Credit - The European Catharsis

"We can easily forgive a child who is afraid of the dark; the real tragedy of life is when men are afraid of the light." - Plato

Looking at the continuation in yield compression in the European government bond space, in conjunction with the deliquescence of French political parties with the Socialist party risking outright implosion with François Hollande shifting towards "Macron-nomics" (Emmanuel Macron being a young  former investment banker and new French minister for the economy), we reminded ourselves for our chosen title of the definition of the Aristotelian "Catharsis", the dramatic art that describes the effect of tragedy. The German philosopher, dramatist, publicist and art critic Gotthold Ephraim Lessing translated "Catharsis as a purification, an experience that brings pity and fear into their proper balance: "In real life," he explained, "men are sometimes too much addicted to pity or fear, sometimes too little; tragedy brings them back to a virtuous and happy mean." Tragedy is then a corrective; through watching tragedy, the audience learns how to feel these emotions at proper levels.

In similar fashion we would argue that in real life, European politicians have been sometimes too much addicted to debt and popularity, indeed, one would hope that the European tragedy unfolding would bring them to more virtuous and happy mean, but, hearing the departing French minister of the economy Montebourg blaming entirely French woes on the implementation of "austerity", we thought this week's chosen title was appropriate given "Catharsis" can apply to both tragedy as well as comedy. Given, purgation and purification, used in previous centuries are still the common interpretations of catharsis and still in wide use today, we wonder when the purgation and purification of the European debt market will happen via "restructuring"? We reminded ourselves as well our January 2012 conversation "The European Overdiagnosis" where our friends from Rcube Global Asset Management pointed out the inherent flaws of the European currency construct when discussing "The likelihood of a Euro Breakup": "By eliminating currency crises, which were common until the mid-1990s (and at the same time preventing evil “speculators” from making billions on them), the Euro built an economic crisis of far larger proportions. Once again, economics provides a good illustration of the old proverb “the road to hell is paved with good intentions”.

In this week's conversation we will look at the prospect for the continuation of the performance of credit and the continuation in the contrarian tactical trade, namely being long European equities (playing the rebound or when "bad economic" news is "good market" news...) and short the Euro.

While Europe continues to go through "Catharsis" as indicated by the latest raft of economic data pointing to weaker growth, European credit continued to post strong performances so far in 2014 with Total Return for Investment Grade Credit at 6.5% and High Yield slightly behind at 5.5%. Talking about "Credit Bubble", Investment Grade did reach last week it's lowest historical yield at 1.55% validating our 2012 conversation "Deleveraging - Bad for equities but good for credit assets"but we ramble again...

The latest flows of funds indicate as reported by Deutsche Bank on the 1st of September in their report entitled "Investors return back to European equities on hopes of (private) QE":
"European funds attract solid inflows on hopes of (private) QE: A week after the Jackson Hole symposium, Total equity funds recorded the 3rd consecutive week of inflows (+0.1% as % of NAV), led by solid flows into Western European and Emerging Asia equity funds.
Following a stack of disappointing economic data releases in Europe over the last few weeks and subsequent outflows thereafter, Western Europe equity funds rebounded strongly with solid inflows (+0.2%, highest inflows in 11 weeks) in anticipation of a possible (private) QE announcement during this week’s ECB meeting. DB’s economists are bringing forward the timing of the announcement of private QE (ABS purchasing) to 4th Sep’14, though admitting it’s a very close call. They expect it not to be a generic QE with government bond purchases and expect ABS purchasing would act as a complement to the already announced TLTRO. What to make out of this?
Observing flows returning back to Europe, we think investors would play this trade mostly via ETFs (Europe ETFs had +0.4% of inflows last week). A basket of common names constituent to the ES50 and the DAX30 could benefit overproportionally as 1) these indices are by far the two largest targets to invest the region via ETFs and 2) where the share of equity held by ETFs is particularly pronounced for these names. This basket’s outperformance in Europe correlates well with flows (top below chart)."

