now as 30Y is -21bps and 10Y -14bps – incredible. Between the Philly Fed’s confirmation of deceleration in US macro data and Europe’s increasingly crescendo-like implosion, is it any wonder that the decoupling thesis has given way to reality. S&P 500 e-mini futures repeated the early rally late fade pattern of the last 8 days but this time it was more aggressive as ES pushed towards 1300. CAT was a dog today accounting for 25% of the Dow’s losses and AAPL tumbled further – heading towards a 20% retracement off its highs. Financials tumbled further with Citi inching very close to red YTD (and JPM falling rapidly). Credit markets, which led the selloff, continue to slide but this time with equities in sync. Equities went out at their very lows of the day – at 3.5 month lows as VIX soared over 24% to close at its highest in 5 months.

Is BTFD DOA?

30Y Treasuries plunged but 10Y fell to record closing low yields!!!

and Gold is back near unch of ther week as the PMs soared today…

Financials are rapidly losing ground with Citi and JPM about to go red YTD…

Tags: 4 Months, 5 Months, 7 Months, Aapl, Confirmation, Credit Markets, Crescendo, Deceleration, Dow, Futures, Jpm, Losing Ground, Lows, Macro Data, Pms, Retracement, Selloff, Treasuries, Unch, Ytd
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Credit Markets – Transformers vs Decepticons (Tchir)

Wednesday, May 16th, 2012

by Peter Tchir, TF Market Advisors

In the movies there are these great battles fought out between the transformers and decepticons. As cool as the battles are, there must be some innocent bystanders wondering what the heck is going on amid all the destruction. That to me is how the credit markets are trading right now.

None of the core stories have changed. Europe is a mess and has gotten weaker. The U.S. economy is doing okay, and ZIRP is here to stay even if QE3 isn’t imminent. Into that already complex world we have thrown the JPM trade into the mix. There seems to be a battle between JPM and those against JPM. That battle is causing carnage across the credit markets. We are seeing big and weird moves on a regular basis. IG gaps out while stocks do nothing. MAIN goes wider while XOVER is tighter, only to go back to moving in lock-step. JNK saw its single biggest share redemption. Both HYG and JNK chug along all day only to have big fades late into the day. MUB has a steep drop only to bounce right back. Whatever battle between the big guys is going on drags everyone else into it. Stop losses are being hit. The price move is causing concern that this is just like 2011 again.

It isn’t like 2011 right now for a couple of key reasons. The transformers and decepticons aren’t battling over the fundamentals, they are battling over positioning. That is real and has consequences, but once that battle is over, the market will look at the fundamentals. So that is one key difference, that in addition to the usual fight between the bulls and the bears, this massive unwind, or potentially fake unwind, or unwind of the hedge of the alleged unwind, or something, is adding to the volatility and making the fixed income market seem more scary than it is.

LTRO is the other big difference. For all the talk about LTRO being a “carry” game to buy sovereign debt, LTRO at its core was designed to ensure that banks have enough money. While the debate rages about what Greece will do, and how bad the situation in Spain and Italy is, there is virtually no talk about banks not being able to fund themselves. People can look at 2 year swap spreads for signs of stress, and they are there, but be careful not to over-react. LTRO is there so that we don’t see a “run” on the banks. I doubt another LTRO would be created merely to try and support sovereign debt, but if there is a need to get money to banks, the ECB will do that. The ECB, without a doubt, is lender of last resort to banks, and is happy and able to fulfill that functions, so that is a big difference between now and 2011.

Greece leaving the Euro would be a big deal because of what it would do for all the corporate loans that have been made. That is yet another reason that leaving the Euro will take more time than people want to think. Even if it was easy at the sovereign level, which it isn’t, and the corporate level it has the potential to cause immense confusion. All of this can be addressed over time, but real plans need to be put in place and solutions to problems thought out, and some resources set aside to deal with unexpected problems. While that preparation is going on, look for the ECB, and the Troika to soften their tone as they decide that they cannot easily deal with the losses they would face on their own Greek exposure.

So, I would be looking to add exposure to credit, particularly U.S. high yield, and possibly in IG, as I think the market has been driven around too much by noise of this alleged unwind (I still think there is a real possibility that prior to the press conference JPM prepared themselves well for the obvious market reaction and is benefitting greatly from the widening and the volatility).

The fact that we tried to rally and then failed yesterday is a sign of how tenuous the overall market is, but right now I can’t help but think the same stories will have less of an effect, and that we are close to the point where Europe manages to take some steps that at least seem to help the problems, if not resolve them.

Tags: Big Guys, Carnage, Credit Markets, Decepticons, Enough Money, Fades, Fixed Income Market, Great Battles, Hyg, Innocent Bystanders, Jpm, Key Reasons, Mub, Price Move, Sovereign Debt, Steep Drop, Transformers, Volatility, Weird Moves, What The Heck
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Volatility is Back! (Tchir)

Saturday, April 14th, 2012

by Peter Tchir, TF Market Advisors

Volatility is back. The S&P moved more than 1% on 4 of the 5 days, had the biggest down day of the year, and even the least volatile day was a 0.7% move.

Back on April 5th, we saw a warning sign in the credit markets that the bid/offer spread for European CDX indices was widening. This has extended into investment grade indices in the US where not every dealer maintains a ½ bp market anymore. That lack of liquidity, which has also been a factor in the sovereign debt market (especially for Spain) has hit the equity markets as well. We are seeing bigger moves on less information. I believe that this volatility will continue in the short term and that we will see at least one big capitulation to the downside in equities. The Nasdaq seems more susceptible to such a move since it is still trading above the 50 day moving average.

European stocks underperformed. That is likely to continue. The problems in Spain and Italy will be directed much more towards European institutions, and banks in particular this time around. Generically I like being long US financials versus short European financials, because although the entire market will get dragged down by renewed problems in the Eurozone, the correlation will not be as high as last time.

The Whale

It is hard to talk about trading last week, particularly in the credit markets, and avoid the big JPM CIO trading story. I think that as details come out, the size of the position has been blown out of proportion. It will be much smaller than some of the headline numbers, and there will be long and short components and it will make a lot of sense both from a specific trade standpoint and also from a JPM business risk standpoint. I continue to believe that it is more in IG9 tranches, with hedges in HY, also possibly in tranches, and some curve trades.

In any case, the trade is still large and should raise concerns for regulators. The too big to fail argument is one obvious question that needs to be addressed. Is this trade for the “bank” or for the “investment bank”? For those looking for a much clearer segregation of the businesses run by JPM, this trade will be something they can point to. It is coming to light in a period of relative calm for the market, unprecedented support for banks from the Fed, and general disdain of bankers from the public in an election year. That could be what is needed to ignite a push towards a return to Glass Steagall or some other new legislation.

