Thursday, 22 September 2011

Markets update - Credit - Anterograde and Retrograde amnesia.

"Anterograde amnesia refers to the inability to remember recent events in the aftermath of a trauma, but recollection of events in the distant past is unaltered.
Retrograde amnesia is the inability to remember events preceding a trauma, but recall of events afterwards is possible."

Another day in the trenches in the credit space, and given the acceleration in the deterioration of the market context, yet another long post starting with a quick review of the price action.
The Itraxx credit indices overview:
The Itraxx SOVx 5 year CDS Western Europe index (15 countries) broke a new record to around 362 bps.
The Itraxx Crossover 5 year CDS index (High Yield) soared to 846.5 bps, highest level since April 2009, a 59 bps increase on the day. Intraday it was almost up by 70 bps.
The Itraxx Main Europe 5 year index (Investment Grade) passed the 200 bps level.
And Itraxx Financial Senior 5 year CDS index as well as Itraxx Financial Subordinate 5 year index widened significantly as well. 318 bps at some point before receding a bit to 302 for the Senior index and 555 bps for the subordinate index, receding in the end to around 540 bps level. Truly nasty price action.

The significant moves today were on the Sovereign CDS space with Germany breaking through 100 bps to 109 bps (39 bps in July) and France breaking the 200 bps level to 205 bps.

Spain 5 year Sovereign CDS versus Italy 5 year Sovereign CDS - we know the story by now. Spain is decoupling:

Another session marked by flight to quality with the 10 German Government bond reaching a new low in terms of yield::
Source Bloomberg - morning snap.
The Bund reached a record low yield of 1.67% and even 30 years reached a record low to 2.47%.

10 year Sweden government bonds versus 10 year German bund, still a correlation of 1:

The liquidity picture, still on the weak side:

But the interesting development we have seen today has been coming from the accelerated deterioration of emerging markets, which so far up had been spared to a certain point.
The SOVX western europe 5 year CDS index versus the SOVx CEEMA (Central Europe and Middle-East and Africa) tells the story:
From divergence back to convergence for both credit indices.

The trigger has been the clear slowdown in Chinese manufacturing, meaning China will not be strong enough to counterweight the US and European slowdown we are seeing.
So, we get a sell-off in emerging equities (down by 4%, a 15 months low), a sell-off in credit, a sell-off in currencies (currencies backed by commodities taking a serious beating in the process), and a sell-off in commodities.

A sell-off in Emerging debt - JP Morgan EMBI Global Diversified:
The J.P.Morgan Emerging Markets Bond Index Global ("EMBI Global") tracks total returns for traded external debt instruments in the emerging markets:

A sell-off in equities - HAIER Electronics Group Co, one of the world's leading white goods home appliance manufacturers. We know it is relevant from the previous post - "Markets - Credit - Controlled demolition" and it follows the decision from the Chinese government to pul its subsidy program it had in place in four Chinese regions:

A sell-off in commodities - pop goes the bubble in copper artificially inflated prices, with China having pulled on the 31st of August another artificial stimulus, namely letters of credit which funded the cash-for-copper collateral game (used as financing instrument...). And copper is closely linked to economic activity as well as fluctuations in Chinese demand, so with a PMI at 49.4 that is what you get:

A sell-off in currencies:
Russian Ruble in trouble:

Indian rupee:

As a reminder from previous post:
"But it isn't only Russia trying to sustain its local currency by buying rubles, it is also happening in India with the regulators also starting to buy local currency and selling dollars and Argentina as well."

Brazilian real - BRL:
Here is the reason:
From Bloomberg - Ye Xie and Josue Leonel.
"The real’s biggest five-day plunge since 2008 is fueling speculation Brazil will sell dollars to shore up the currency, reversing a 28-month-old strategy aimed at stemming gains.
Brazil’s currency has lost 8.6 percent against the dollar since Sept. 14, the most since the global financial crisis drove it down 10.9 percent in the five days through Dec. 3, 2008, according to data compiled by Bloomberg. The slump handed investors in real-denominated bonds a loss of 13.5 percent in dollar terms this month, the worst performance in emerging markets, according to data compiled by JPMorgan Chase & Co.
Speculation is mounting that the real’s slide may deepen, pushing up import prices and adding to the highest inflation rate in six years, if the central bank fails to deploy some of its $352 billion in reserves to defend the currency. Concern policy makers’ surprise rate cut last month signals they are giving up on their goal of slowing inflation is compounding the real’s decline as Europe’s debt crisis erodes demand for emerging-market assets."