- source Deutsche Bank

Another important point from Deutsche Bank's note relates to ETF flows becoming an increasingly important indicator:
"ETF flow has become an increasingly important driver of stock returns over the past years as the share of equity held by ETFs has gone up significantly. In case of the DAX, this share has increased to 6.2% from 0% 10-years ago (Figure 1)."

The two largest ETFs to invest Europe based on AuMs are those on the ES50 + DAX30.

Hence, it doesn’t seem too far-fetched assuming that stocks constituent to both benchmarks could benefit/suffer over-proportionally depending on flow in and out of these vehicles. Figure 2 highlights the blend of stocks constituent to both indices.

We can show that ever since the Great Financial Crisis (GFC) hit markets and ETFs became common tools to implement (rather short-term oriented) market views, flows into Western European ETF funds correlate well with this basket’s outperformance in Europe, based on market cap weights (Figure 3).

The basket P/E ratio trades at a 20% premium to Europe (Stoxx600) and at a 10% discount using P/B (Figure 4). 

Since the basket comprises Financials as well as Industrials, we consider the P/B ratio as more meaningful in this context since Financials are generally valued over their book value of equity rather than earnings.
Should the money flow return to Europe (predominantly via ETFs) once positive economic surprises come through as implied by our credit impulse framework, we think the recent pull-back (and subsequent underperformance of the basket) should be seen as an attractive entry point." - source Deutsche Bank

In similar fashion to Deutsche Bank our good friends at Rcube Global Asset Management in their latest note entitled "Is Europe's situation so bad that it is good?", posit the following:
"Global equities have reached a strong resistance level, sentiment is frothy (EM and US), breadth is poor, bearish technical divergence abound; all this makes a larger correction likely. This would create a great buying opportunity for European equities for a year end and H2 2015 rally. The periphery and banks should be the clear winners".

During this summer, European equities have indeed been punished due to the significant fall in European inflation expectations as shown as well by our friends in their note:

"European Inflation expectations have crashed this summer. French 3 year breakevens have lost 100 bps since April. This has worried equity investors who punished European equities both on absolute and relative basis

If left unanswered for too long by the ECB, the deflation scare could clearly trigger more selling pressure, this would be we think a major opportunity to play both a rebound on absolute terms and a catch up with US stocks from a relative perspective. When met with action by the European central bank, the European and US liquidity environment will look very different (QE ending in the US, starting in Europe; Monetary tightening in the US, Negative interest rates in Europe, EURUSD weakness).

In the very short term, the gap that has opened up between inflation expectations and equity prices is such that if deflation fear persist, the selloff could be more severe, or it is also possible that financial markets stress will be the trigger for the ECB to act, in which case lower equity prices are likely before the rebound set up gets clearer. In the past this is exactly what happened. Inflation expectations following a market shock would melt, prompting a response from the central bank. Hence this is why inflation expectations are such a good contrarian explanatory factor equities forward returns.

As the back test below shows, the lower the forward inflation rate, the higher the Stoxx 600 forward returns. This clearly makes the decision process harder this time around since there has not been any correction in equities following the crash in breakevens. This is explained by the high hopes over Quantitative easing by the ECB, the lower inflation expectations are falling the higher are the hopes for QE, and its positive impact on equities.

As explained below, in the medium term we strongly believe that European equities are going higher. So this is only a question of timing.

Our Equity model for European equities is sending its stronger buy signal since just after the 1987 crash

Valuations according to our methodology are the cheapest since March 2009 thanks to the yield meltdown

- source Rcube Global Asset Management

Where we slightly disagree with our friends is that should QE materialise banks should be the clear winners. We'd rather hold bank debt than bank equities given the upcoming AQR which should highlight the capital needs of some European banks. Given banks' stocks are a leverage play on the economy and looking at the weakening economic growth outlook, we would rather hold bank senior debt than their stocks from an investor point of view. We will in another post touch again on the European banking situation rest assured.

In similar fashion to Deutsche Bank and our friends at Rcube, Barclays as well on the 2nd of September also added to the contrarian views of a possible tactical rebound in European equities in their note entitled "Don't exit Europe":

"Recent trends suggest we are near a turning point for continental European equities.