It may also be the straw that breaks the camel’s back in terms of pushing derivatives on to exchanges. This is something that should have been done immediately after Bear Stearns if not before, but for a variety of reasons (bank lobbyists) has been avoided up until now. The regulators should examine the whole chain of these trades. Who bought them and what they did with them? How many billions are sitting in mark to model books as opposed to having been traded? How much smaller would the trades been, and how much less would any distortion be, if every trade was on an exchange with a standard initial margin requirement and variation margin?

Regulators need to examine the whole series of trades, not just what JPM has on their books, and a renewed effort to develop proper exchange traded CDS needs to be done. None of the arguments against this have much credibility, as mark to model carries risk, and if the market has to shrink to support proper margin requirement, who really is hurt?

Jobs and Housing

The jobless claims this week were bad, plain and simple. I have seen arguments that more people quit, so it is “good” jobless claims, but since I have never seen a report detailing how many people were laid off but not eligible to make claims (which I think is a growing proportion of the workforce), I will largely ignore that positive spin.

Virtually every data point signals that the January and February reports overstated the real long term improvement in the economy. The jobs number is important, but mostly for what it could have meant to housing. Ultimately, we need the housing market to rebound to see the economy as a whole benefit, and that data lagged the job data all year long. The hopes were that somehow the jobs data was correct and housing would catch up. Now, it seems clear that housing was correct and jobs were overstated, so we may have a lot longer to wait for that housing recovery.

Without a housing recovery the market will struggle to go up much from here. It is too important of a sector, so it is hard to be bullish at these valuations with no real support from housing.

China and Europe

China disappointed this week. There is no landing yet so it is impossible to determine whether it will be “hard” or “soft”. I am leaning more and more towards hard, as I find it hard to believe the weak data reflects the whole truth, and there seems to be enough real concern about inflation in China and the state of the banks that more easing may be slow to come, and the pressure on the banks and property may come far faster than any new easing policy can stop.

Spain is in trouble. There is no liquidity for their bonds. Spanish 5 year and 2 year bonds now trade with higher yields than Italy. That was always the case in CDS, but the LTRO money and much smaller Spanish bond market had distorted that relationship in the cash markets. It is an ominous sign that those spreads have moved so much – as it shows that not only is LTRO no longer working for sovereign debt, but that the banks own too much and are better sellers if anything. The focus is on the 10 year, and the fact that it looks set to breach 6%, and that is bad, but this rapid normalization of the shorter end of the curve is possibly even more important.

Any fund that purchased these bonds leading up to LTRO2 is now facing a significant loss, and the lack of liquidity is scary. I do NOT think the ECB will step up in a meaningful way this week. The EFSF is supposed to take over secondary market purchases, and it is shameful that it doesn’t seem set up to do that yet, but there are other reasons that the ECB may not buy bonds. It is close to what it viewed as its limit for SMP, which leads to the obvious question of why didn’t they sell some bonds in the past month when the markets were hot? More importantly, the countries may not want the ECB to buy bonds if they are seriously considering a PSI. The ECB holdings were incredibly disruptive during the Greek debt negotiations and are the primary reason the restructuring has been a failure (any restructuring where the new bonds trade at 20% of par has to be deemed a failure). So don’t get too excited about possible ECB intervention.

There is some talk about Eurobonds (again) and various other possible programs to unite Europe, but I don’t see that happening any time soon. I think the strangest thing is that Spain agreed to 3% deficit target in the future. I never believed it would happen, but healthcare costs aren’t part of the Spanish deficit. No, in Spain, healthcare is largely a “regional” issue. That is why the regions are in such deep trouble. It is clear that no country in Europe counts for anything in the same way, and any of these “targets” is easily manipulated with some simple changes, and the use of “guarantees” as opposed to debt.

The Spanish debt load is looking like a “black hole”. You start with what seems a manageable sovereign debt to GDP ratio, but finally gravity is starting to pull regional guarantees, bank debt guarantees, off market swaps, and banks full of unrealized property losses, into the same spot. That “black hole” is not manageable and as realization hits, Spain can choose to struggle for years and capitulate down the road when things are much worse (like Greece did and Portugal is in the process of doing) or they can stop the nonsense and work out a proper debt restructuring plan now. This will hit European banks harder than any other sector.

The Outlook

I expect lower equity prices at some point this week. We may open with a bounce based on some IMF announcement or some ECB intervention, but this is why I think one more downleg:

• Spain in particular, and Italy to a less degree will weigh on the markets, dragging European bank shares down, and affecting the rest of the market
• Realization that the data in the US has been decidedly weak over the past month will finally overwhelm the market and those clinging to memories of January and February NFP
• QE in any of its myriad of forms is further away than the market currently priced in, the reaction to Yellen’s comments shows just how critical QE is to stock market valuation, but it is NOT critical to the economy and those concerned that it is actually hindering the economy are becoming more vocal, so QE expectations will take another hit
• Credit markets are becoming more volatile, less liquid, and not just in CDS and for banks, but across the board, this has been a consistent leading indicator of further weakness
• Weak data globally, and not just in the U.S. has been ignored so that will come into play making any sell-off that much worse
• AAPL. I have no real reason to dislike AAPL, but lots of “fast money” seems to be sitting on big profits and could choose to sell, and the price seems to have outrun what is actually being accomplished, it seems like it is being valued on I-Phone 7 sales, I-Pad 5 sales, and other future earnings while ignoring that everywhere I go, nothing is sold out or difficult to get – like it used to be. For this reason, I like Nasdaq to underperform. Also, if big companies start spending billions of their cash hoard in what might be viewed as a frivolous manner, then valuations for the entire sector can drop quickly.

As always we will see what the data comes up with, or whether any believable political, central bank, or supranational institution actions develop to change the view. I don’t expect anything dramatic, but could certainly see the S&P 500 pulling back towards its 100 DMA, now that is has breached the 50.