From the same Bloomberg article we learn the following:
"The central bank hasn’t bought dollars in the spot market since Sept. 13, breaking a practice it adopted since May 2009. It bought $47.6 billion in the first eight months of this year, surpassing the $41.4 billion it purchased in 2010. It last sold dollars on Feb. 3, 2009, when the real closed at 2.3052 per dollar. It closed yesterday at 1.8756."

Also from Bloomberg:
"Brazil’s central bank yesterday decided not to roll over reverse-currency swap contracts expiring in October, which will lead to the unwinding of $2 billion worth of bets against the dollar. It’s the first time policy makers refrained fromrenewing the contracts since January."

Which led to a surge in Brasil Sovereign CDS of 23 bps to 196 bps on the 5 year. At the same time, Argentina's reserves, following the same path, is seeing its dollar reserves depleted:
"Policy makers on Sept. 20 sold around $700 million in futures contracts due through October to show investors they are maintaining a policy of sustaining the peso and to discourage speculation in the currency, said a central bank official who asked not to be named because of the institution’s policy. The bank buys and sells dollars in futures markets on a regular basis, he said." - source Bloomberg - Camila Russo and Katia Porzecanski - 22nd of September.
Argentina's bonds are now yielding 972 bps more than US treasuries with the 5 year CDS trading at 983 bps according to CMA.

And contagion we have now in emerging markets.
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Sovereign CDS 5 year wideners on the 22nd of September - source CMA:

In relation to the credit funding issues story in the European space with have been discussing in various credit related posts, the consequences of the deterioration in liquidity are reaching alarming levels. While we know from the post "Macro and Markets update - It's the liquidity stupid...and why it matters again...", that European banks are on average issued 90% of their term funding needs for 2011, with significant liquidity pools and ECB support, the impossibility for banks to issue term funding and in particularly issue unsecured funding is a big concern given funding needs for 2012.
As Bloomberg points out in an article published by John Glover and Ben Martin:
"It’s been 2 1/2 months since a bank managed to sell a conventional bond in Europe’s public markets, the longest period without a deal ever and another example of the sovereign crisis choking off funding.
UniCredit SpA was the last non state-owned bank to issue senior, unsecured benchmark notes in Europe with a 1 billion-euro ($1.4 billion) sale on July 13, according to data compiled by Bloomberg. That compares with deals worth 41.9 billion euros in the third quarter of last year."

And Bloomberg to add:
"The extra yield investors demand to hold banks’ senior bonds instead of benchmark government debt has soared to 320 basis points, from 202 at the end of July, according to Barclays Capital’s Euro Aggregate Banking Senior Index. The gauge reached an all-time high 325 basis points on Dec. 30, 2008."

From "Markets update - Credit - Crossing An Event Horizon", we know that banks have only managed to issue recently covered bonds, backed by pools of prime loans:
"Lenders, by using prime assets are willing to do whatever is necessary to get funding, as other sources, such as unsecured issuance have dried up, clearly reflected by the very high level reached by the Itraxx Financial Subordinate 5 year index."

Covered bonds - Bloomberg:
"Pioneered in 18th century Prussia, covered bonds give holders first call on a pool of assets that’s managed by the borrower, with the debt given preferential treatment in a default to senior, unsecured notes.
Covered bond issuance rose to 287 billion euros this year, up from 268 billion euros in the same period of 2010, Bloomberg data show."

And we know:
"The recent significant increase in credit spreads for many financials have been driven by the markets concerned about the ability of the weaker players to access credit at reasonable rates."

Given ongoing market concerns on potential losses on sovereign bonds, banks prefer to deposit their cash at the ECB (135 billion euros in the last 10 days). So access to term funding for banks in Europe being very weak is a clear and present danger.

And on a final note, last chart of the day, following the downgrade of US banks by Moody's, this is the picture between Bank of America 5 year CDS and Citi 5 year CDS:

“Panics do not destroy capital – they merely reveal the extent to which it has previously been destroyed by its betrayal in hopelessly unproductive works” - John Mills, “Credit Cycles and the Origins of Commercial Panics”, 1867

Stay tuned!


  1. Great post as usual - always look forward to these especially after a volatile day like today.
    Is it possible to draw any prelim conclusions from SPA continuing to tighten over ITA cds spreads? Conversely Spains 10yrs are also trading a bit better than Italy's, but I wonder why this is the case - an arb exploited by the market maybe? Seemed like in the PIIGS spain was always the bigger one:)

  2. Debt to GDP levels is smaller for Spain than Italy and even France and Germany. Given the already massive impressive level of Debt to GDP and the outstanding debt on Italy, as well as the massive needs in refinancing in 2012 (around 16% of the stock of debt), Italy appears to be a worse risk than Spain currently. It isn't an arb but the market simply looking at debt dynamics hence the difference between both.


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