While the poor performance of Continental European equities since May owes something to the ongoing conflict in Eastern Ukraine, the main cause is more fundamental.

Negative data surprises have now reached an extreme relative to those in the US with underperformance to match. History suggests such episodes have been turning points.

The weakening in the Euro should help revenue and earnings growth, while there is evidence that bottom-up earnings estimates are responding to a solid Q2 reporting season and no doubt the weaker Euro.

While we have cut our forecast for earnings growth in Continental Europe to 10% in 2014, this should accelerate to 17% in 2015. Both forecasts are slightly above the bottom-up consensus.

There is an increasing chance the ECB will ease monetary policy further with full blown QE becoming more likely. Such a move would represent a major regime change and echoes some past experiences such as the major ERM realignments of the early 1990s.

Finally, Europe’s underperformance has not been confined to domestically focused stocks. Several globally focused sectors such as Energy, Industrials and Healthcare are trading at multi-year lows compared with their US peers."

- source Barclays

This adds more ammunition to our views expressed in our 19th of August conversation "Thermocline - What lies beneath":

"The lag in European stocks given the very recent negative tone in Europe due to the Russian sanctions have made them much more volatile. Should the "Risk-On" scenario persist in the coming weeks it should lead once again to an outperformance of European stocks versus US stocks."

Of course all eyes are on the ECB and expectations are high the ECB will sooner rather than later unleash a QE of its own. On that matter we agree with Bank of America Merrill Lynch's take from their Liquid Insight note of the 1st of September entitled "Muddle-nomics", that, QE won't happen just yet:

"No QE, yet

Draghi’s speech at Jackson Hole was dovish enough to confirm our view that small scale ABS purchases will take place, very likely before year-end, but not to change our view that QE is unlikely to happen within 12 months (a close call and in contrast to our view that more aggressive action by the ECB is warranted).

For this week’s meeting, we do not rule out smaller measures, such as fine-tuning the upcoming TLTROs or a detailed timeline of how and when ABS purchases could take place, given the need to deliver after the market’s reaction to Draghi’s speech. However, in our view, none of these would change the outlook substantially. The key issue will be to understand how many members of the governing council share Draghi’s latest concerns, particularly since his comments on inflation expectations were not included in the original text posted on the ECB website. We believe Draghi will not be able to convince the governing council to adopt broad-based QE just yet. But we think further disappointments in inflation data could do the trick." - source Bank of America Merrill Lynch

We also agree with Bank of America Merrill Lynch when it comes to further yield compression in our "Japanification process":

"Rates: Trade the journey not the destination

The reaction in the rates market will not just be a function of what specific measures the ECB announces, but also the extent to which the ECB lays out the conditions for future action. Even if the market would arguably be disappointed by our central scenario, a dovish press conference would still be possible. We have argued here that rates are not pricing in a significant QE probability. Following the Jackson hole repricing, we would argue this statement generally still holds. We remain constructive European rates and express that by being long duration in the periphery." - source Bank of America Merrill Lynch

Moving on to the subject of the Euro, with the on-going "Japanification" process, what appears clear to us is that you can expect significant rise in volatility in the FX space particularly with EUR/USD, in similar fashion you had significant volatility throughout the years in USD/JPY. On that note Mohamed El-Erian's recent comments in the Financial Times in his article "Foreign exchange volatility is the risk to watch" are worth mentioning:

"The biggest threat to investors may come from the foreign exchange market rather than directly from the stretched prices of equity and bond markets. Judging by recent policy and technical signals, the forex market may be about to exit an unusual phase of low volatility." - Mohamed El-Erian - FT.

We expect a "regime change" in FX volatility as well. In fact we voiced our concern with the impact the end of tapering would have in terms of dollar liquidity in June 2013 in our conversation "Singin' in the Rain":

"If the Fed starts draining liquidity, some "big whales" might turn up belly up. Could it be Chinese banks defaulting? Emerging Markets countries defaulting as well due to lack of access to US dollars?