Copyright © TF Market Advisors

Tags: Business Risk, Capitulation, Correlation, Credit Markets, Day Of The Year, Debt Market, Downside, European Stocks, Eurozone, Hedges, Hy, Jpm, liquidity, Questio, Sovereign Debt, Standpoint, Tranches, Volatility, Warning Sign, Whale
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The Danger of HY ETF’s Trading at Discounts to NAV

Wednesday, April 11th, 2012

by Peter Tchir, TF Market Advisors

Alcoa helped the markets bounce back after the close, and some indications that the ECB may start buying bonds again helped the market even more. One company’s earnings don’t make a trend, and I am still concerned that earnings will be mediocre at best. Spanish bonds are already off their highs, and CDS never really moved on the back of the ECB stories. I remain skeptical that anything meaningful will be done, and now that we have the “ECB” rally out of the way, I expect to see the weakness resume. In the TFMkts Best Ideas which went out earlier, we liked adding to shorts this morning.

The fact that the High Yield ETF’s are trading at a discount should be a big concern to anyone in the high yield market, not just those who own the ETF. There is a real risk that this discount can translate into arb activity which leads to further declines.

With the ETF’s trading at a discount, the trade would be to sell bonds in the market and to buy shares. They would then deliver the shares to the ETF providers as a “redemption” and take the bonds to cover the ones they shorted. Although this has the appearance of being risk neutral, my experience is that it can become a big driver. I also don’t think many HY bond traders or ETF desks have seen this scenario play out in the credit markets. We saw a bit of it on the way up, many of the shares the ETF’s “created” were for ETF arb clients, but on the way up, where those participants were buying bonds, no one seemed to care much. In a downside scenario it can be far worse.

I will walk through a rough example of what used to happen in CDS with “index” arb, and I don’t see what it wouldn’t apply to the ETF’s if they remain at a discount.

Assume there are two virtually identical companies and most of the time their CDS trades roughly in line. Then one day you notice that over the past week, both went from trading at about 90, to one trading at 100, and the one that is in the index trading at 110. Many accounts will look at this and determine that it doesn’t make sense. They may sell protection on the name at 110 thinking the market has moved “too far too fast”. They may put a “pairs” trade on and buy the one at 100 and sell the other at 110. Neither are bad trades, but what they have missed, is the overall weakness in the market (that saw even the non index name to move 10 bps wider) has been priced into the CDX indices. They are say trading at 115, in spite of fair value being 110 for example. They tend to trade “rich” or “cheap” to fair value based on market sentiment. Hedgers in particular like to be “temporarily” short the liquid index, while retaining specific (and usually less liquid) credit bets.

The “index arb” clients will come in and pay 110 for the “index” name, while selling the index at 115 (it is more complicated than that, but that is the basic premise). The “arb” trader doesn’t care if 110 is a “good” or “fair” price for that CDS, they only care that they can buy all the names in the index at a spread tighter than where they can sell the index. That is it. They have no interest in buying the name that trades at 100. They only care about the richness or cheapness of the index versus the single names.

What tends to happen next, is hard to explain, but seems to happen all the time. The single name traders who sold protection feeling it had gone too far, start having difficulty finding sellers to take the other side. They are getting long credit risk. What do they do? They buy protection on the index because somehow it makes them feel better than just closing out their position. Effectively single name desks put on the opposite trade as the arbs. Doesn’t make sense, but happens all the time. So by buying the index as a hedge, they ensure that it continues to trade cheap, meaning that the index arbs will be back to buy more of the single name.

But why won’t others sell that name or put on the pairs trade? The problem here is that the spread between the index and non index name continues to widen. So after some decent sized arbs go through, the names now trade at 105 and 120. Anyone who sold at 110, thinking to make 10 to 20 bps, just lost 10 bps. What is the probability that a) they add more, b) they sit tight, or c) they get stopped out on some? I can almost guarantee that option a is the lowest probability. Similarly, anyone who put on the “pairs” trade at 10 bps, is now down 5 bps since the spread is 15 (and that ignores bid/offer). These people are more likely to add to the position, but even there, people start getting nervous that there is something really wrong with the one company. That fear creeps in. In credit, being wrong means instead of earning 1.1% per annum you lose 60%. That fear, whether rational or not, makes it difficult to find sellers of protection.

So the “cheapness” of the index feeds on itself and creates a feedback loop that drives all spreads wider. The index names get hit the worst, but everything moves. It doesn’t end usually until the index is at a level that new entrants come into the market to sell the index, which is not only at a good level, but very cheap to fair value.

I am very concerned that this same process can occur in the HY bond market and liquidity, as bad as it is in a strong market, is far worse in a down market. As of yet there is no sign that this is happening in a meaningful way, but JNK has seen outflows for a few days and HYG saw outflows yesterday.

Copyright © TF Market Advisors

Tags: Alcoa, Appearance, Arb, Bond Traders, Bonds, Credit Markets, Declines, Desks, Downside, Earnings, ECB, ETF, high yield, Hy, Participants, Rally, Redemption, S Trading, Tf, Trades
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Credit Plunge Signals “All is Not Well”

Tuesday, February 14th, 2012

European (like US) stocks remain in a narrow range just above the cliff of the unbelievably good NFP print of 2/3. US and European credit markets have lost significant ground since then and it seems equity investors just want to ignore this ‘uglier’ reality for now. The BE500 (Bloomberg’s broad European equity index) is unchanged from immediately after the NFP ‘jump’, investment grade credit is +10bps from its post-NFP tights, crossover (or high yield) credit is around 50bps wider, Subordinated financial credit is +50bps off its post-NFP wides at 382bps, and senior financial credit is an incredible 36bps wider at 225bps (by far the largest on a beta adjusted basis). The divergence is very large, increasing, and a week old now and perhaps most importantly as we look forward to LTRO Part Deux, LTRO-ridden banks have underperformed dramatically (40bps wider since 2/7 as opposed to non-LTRO banks which are only 10bps wider) – how’s that for a Stigma? Some ‘banks’ have suggested the underperformance of credit is due to ‘technicals’ from profit-taking in the CDS market – perhaps they should reflect on why there is profit-taking as opposed to relying on recency bias to maintain their bullish and self-interest positioning as the clear message across all of the credit asset class is – all is not well.

European financial credit is at over a two-week wide here and across the board credit markets have underperformed since the NFP print – perhaps they saw through the headline numbers?

European financial stocks ignored credit last week and then caught up, we now see the divergence growing dramatically. If nothing else, its an arbitrage opportunity but the drift in spreads is much more than technicals here and we suspect is a realization of the growing impact on the capital structure of banks of the ECB sucking up all the collateral supporting it (while capital is not exactly being raised hand over fist).

The most glaring divide remains the ‘stigma-trade’ where we have seen LTRO banks underperform dramatically (wider by 40bps) over non-LTRO banks (wider by only 10bps) and this is perhaps the key for why banks overall are underperforming.

Either way, it should be drastically clear to any and all (that choose to look and not ignore relaity in the interest of a fiat-currency-numeraire-based stock market ‘hoping’ for more printing) that all is not well in the Euro-zone. It is also not just Europe (as we have discussed for a week now) as high-yield credit in the US is also sending warning signals.

Charts: Bloomberg

Tags: Adjusted Basis, Arbitrage, asset class, Bias, Capital Structure, Credit Markets, Crossover, Divergence, Drift, ECB, Equity Index, Equity Investors, European Equity, financial stocks, Hand Over Fist, Investment Grade, Plunge, Realization, Self Interest, Stigma
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Bond Math: Duration Risk at the Zero Boundary

Thursday, February 9th, 2012

via Econompic Data

There seems to be lots of confusion surrounding Bill Gross’ latest Investment Outlook, Life and Death Proposition. First, some background of what Bill Gross stated…

Investors aren’t only concerned with credit risk (i.e. the ability to get paid back), but also duration risk (the risk of lending for an extended period of time in fear that rates may rise).
In Bill’s words:

What perhaps is not so often recognized is that liquidity can be trapped by the “price” of credit, in addition to its “risk.” Capitalism depends on risk-taking in several forms. Developers, homeowners, entrepreneurs of all shapes and sizes epitomize the riskiness of business building via equity and credit risk extension. But modern capitalism is dependent as well on maturity extension in credit markets. No venture, aside from one financed with 100% owners’ capital, could survive on credit or loans that matured or were callable overnight. Buildings, utilities and homes require 20- and 30-year loan commitments to smooth and justify their returns.

Investors had been willing to take on this duration risk because they would be compensated with additional yield AND (this is important) because bonds could appreciate if rates fell (i.e. when yields fall, bonds rise).

Back to Bill:

Because this is so, lenders require a yield premium, expressed as a positively sloped yield curve, to make the extended loan. A flat yield curve, in contrast, is a disincentive for lenders to lend unless there is sufficient downside room for yields to fall and provide bond market capital gains.

And although the yield curve is steep, it is very low in nominal terms (i.e. there is less room for rates to move down).
Last time to Bill for his main argument:

Even if nodding in agreement, an observer might immediately comment that today’s yield curve is anything but flat and that might be true. Most short to intermediate Treasury yields, however, are dangerously close to the zero-bound which imply little if any room to fall: no margin, no air underneath those bond yields and therefore limited, if any, price appreciation. What incentive does a bank have to buy two-year Treasuries at 20 basis points when they can park overnight reserves with the Fed at 25? What incentives do investment managers or even individual investors have to take price risk with a five-, 10- or 30-year Treasury when there are multiples of downside price risk compared to appreciation? At 75 basis points, a five-year Treasury can only rationally appreciate by two more points, but theoretically can go down by an unlimited amount. Duration risk and flatness at the zero-bound, to make the simple point, can freeze and trap liquidity by convincing investors to hold cash as opposed to extend credit.

Now my oversimplified explanation using two interest rate scenarios…

Scenario one… bonds yielding 5%.
In this scenario, bonds with maturities 1 year through 5 are yielding 5%. Should rates stay at 5%, the bonds are worth PAR (i.e. $100) in all scenarios. However, the bonds have the potential to appreciate should yields move lower. In fact, should rates fall all the way to 1% (a huge decline, but this is meant to illustrate the point), the bonds actually appreciate almost 20% in the case of the 5 year Treasury. Compare that to the one year Treasury that gained less than 5%.
In other words, in a flight to quality scenario there is a HUGE incentive to own the longer duration bond when yields have room to compress.



Scenario two… bonds yielding 1%.

In this scenario, bonds with maturities 1 year through 5 are yielding 1% (yes the yield curve is upward sloping in “real life”, but this isn’t far off). Should rates stay at 1%, the bonds are again worth PAR (i.e. $100), but in this case they have limited room to move due to the zero boundary. Should rates move all the way to 0%, the five year bonds don’t appreciate 20% like in scenario 1, they appreciate only 5%, while the one year Treasury appreciates around 1%.
In other words, in a flight to quality scenario the potential benefit of a longer duration Treasury is 75% lower than in scenario one and only 4% higher than the one year maturity bond.

The example above is close to current rates (as of this writing, a five year bond yields 0.82%). The result, as Bill Gross points out, is a lack of incentive for a lender to lend and take that risk as they can get roughly the same yield just putting their money in a mattress without the risk of rates moving higher (0% isn’t far from 0.82%). In addition, for an investor that is allocating to bonds to diversity their equity holdings, fixed income will no longer appreciate in a flight to quality scenario to offset equity losses. As a result, businesses should in theory be having a hard time getting money for their businesses outside of equity financing.
But, the evidence doesn’t point to any of this being an issue. As far as I know, investors are still willing to extend the duration of their investments to pick up this incremental yield. And why not? The Fed has made it clear there is zero risk that rates will rise going out to at least 2014. So why not pocket that additional 82 bps regardless of the lack of capital appreciation?

Tags: Bill Gross, Bond Duration, Bond Market, Bond Math, Bou, Business Building, Capital Gains, capitalism, Credit Markets, Credit Risk, Downside, Investment Outlook, Lenders, Life And Death, liquidity, Loan Commitments, Maturity, Shapes And Sizes, Treasury Yields, Yield Curve
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Everything You Wanted To Know About Credit Trading But Were Afraid To Ask

Wednesday, January 25th, 2012

ia Peter Tchir of TF Market Advisors,

Markets have become far less volatile than last year, but many investors remain focused on the Credit Markets for signs and cues as to the next move. With so many people looking to moves in credit markets and trying to determine how successful an auction has been, I thought it would make sense to go through some examples of how credit trades. At one extreme you have a real market like for the E-mini S&P futures. That trades from Sunday at 6pm EST until Friday at 4:15 EST. It is virtually continuous and at any given time you can see the bids and offers of the entire market. Then you have credit trading, which has almost nothing in common with ES futures and their incredible liquidity and transparency.

I will look at some examples of how European CDX Indices trade, a Single Name CDS trades, what an Investment Grade Bond New Issue looks like, and how a block trade in High Yield bonds work. These examples aren’t quite meant to be the norm, but in spite of being simplified with some slight embellishments, they aren’t atypical either.

This is a work of fiction and none of the banks or people mentioned represent real banks or individuals (even if you know who you are).

An hour in the life of the MAIN CDX index in Europe

Cast of Characters

· MAIN CDX Index

o This is a CDS index with 125 Reference Entities. They are all European Investment Grade Credits – a mix of corporate and financials.