It is a possibility we fathom." - Macronomics, June 2013 

We also reminded ourselves in this particular conversation the following: 

"Back in November 2011, we shared our concerns relating to a particular type of rogue wave three sisters that sank the Big Fitz - SS Edmund Fitzgerald, an analogy used by Grant Williams in one of John Mauldin's Outside the Box letter:

"In fact we could go further into the analogy relating to the "three sisters" rogue waves that sank SS Edmund Fitzgerald - Big Fitz, given we are witnessing three sisters rogue waves in our European crisis, namely:

-Wave number 1 - Financial crisis

-Wave number 2 - Sovereign crisis

-Wave number 3 - Currency crisis

if the dollar goes even more in short supply courtesy of Bernanke's "Tap dancing" with his "Singin' in the Rain", could it mean we will have wave number 3 namely a currency crisis on our hands? We wonder..."

Rest assured that higher real yield on US debt will continue to attract foreign investors towards US Treasuries hence our continued expectations for lower US long term yields. We have made no secret that we have been riding the long duration trade since early January 2014 via ETF ZROZ has a good proxy exposure to long US duration with some success...

When it comes to net USD buying the trend has continued as displayed by Bank of America Merrill Lynch in their CFTC FX Futures Watch from the 29th of August entitled "Largest USD longs in a year":

"EUR selling continues; short positioning stretched

Speculators this week sold $1.7bn of EUR contracts, increasing net short positioning to $24.8bn. Speculators have sold $30.5bn of EUR contracts since the dovish ECB meeting in May. Net short EUR positioning is beginning to look stretched (Chart 2). 

Technicals suggest the near term trend is pointing to a maturing decline and a range trade, while our positioning models suggest a medium risk of reversal in the EUR/USD downtrend. - source Bank of America Merrill Lynch

On a final note and from a contrarian point of view, should the ECB disappoint there is potential for some heightened volatility and reversal given the short consensus trade on the Euro we think. What has been driving the move have been flows and QE expectations rather than "fundamentals" which can be seen when one looks at the forward curve at the 5 year point (we look at the 5 year point because for the ECB the five-year forward break-even in five years is certainly one of the important indicator) - table source Bloomberg - EURO/USD Forward Curve:

Flow matters...but the stock of European debt too.

When it comes to our European Catharsis, being the prelude to the European tragedy and the current high expectations of QE we think our final quotes resonate well with our sentiment on European woes and QE:

"There are only two tragedies in life: one is not getting what one wants, and the other is getting it." - Oscar Wilde

Stay tuned!

Equities - Defensive versus Cyclicals, a volatility update

"Winning takes talent, to repeat takes character." - John Wooden 

Following the rise in volatility in May leading to a strong sectorial rotation, please find below an update on the derivatives markets for 4 emblematic sectors:

-ETFs Healthcare and Consumer Staples for the "defensive" sector (XLV & XLP)

-ETFs Consumer Discretionary and Industrials for cyclicals (XLY & XLI)

Chart 1 : Volatiliies 1 year ATM (At The Money) for XLV & XLP versus XLI & XLY:

- chart source Bloomberg

Chart 2 : Spread Volatility 1 year ATM XLI (Industrials) vs XLV (Healthcare) - source Bloomberg:

One conclusion can be reached from the above is that spreads for long implied volatilities for  the cyclical sector as well as  the defensive sector have touched the lowest levels seen in the last couple of years.

Are the equities derivatives markets pricing correctly or incorrectly the end of the paradigm "min-variance / low-volatility " of the defensive sectors? 

The impact in terms of sectorial allocation based on historical VaR models could be significant should the convergence between historical/implicit volatilities of the sector continue its trend.

In Europe, there is a similar situation going on if you look at for example the volatility for a defensive index such as the SMI versus the volatility of a more cyclical index such as the German DAX.

Chart 3 : Spread 6 months at the money (ATM) volatility for the German DAX vs SMI, source Bloomberg:

Chart 4 : min-var sector valuation premiums (source Barclays):

"Premium for safe, low volatility sectors in Europe looks high. This level was last seen in March 2009 and June 2012". - source Barclays.