· Market Makers

o Big Axed Bank: This bank is a major dealer and for some reason (positioning or client flows) is currently an “axed” buyer of MAIN

o Big Bank 2: A strong market maker and liquidity provider in MAIN but currently indifferent on the market

o Weak Bank: A marginal player in the market trying to retain a presence because they feel they need to be in the business

o Interdealer Broker: Not really a market maker, but not really a client either, they only trade with market makers, and market makers only trade with each other through an interdealer broker

· Clients

o Aggressive Hedge Fund: Looks for opportunities to push the market and profit from making the market “more efficient”

o Fast Momo Fund: A fund that is very momentum driven and is fast to react for quick small trades

o Slow Momo Fund: Looks for trends to develop a bit longer before making decisions, especially in credit where they have less experience

o Caught Short Fund: This fund is positioned short the market with tight stops

o Bank Hedger: This is the desk responsible for hedging a bank’s exposure to credit across all products

Initial Runs or Prices

Each dealer sends out runs via Bloomberg and updates their “screens” for clients.

Big Axed Bank goes out 155.5/156.5 and updates their client screen with that price. They also put up 155/157 on the Interdealer Broker screen just to get something going “in the street”.

Big Bank 2 goes out 155/156. They hear that it is better bid away, but with stocks stable, and if anything, ticking up a bit in spite of mediocre data, they think there are more likely to be sellers than buyers. They decide to join the bid on the Broker screen mostly because they are bored and doubt they will get hit since they are second bid, but figure it will mess up the better bid that is out there.

Weak Bank also goes out 155/156. They checked with some of their “run monkeys” and got colour on where everyone else was. With the stability in stocks they think 155/156 is far safer than going out 155.5/156.5 though they are a bit scared that if they get lifted they can’t immediately cover in the street.

The First Trade

Aggressive hedge fund sees all three screens. He is curious why Big Axed Bank is so well bid. It seems a bit aggressive, especially with stocks ticking up a bit in spite of weak data. He gets on the phone with his salesperson at Big Axed Bank:

Aggressive Hedge Fund (AHF): Hey, how’s it going? You guys seem axed to buy MAIN, anything going on?

Big Axed Bank Sales (BABS): Nah, I was already checked by someone else. Trader wants to clean up a small position. Thinks it might go tighter but just wants to book some profits.

AHF: How much is he looking for?

BABS: I can ask, how much are you looking to do?

AHF: I’m just checking some other positions, but probably not too much if I have anything to do.

BABS: Trader said he was really looking for 100 MM, but would take 250 MM for you if he had to.

AHF: I’m not sure I have 250 to go, but what size would take him out? Last thing I want to do is hit him and have him leave it bid.

BABS: 150 would take him out.

AHF: Done, I sell you 150 MM at 155.5.

BABS: Done, thanks for the trade.

The Next Trade

Big Axed Bank refreshes their screen 155/156 and sends out a run posting the trade and refreshing the market via Bloomberg as well. While this is occurring, AHF is quickly hitting the 155 bid Weak Bank had up on their screens. The screen only worked for 100 MM, but AHF sells 100MM at 155 electronically. This leads to a quick call from Weak Bank Salesperson to thank them for the trade and confirm it is done. A junior trader at AHF asks the senior trader why he didn’t sell more at 155.5 to Big Axed Bank or why he didn’t hit Big Bank 2 at 155 since they do a lot more business with them than Weak Bank. The senior trader just rolls his eyes and explains that he knows Weak Bank has no tolerance for risk and would immediately offer it out in an attempt for a quick profit. Although Big Axed Bank had told him that they were out of the axe, he didn’t think selling them much more at 155.5 or even 155 would have scared them at all. Big Bank 2 also has enough strength it might have taken a lot of size to move them off their bid, but Weak Bank is already scrambling to cover.

Sure enough, Weak Bank immediately refreshes their screens at 154.5/155.5 and updates their Bloomberg distribution with the post that it traded down. They also put in a 156.5 offer on the Broker screen. The Broker screen had been 155/157 with 2 guys on the bid. Weak Bank gives them the 156.5 offer (which is higher than where they are offering it to clients) in the hopes one of the bids steps up to 155.5.

Now It Gets Interesting

Both Big Axed Bank and Big Bank 2 are immediately posted by friendly clients that it traded down at 155 away. Big Bank 2 immediately refreshes his price as 154.5/155.5 for clients and pulls his “street” bid on Broker Screen from 155 to 154 since he really doesn’t want to get hit by another dealer.

The trader at Big Axed Bank puts all his skills to work. While screaming at the salesperson who covers AHF and asking the heck is going on and if it’s his client spraying the street, he is sending out a fresh price of 154.5/155.5 and yanks his bid from Broker screen in disgust. The salesperson who covers AHF comes over and quietly explains to the trader that there is no way AHF is spraying the street, that’s not how that account behaves, and that even if they did, they would never do it to us since we are mates. We were out last week at that new restaurant, he loves us, he was just trying to throw us some biz. If anything he was just helping out since you were axed, so relax. It definitely isn’t our guy out there screwing around, besides stocks are ticking up a bit so someone else probably decided to sell some here too.

Weak Bank is getting a bit nervous now. The “street picture” went from 155/157 with two guys on the bid, and now it’s 154/156.5, his offer and only one bid. He picks up the phone to talk to his broker at Interdealer Broker.

Weak Bank Trader (WBT): What the hell is going on, where did the bids go?

Broker 1: Hey mate, how are you? What you thinking here?

WBT: What am I thinking? I’m thinking you had two bids that you lost and why the hell should I ever use you guys if you can’t keep your markets together.

Broker 1: C’mon mate, you know how hard it is with these screens, let me give em a ring and see if we can get them back, I’m sure we can.

WBT: Fine, just do it. (hangs up the line)

Broker 1 (turns to the other guys on the desk): C’mon you bunch of wankers, get those MAIN bids back. We haven’t done a trade all day, and I can smell this one. I can tell the guy at WBT got hit and has to get out. His boss is already probably freaking out on him since he’s had the position for 12 seconds (laughs and shakes head), so let’s get those bids back and make us some money.

The brokers call their traders at the two big banks seeing if they can’t get their bids back. The trader at Big Axed Bank is mad at himself for leaving money on table and just to share the misery decides to pull his bid completely at broker and actually put up a 156 offer, undercutting the other offer for no reason other than he is annoyed at himself for paying 155.5 when suddenly the market feels well offered. He leaves his price 154.5/155.5 for retail.

Big Bank 2 sees the street suddenly go offered and decides to play it safe. He refreshes his price to retail as 154/155.