So, are implicit volatilities pricing correctly or incorrectly a shift in this paradigm? 

Or are the excess valuation premium anticipating a sudden surge in risk aversion which has not yet been seen yet in long-dated volatilities? We wonder...

"Isn't life a series of images that change as they repeat themselves?" - Andy Warhol 

Stay tuned!

Guest post - European Credit versus volatility looks increasingly appealing

"The facts will speak for themselves. Credit them or not, but read!"
Ralph Chaplin - American activist.

Back in January 2011, in our credit conversation "A tale of two markets - Credit versus Equities", we indicated the following in relation to credit and the relationship with equity volatility:
"In theory Credit can be assimilated to a long OTM (Out of the Money) equity option. A Credit Default Swap (CDS) is a proxy for a Put Option on the Assets of a Firm. This means that by going long on bonds the bondholders are long the face value of the bond and short a put option on the assets of the firm with the strike price being the face value (principal) of the bonds.

In recent years, according to a research published by Morgan Stanley in March 2009 by Sivan Mahadevan, correlations between changes in credit spreads and changes in various implied volatility metrics, have been very similar to short-dated ATM (At The Money) equity options. Liquidity being an important factor and short-dated ATM being the most liquid in equities, whereas the 5 year point being the most liquid CDS point (Credit Default Swap). Given there is an extremely low probability of an entire equity index going bankrupt, Morgan Stanley's research team further comment that ATM volatility can be used to make comparisons between equity and credit. The cash equity/credit relationship is apparently less stable than the volatility/credit relationship according to Morgan Stanley's study."

In continuation of our previous conversation relating to the relationship between equity volatility and credit, please find the recent analysis from our good cross-asset friend pointing to the current relative attractiveness of being long credit and long volatility:

"Long 1 year atm (At the Money) volatility on Equity Indexes versus long credit via short CDS Indexes positions look increasingly appealing on current levels.

Following the Greek Elections and the European Summit, implied volatilities levels on equity indexes have corrected dramatically while other risk measures are clearly not validating any “blue-sky” scenario (Spain/Italian sov spreads, bund yield, credit spreads…). On current relative valuations long credit vs long equity volalitility positions look particularly interesting.

On the credit side you benefit from the relative backing of huge flows from institutional investors hungry for yield, while still enjoying relatively solid balance sheets from a corporate universe that has consistently been rolling over debt maturities.

On the equity side you are paying reasonable volatility levels, almost in line with the recent subdued realized levels with a large upside should any stress materialize in coming months."

Below the Itraxx Crossover 5 year index vs German DAX Index example :

Chart1 – DAX 1 year volatility ATM (At the Money) chart - source Bloomberg:

Chart 2 : Ratio of Itraxx Crossover versus Dax 1year ATM (At the Money) Volatility since early 2011 - source Bloomberg:

Chart 3 : Using a power regression with a very strong R2 (0.80) here is a chart displaying the implied Itraxx Crossover spread versus the current 1year DAX ATM volatility - source Bloomberg:

Nota Bene: Itraxx Crossover in the above charts has not been adjusted for the 6 month roll effect.

Stay tuned!

Markets update - Credit Terminal Velocity?

Definition of Terminal Velocity:
"In fluid dynamics an object is moving at its terminal velocity if its speed is constant due to the restraining force exerted by the fluid through which it is moving.

A free-falling object achieves its terminal velocity when the downward force of gravity (Fg) equals the upward force of drag (Fd). This causes the net force on the object to be zero, resulting in an acceleration of zero.

As the object accelerates (usually downwards due to gravity), the drag force acting on the object increases, causing the acceleration to decrease. At a particular speed, the drag force produced will equal the object's weight (mg). At this point the object ceases to accelerate altogether and continues falling at a constant speed called terminal velocity (also called settling velocity)."

As per my previous post relating on liquidity issues (Macro and Markets update - It's the liquidity stupid...and why it matters again...), tensions are indeed escalating in the global banking system and in particular in the USD funding markets.

Large cash USD cash buffers have been built up on balance sheets of US branches by large European banks:

In addition to these large cash buffers, thanks to QE2 and courtesy of Ben Bernanke, additional reserves have been accruing on foreign banks balance sheets as European banks hoarded USD cash as a precautionary measure.

But, according to a recent report by Nomura (Special Topics - The Growing USD funding problem) from the 19th of August, over recent weeks, the dynamics of the funding market have changed. The USD cash buffer has been falling according to FED data from 889 billions USD on July 20 to 758 billions USD on August 3rd:

In fact, according to the same report, there was a notable decline of 131 billions USD in two weeks, clearly a trend to watch.

Nomura's analysts in the report estimate that the USD cash buffer highlighted above is down 125 to 175 billions USD from its August 3 level to 580-630 billions USD currently. Terminal velocity?

As I previously posted banks CDS, and in particular in the subordinate space have been dramatically rising recently:
Itraxx 5 year Financial Subordinate index:

Itraxx 5 year Financial Senior index:

We are definitely in the red zone as far as CDS spreads for financials are indicating. At 250 bps on the 5 year for Itraxx Financial Senior CDS, we have broken another record.

Nomura to add:
"Access to USD CP funding for international banks continue to deteriorate. Thursday's Fed data on outstanding commercial paper showed a further decline, indicating that some European banks are having difficulty rolling paper."


So far, we have a clear sign of deterioration of the outlook for future funding given current volatility in the credit markets, reducing therefore the ability for banks to raise medium to long term funding as I previously explained.

In my previous post, we saw that most of the funding needs for 2011 had been covered for major European banks.

According to the same report from Nomura the USD cash buffer remains large from a historical perspective at 580-630 bn USD. It was 50 bn USD pre-crisis (2007 and early 2008) and averaged around 400 bn USD in 2010.

The lack of political resolve in Europe in relation to the size of the EFSF and Euro Bonds and, with credit spreads and volatility remaining high, it could potentially become problematic, with markets being shut down for new issues at the moment, if the situation lasts for too long.

In relation to banks in the peripheral space, the market is definitely and utterly shut down as clearly indicated by the CDS market:


So yes, as I stated in my post on liquidity, the weaker players cannot access credit at reasonable rates and it will have consequences for their economy and growth prospects. Credit crunch redux?

And that's what Societe Generale's analyst Suki Mann had to say in today's Euro Credit Wrap untitled "Messy":

"There's nearly always a way out of an economic mess that doesn't cause all involved a severe amount of pain; but this time it doesn't look too great for anyone. This decade's long debt binge-fuelled malaise just runs too deep, such that a painless solution to the crises no longer exists. The sticking plaster type response we've seen so far in Europe has failed to convince or work, with the politicians still thinking a cattle prod can control a stampede. The markets are not even waiting for an official recession to be called in the US - they've already made up their minds. Political foot-in-mouth disease, the weakening economic outlook and policy response which is inadequate are leaving risk markets living in perpetual fright. At least the corporate sector has been well prepared for this situation. Our analysis indicates that is the only positive one can hold onto. And just as well, because the funding markets in Europe have been closed for weeks After all, at these growth rates and anticipated more difficult refinancing markets for HY entities, we should be looking at greater default rates than we are at present. In the medium term we will be, but we need to stop looking at medium/longer term outlooks and focus on the immediate issues and risks. Here it's about fear as we enter uncharted waters; investors are still fortifying cash positions while witnessing minimal credit fund outflows and some are positioning for weaker growth; versus, dare we say it - again, the ultimate demise of the single currency. The former is the lesser of two evils; should the latter occur, nobody wins. Most are on the fence so far as a break-up of any sorts is concerned, as it is still deemed incomprehensible (an “it'll be ok in the end” mentality still prevails). So we toy with the idea of eurobonds (will that even work?), expect more ECB buying of peripheral paper and await the EFSF further dirtying its hands. Tomorrow probably won't be better than today."