Another Player Gets Involved

Fast Momo Fund has seen stocks tick up and seen 155.5 and 155 get hit in MAIN. He watches stocks continue to tick up and is thinking that selling MAIN could be a good trade. Then his screen flashes as Big Bank 2 pulls back to 154/155. He reacts quickly and hits Big Axed Bank at 154.5 before that bid disappears. As he confirms with the salesperson that his trade is done, he smiles as he notices Weak Bank had already refreshed as 154/155 (what a joke, he thinks to himself).

So now Big Axed Bank paid 155.5 for some to cover an axe and is short at 154.5. Weak Bank is short at 155 and thinks it may have traded tighter than that, and can’t find a decent street bid to get out of his position. Aggressive Hedge Fund got a block off at 155.5 and another piece at 155 and knows it just went down at 154.5 so is feeling good about his trades. Fast Momo Fund is long at 154.5.

Price Action and Weak Hands

Each dealer is now out 154/155 to their clients. Big Axed Bank had started the day well, is annoyed for leaving money on the table, but isn’t particularly worried about having being hit at 154.5. Big Bank 2 hasn’t done a trade and is kind of happy, and still doesn’t really have a strong view, but his thinking that he will be a buyer soon. Weak Bank trader is freaking out a bit. His best case now is breaking even if he can get lifted at 155. Interdealer broker is having a rough day. Somehow it went from two bids and a chance of a trade to total bullocks. They now have 2 guys sitting on 156 offers without a bid, and they know that Weak Bank would improve their offer if they could get a good bid.

Slow Momo Fund can’t help but notice the price action. They call each of the 3 market makers and see if anyone will step up and pay them 154.5 for MAIN. All of the dealers just repeat their 154 bid and ask for orders. He doesn’t feel like leaving an order (since if it starts going wider, his whole momentum trade is pointless). He is thinking about holding off for now, but then sees S&P futures tick up 1 point and decides he better smack a bid in case the US comes in and takes everything higher and tighter. Since he had been on the phone, he calls back Weak Bank and tries to sell them 154’s on MAIN. They flake, the salesperson claims they are 153.5 bid best now, and the trader at Slow Momo Fund winces as he sees the Weak Bank Screen refresh as 153.5/155. He quickly hits the 154 screen bid at Big Bank 2 and wonders why the hell he ever tries to deal with that flake at Weak Bank.

Weak Bank is in panic mode. They are calling all potential buyers of MAIN to see if they can get out of this trade. They are willing to sell at 154.5, thinking that is an extremely good offer and thinking losing a ½ bp isn’t the worst thing in the world especially as they are getting some good flows and inquiry.

The Caught Short Fund is getting a bit nervous. They had it marked at 155.5 and now it just went down at 154. Worse than that, it seems like suddenly everyone is a seller. Maybe they should cut the loss and reload later? They are going to hold off for a bit, but are seriously considering cutting.

The trader at the bank hedging desk gets the call from Weak Bank. She is thinking that 154.5 sounds like a decent offer and that she might even be able to get the offer down a bit with the market feeling so strong. They are a bit under hedged so this seems like a good opportunity to take off some risk. Just as she is considering the trade, her boss rings her up and explains that the market feels good and he is worried about losses on the hedges. Exasperated, she tries to point out that if anything they are underhedged, so this move tighter is a good opportunity for them, and that so far the move seems isolated to the indices as neither single name CDS nor the cash markets seem particularly strong. The all knowing manager sitting in the corner office insists that the market is turning and that soon there will be some great bids for their precious bond and loan inventory and that he wants her to take some hedges off in advance of that. She is embarrassed and out of courtesy calls Weak Bank back and explains that not only is she not a buyer of MAIN right now, she would be looking to sell some, and asks Weak Bank if they want some at 154?

Not only does Weak Bank not want any at 154, they are starting to panic. That small 155 trade from the morning is starting to look a bit ugly. They can’t afford to let Bank Hedger trade away though, that would completely mess up their position so they basically beg her to leave an order with them. They point out that they are a seller themselves and if they get lifted, they will sell some along for her. She doesn’t have a good feel about this but decides to leave Weak Bank with an order at 154.25.

The Capitulation

Big Axed Bank and Big Bank 2 are both 153.5/154.5 now. The Broker is now 155 offered (Big Axed Bank cut his own offer in further frustration at his dumb first trade at 155.5). The brokers are “discussing” how to get a decent bid back (“discussing” involves sitting around and calling each other a bunch of wankers and saying the market and the job is total bullocks while lamenting that all the market makers are ungrateful sods).

Weak Bank sends out a Bloomberg message stating that they are an axed seller and have a block to go at 154.25. They figure that is best offer by a ¼ bp and if they get lifted they can probably convince Bank Hedger to trade at 154, so they lose ¾ bp on their original trade, but make back a ¼ bp on the order. Not good but not horrible.

The Caught Short Fund sees the axed seller message from Weak Bank. He knows how weak the Weak Bank is and has this gut feel that they are going to have to puke out of a position soon. He knows that if he calls either of the Big Banks they are likely to flake, so he hits Big Axed Bank on the screens at 153.5. He’s not happy, but thinks it’s the prudent thing to do as market feels so strong and he will be able to reload later.

Bank Hedger sees the 153.5 trade print and gives Weak Bank a fill or kill on her order. They can’t fill her and worse than that, they won’t even provide her with a bid! And sure enough the boss is calling, no doubt to see if she had sold any MAIN. Both of the Big Banks have refreshed their screens as 153/154, but she knows Big Bank 2 hadn’t been hit, so calls them and sees if they will match the trade away and take some at 153.5. Big Bank 2’s trader thinks about it and decides that the move is a bit overdone, so doesn’t mind buying some MAIN here and Bank Hedger is a good and fair client so sure, he will pay 153.5 for some. Bank Hedger is happy. Well happy isn’t exactly the right word, she thinks her boss is clueless and they should have been adding to their hedge on this move rather than selling into it, but c’est la vie.

Big Bank 2 is feeling good about his trades. He owns MAIN down at 153.75 on average and doesn’t see anything in the cash markets to justify such a big move. He is getting colour that Weak Bank needs to get out of a position so decides to mess around with him, plus he is annoyed with his Interdealer Broker constantly bugging him for a bid. He decides to “fix” that problem and gives the Broker screens at 151/154 market. The broker kindly thanks him for the two sided market, knowing that the bid sucks and the rest of the desk is going to be pissed off about the improved offer.

Weak Bank sees the street go 151/154. They hear it is 153/154 away at both Big Banks but can’t get that bid. They know Bank Hedger sold some away, they don’t know what level, but figure someone has an axe. Damn, they wish they had just bought more from her, this is really screwing up their picture.

Aggressive Hedge Fund has seen almost no follow through in stocks, bonds, or single name CDS. The market is okay, but nothing special. He can see that Big Banks are both 153/154 and that Weak Bank is 152.5/154 right now. He saw their plea to find a buyer at 154.25 and decides the time is right and calls Weak Bank’s salesperson.

AHF: Hey, what you think of market here?

Weak Banks Sales (WBS): Feels strong, looks like lots of sellers of MAIN (then in a whisper) I don’t think our trader is too happy about that trade earlier, we can’t find any buyers.

AHF: Tell you what, since we did that trade I shifted some other positions around (total lie) and could actually buy back the MAIN I sold earlier.

WBS: Really?

AHF: Yeah, where do you think you could get it done.

WBS: I checked, the trader would sell them at 154, and I might be able to get him down to 153.75.

AHF: Might? What they hell do you mean might? That is a crap offer. The guy who got hit at 153.5 is desperate to get out of them (total lie) and I’m hearing it was a big seller who may have a lot more to go (total lie).

WBS: Crap, let me see what I can do. What’s your best?

AHF: I will pay 153.25. I’m pretty sure I can get that done away in a heartbeat if you don’t care, though I might hold off because it seems like this thing could run a lot tighter.

WBS: Fine, my trader can sell you at 153.25, but you have to keep us in the flows. This trade hurt, but I told him how important it was to see your flows and that you would work hard to make it up to us.

AHF: Sure, tell you what, I think I can source more of the bonds I’m buying away (total lie), and could upsize the trade at 153.25. I have another block to buy, you want to sell those and increase size of the trade?

WBS: Sure, let me check…..yeah, that’s done. Thanks for the trades. We will do an unwind on our trade from this morning, and is that a new trade on the other piece?

AHF: I think it might be an assignment, I have sold old hedges around, so let me figure it out and give you a name you will face on that second piece.

WBS: Cool, thank a lot, appreciate the trade and keep us up. Glad we are getting business going.

As soon as he hangs up he strolls over to the trader to explain how wrong the trader was about the client and how well this relationship is going to work. The trader can’t understand why the salesperson doesn’t think the 1 ¾ bp loss isn’t a big deal to him, and so far he hasn’t made money on the short he just put on at 153.25.

The Reversal

Weak Bank puts in a call to Bank Hedger letting them know that they can pay 153 now. Bank Hedger is starting to get a little annoyed with Weak Bank and “congratulates” the salesperson for informing her that Weak Bank now has a generic bid. Just to make her day extra special, she gets a call from the boss. Not only doesn’t it look like they are going to be able sell any of their cash inventory, but they are being asked to participate in a new loan, so they need to put that hedge back on. Then a little sheepishly he explains that management wants to run a completely hedged book, so wants them to take advantage of the strength in the market to put on some additional hedge. Typical, she thinks, and then decides what to do. If Weak Bank is now a buyer she knows they won’t make a good offer since they don’t have the limits to take on much risk, let along print her on a double trade. She calls Big Bank 2 and tells them that her boss changed the mind, and she wants to buy back the MAIN she sold earlier and actually wants to buy an additional block. The salesperson is hoping the trader will do it all at 153.5 so that his client doesn’t lose money on the first trade. The trader laughs at that, explains that the market is doing nothing, and if anything it feels like buyers of MAIN are creeping out of the wordwork and he is considering moving the market back to 153.5/154.5 but he would sell the entire piece at 154. Bank Hedger decides that is fair and is almost happy to lose a ½ bp on the boss’s dumb trade idea just so that he will keep his nose out of the day to day trading which he seems so clueless on.

A quick recap of what has gone on so far:

Aggressive Hedge Fund sold MAIN at 155.5 and 155 and covered the entire piece at 153.25 for an average profit of 2 bps on two pieces.

Fast Momo Fund is long at 154.5.

Slow Momo Fund is still long at 154.

Caught Short Fund closed the short at 153.5, but is getting a bit nervous that he covered too early especially since he HATES the market!!

Weak Bank bought 155 and covered it at 153.25 for a loss of 1 ¾ bps and is now long at 153.25.

Bank Hedger lost a ½ bp on one block but now has added to the short on the day and is exactly where they want to be from a risk standpoint.

Big Bank 2, bought a piece at 154 and 153.5 and sold it all back at 154, so made a ¼ bp on average and is back to flat.

Interdealer Broker hasn’t done a trade and just got it shoved in his mush as Big Bank 2 pulled the 151/154 market and said they were going to lunch.

Big Axed Bank covered their axe at 155.5, a trade for which the trader is kicking himself and is short at 154.5 and got shorter at 153.5, which is annoying, but not a particularly big concern yet since they did have buyers the previous day, giving him the axe, but he definitely wants to sell some MAIN here rather than buying more.

Back to Unchanged:

Big Bank 2 goes out 153.75/154.75 fresh. Still no strong view, and made a bit of money, but “for choice” would prefer to buy some more MAIN rather than selling any here.

Big Axed Bank hears about the market away and guesses someone just lifted 154 away, so goes out 153.5/154.5 fresh as they are now getting too short and wants to be an offer.

Weak Bank can’t believe they sold at 153.25 and now seem to be getting topped and turned. They call Interdealer Broker and beg them to get 154 offer back. This time one of the brokers manages to convince Big Axed Bank to flash a 154.25 offer on the screen. Weak Bank lifts the 154.25, the broker pounds his chest and calls the rest of the desk a bunch of losers, and has the guts to ask each of the banks if they want to leave something on the follow. All he gets from Weak Bank is a click as the trader closes the line to think about what a miserable day it’s been, and Big Axed Bank gives him the only order he cares about now, some nice curry for the desk.

While joking around with the broker Fast Momo lifts his 154.5 offer on the screen, taking him out of another block.

Damn I hate these screens he mumbles to himself as he goes out 154/155 fresh. Big Bank 2 comes back from lunch and makes em 154/155 as well. Weak Bank goes out 153.75/155.25 and has no desire to sit there any longer. Caught Short regrets covering since he hates the market so much and comes back to lift 155 from Big Axed Bank. Slow momentum is annoyed but decides to hold on for now, but the market is back to 154.5/155.5 after starting the day at 155/156 with a high print of 155.5 and a low print of 153.25.

What can we learn from this series of trades?