And in relation to upcoming defaults some names are clearly coming close to that point in the mortgage insurance business:

PMI Group Inc., the mortgage insurer has posted 16 straight quarterly losses and today dropped 32% to around 20 cents.
"The Arizona Department of Insurance told PMI to halt sales of new policies and stop making interest payments on $285 million in surplus notes.
“The department may take appropriate action, including commencing conservatorship proceedings” if PMI fails to satisfy regulators’" - Source Bloomberg.
The PMI Group CDS 5 year in equivalent spread:

Goodbye PMI?

And PMI's competitor MGIC Investment under tremendous pressure as well according to its 5 year CDS level:

Radian Group also in the crosshairs:

The reason behind?
"The percentage of U.S. mortgages overdue by one month rose to the highest level in a year in the second quarter as homeowners who lost jobs were unable to make their payments. The share of home loans overdue by 30 days rose to 3.46 percent of all mortgages, from 3.35 percent in the first quarter, according to a report today from the Mortgage Bankers Association in Washington. The percentage of mortgages overdue by 60 days increased to 1.37 percent from 1.35 percent, while foreclosures dropped for the second consecutive quarter.
The gain in early delinquencies signals a slowing economy may increase foreclosures, said Jay Brinkmann, chief economist of the trade group." - Source Bloomberg, Kathleen M. Howley - 22nd of August 2011

Home builder Hovnanian is also coming under fire.
Hovnanian Entreprises, under pressure as per its 5 year CDS level:

Reason behind:
Bloomberg - Kathleen M. Howley, Aug. 22:
"Sanjay Jain called his real estate broker four days ago to cancel a deal to buy a three-bedroom home in Folsom, California, unnerved by another plunge in the most volatile equities market on record. “Seeing what’s happening on the stock market made me think that it’s not a good time to be buying a home,” Jain said. “I’m going to wait and see.”
As the U.S. economy shows signs of sputtering, instability on Wall Street is sapping the confidence of would-be property buyers, said Karl Case, co founder of the S&P/Case-Shiller home-price index. That means housing, which aided every recovery except one before the most recent recession, may deepen its five-year drag on growth."

And finally as it wasn't enough for the day, I leave you with Bloomberg Chart of the day, suggesting there is a German recession ahead:
"The CHART OF THE DAY shows that when the benchmark DAX Index’s valuation fell below 1.15 times the assets of its companies in 2002 and 2008, the German economy retracted for two quarters on each occasion. The gauge’s price-to-book ratio dropped to 1.16 on Aug. 19, the lowest since 2009." - Source Bloomberg:

Stay tuned!

Markets update: European Debt Crisis - EFSF and The Sum of All Fears

“ "Why, you may take the most gallant sailor, the most intrepid airman or the most audacious soldier, put them at a table together - what do you get? The sum of their fears." „

—Winston Churchill

"Worth noting the FT has reported that Merkel faces a revolt among her own coalition in Berlin over the EU/IIF deal agreed at the 21st July summit.

Some members of the CDU have apparently called for an emergency party conference to debate the government's euro zone strategy including the expanded powers of EFSF.

Belgium's Finance Minister said he aims to have the parliament's finance commission meet on the 5th September to present the text of the amended EU bailout agreement in part because Greece will need funding again in mid-September.

Back from his holidays, Dutch Finance Minister wrote in a letter to lawmakers that the EFSF is "no panacea" to solve the mounting troubles in the euro zone and "any significant increase of the EFSF can...have consequences on the creditworthiness of guarantor nations".

The launch of EFSF 2.0 is clearly a top priority when politicians return from summer holidays and continues to be a space that will probably bring us more volatility along the way."
(Source : Deutsche Bank)

Slithering to the wrong kind of union - Otmar Issing

A must read. Otmar Issing argues that Euro Bonds are the only way to alleviate funding issues of the failing peripherals and relieve the pressure which is still building up.

Markets udpate:

Equities - from BFTD to STFB...
CAC40 intraday move, another epic day:

DAX intraday move, I feel dizzy...

Rumours of issues with Societe Generale, stock getting slaughtered:

FX - Swiss National Bank - EUR/CHF a real issue for tourism when a Big Mac menu cost 17 USD in Zurich...

Credit - Same story as yesterday, except a tad wider...
Itraxx Sub Financial 5 year index breaking a new record.