Main moved over 2 bps and not one single trade had anything to do with “valuation” or “fundamentals”. Thinking that all moves reflect a change in fundamentals or a large scale change in risk positioning is just wrong in a market that is as illiquid as this – and MAIN is about as liquid as it gets in the credit markets.

Some clients are just as happy to keep CDS Indices off exchanges as the dealers are.

The salesperson at Weak Bank will be annoyed that the trader is losing money and dropping his clients because how will he get paid on the salescredits and keep his great relationships intact when the trader sucks so bad.

All market makers will go home cursing the screens, wondering why salespeople get anything when their clients just click on a screen, but will not see the irony of hating individual screens and hating the idea of an exchange.

The broker who got the trade done will go home thinking it’s better than the alternative ways of making a living and wondering if he should take the trader to the Gunners match next week.

Aggressive Hedge Fund will go home wondering when the Weak Banks will give up and wonder why other funds spend so much money on research when it is all so easy. Caught Short will go home promising not to second guess himself so quickly. Fast Momo fund will go home breaking even, somehow feeling they could have done a bit better, but not too upset since it was all just a guess and hadn’t worked out badly. Slow Momo just wishes this market would go back to trend following, but has decided that the trade is actually not so much a momentum trade, but a view that the market seemed so strong that fundamentals are better and he will keep the trade on since it should work out well over the next day or two.

Bank Hedger checks out the bank share price before heading home and can only think that if they didn’t leave the idiots in charge the bank would be in a lot better shape.

Tags: 6pm, Amp, Auction, Banks, Cdx Index, Credit Markets, Cues, Embellishments, Entities, Futures, High Yield Bonds, Investment Grade, Liquidity Provider, Norm, Signs, Spite, Strong Market, Trades, Transparency, Would Make Sense
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ECB Says Credit Crunch Averted; Yet ECB Overnight Deposits Again Hit Record High; Skyrocketing ECB Balance Sheet

Friday, January 13th, 2012

Following a relatively tiny two-day rally in the Euro the ECB blows its horn with a statement Credit Crunch Averted

The euro rose, extending its first weekly gain versus the dollar in six weeks, as Italian bonds advanced and after European Central Bank President Mario Draghi said policy makers have averted a credit shortage.

The 17-nation currency climbed against all but two of its 16 major counterparts as Spanish debt also rallied as Italy prepared to sell notes today. The Dollar Index (SPX) dropped for a second day before a U.S. report forecast to show consumer confidence improved this month, reducing demand for the U.S. currency as a haven.

Draghi said the central bank’s massive injection of cash into the financial system last month is beginning to flow through into credit markets. “There are tentative signs of stabilization of economic activity,” he said in Frankfurt after the ECB’s policy meeting yesterday. Policy makers kept the benchmark rate at a record low of 1 percent after two straight quarter-point reductions.

Draghi’s Statement in Perspective

After a 5-week decline, some snapback in the Euro is to be expected. The impetus is just as likely to be the action by the ECB to hold interest rates at 1% as anything else.

Actually, given extreme bearish sentiment on the Euro, no reason at all is needed for a euro relief rally.

For a look at sentiment including charts of record-high short interest on Euro futures, please see Euro Suffers Longest Losing Streak Since 2010; Record High Speculative Short Positions; Big Specs vs. Currency Movements; Not Timing Devices written January 8.

ECB Overnight Deposits Again Hit Record High

As for the idea a “credit crunch has been averted”, please consider the Wall Street Journal report for January 13 that says ECB Overnight Deposits Again Hit Record High

Euro-zone banks’ overnight deposits with the European Central Bank hit yet another all-time high Thursday, likely reflecting continued funding pressures in the banking sector as well as the approaching end of the reserve period.

Banks deposited €489.906 billion ($627.77 billion), the central bank said Friday, up from €470.632 billion Wednesday.

The daily deposits have been extremely high since banks in December tapped the ECB for its first-ever three-year loan. ECB President Mario Draghi Thursday said the extra long-term facility has been successful at preventing a serious credit contraction in the banking sector. The ECB launched the operation to address the fact more than €200 billion in bank loans was coming due in the first quarter, Mr. Draghi added.

Some analysts attribute that the ever-increasing deposits to the fact that banks are hoarding their excess funds—a good deal of which originate from the three-year ECB loan—by channeling them back to the central bank.

However, Mr. Draghi dismissed that idea at his press conference Thursday. He said the banks drawing on the ECB’s refinancing operation are “by and large” different from those banks that have been depositing their funds with the ECB overnight.

European Banks Hoarding Cash

European banks aren’t lending now, nor will they lend any time soon as discussed in German Economy Contracts in 4th Quarter; Spain’s Industrial Output Plunges 7%; UK Trade Deficit Widens; European Banks Wisely Hoard Cash

Skyrocketing ECB Balance Sheet

The reason for debt rally is not that a credit crunch has been avoided, but rather, the ECB has become the lender of only resort, bloating its balance sheet to record levels.

Please consider Swelling ECB Balance Sheet Brings Relief, Poses Risk For Euro

The European Central Bank’s increasingly swollen balance sheet has helped calm volatile markets, but some believe it could itself become a problem and bring more volatility to the 17-nation currency bloc.

Nearly a year’s worth of anticrisis lending measures have sent the ECB’s books to a record EUR2.73 trillion, some 29% of the euro zone’s gross domestic product. This expansion, capturing both the collateral pledged by banks receiving funds from the central bank and the sovereign bonds it has purchased for its own account, has been welcomed by bond investors, who see it as a stabilizing force. But the excess liquidity bodes for a weaker euro, and has some wondering if the ECB’s own solvency could eventually be in peril.

Many investors are concerned that a default in the Hellenic republic could ricochet across the 17-nation currency bloc. That could renew an assault on other euro-zone bond markets that are already distressed.

More worrisome are relaxed collateral rules. When the ECB introduced a three-year tender last month at generous 1% interest rates, more than 500 banks gorged themselves on a record EUR489 billion of the central bank’s cash. Some commentators worry that a worsening of peripheral bond markets could endanger securities pledged by the banks, posing a considerable solvency threat to the central bank.

“The quality of the balance sheet deteriorates as it expands, which is doubly problematic,” said Michael Woolfolk, senior currency strategist at BNY Mellon in New York.

European banks are dumping sovereign debt at record levels on the ECB. Germany and France are on the hook. 10-year Italian bonds are down substantially, but the rate is still 6.5% with the ECB the buyer of only resort.

Good luck with that policy as Europe heads into a massive recession.

Mike “Mish” Shedlock
http://globaleconomicanalysis.blogspot.com

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