Gold, well you know the score...

Risk indicators - still in the red and on DEFCON 1
VIX INDEX

OIS-Libor - Liquidity getting poor in the Euro area.

German 10 year Government bond aka DA BUND - can you spell Lufthansa flight to quality?

EFSF and The Sum of All Fears:
The European credit crisis is worsening. The Euro lost 1.3% today to 1.4188, while Gold hit 1800. The Euro Stoxx 600 crashed to a two year low and Paris based Societe Generale closed down 15%, after an intraday low of -22%.
The US 10 year bond reached a low of 2.13% after touching a record low of 2.03%. The US is turning like Japan and star analyst Meredith Withney even mentioned "zombie banks", a term I have already used in this blog in relation to Irish banks.
What the FOMC told us is that Ben Bernanke is well aware of the economic situation and has indicated to the market that the FED is going to stay accomodative for a while which according to me, means that long bond yields are going to fall much further:
UST 30 year yields:

France is next on the line and their were some nasty rumours of downgrade on France today leading to massive sell-off in French financial stocks today.
France is indeed in the crosshairs of the bonds vigilantes and the EFSF is definitely in jeopardy unless a very fast solution is find. France's five year Sovereign CDS reached 172 bps today. France's AAA rating has been affirmed by all three rating agencies, Moody's, S&P and Fitch. The market is very nervous and if France CDS is under attack it is not a good sign.
Not only France was under attack but French banks 5 year Credit Default Swaps were as well targeted.
Not only did Societe General stock tanked, its 5 year senior CDS reached 300 bps according to CDS data provider CMA.
Here is a run sent by a dealer regarding French banks CDS:

ACAFP being Credit Agricole, for your information.

Credit markets liquidity is drying up very fast, meaning new issues are being delayed and bank funding is under increasing pressure.

So what is happening now? Are we getting to the end game as mentioned previously in this blog?

As a reminder, this is what you have in a deflationary environment:

The "Beggar-thy-neighbor" policy induced by both the UK to some extent and by the FED is pushing us towards debt defaults for countries. For instance this policy is now crushing Swiss and Japanese exports and has taken a severe toll on European exports.
The fight between the Keynesian FED and the Austrian ECB is reaching fever pitch. Given the size of the bonds purchases needed to support Italy and Spain, the ECB doesn't have enough ammunition and a sizeable balance sheet to sterilise as it did previously its purchases of Portuguese, Irish and Greek bonds.
If the ECB start "printing", then the consequences will be a meteoric rise in the price of Gold, and we are, dear readers, getting very close to that point of no return for the ECB, unless Euro Bonds are set up, fiscal union reached, but given political uncertainties within the German CDU and Angela Merkel, the outlook is grim, given the very high fear of extending the size of the whale CDO, namely the EFSF. This is indeed The Sum of All Fears.

While I thought, I have been quite pessimistic recently in my outlook, so far, about the situation, Martin Sibileau in his latest post is even more scarier:

A View from the Trenches, August 9th, 2011: "The beginning of the end"

"The dam is broken and there is really no way to hold the fury back. The forces that will be unleashed here will surpass what anyone of us can imagine and the end game is a world’s reserve currency backed by gold. Within a fractionary reserve system? Unfortunately we think so, but backed by gold!"

This article is a must read as, I believe can explain what is at stake if European politicians cannot reach an agreement relating to Euro Bonds and a EFSF increase very fast.

Markets update - Credit - Rates - Equities - The Fast and the Furious...and unintended consequences of the US downgrade.

The Fast and the Furious...

Markets update:

In the equity space, it has been volatile to say the least and given sometimes pictures are worth more than words, we'll go through some of the action today.

CAC40 intraday movement, welcome to Disneyland Magic Mountain!

Around 6.5% intraday movement.

But the German Dax index was even more volatile:

EUR/CHF - the trend is your friend and the Swiss National Bank might start printing soon, and join the debasing currency club because it must be starting to hurt exports:

In this "Risk Off" mode, Gold is continuing its uninterrupted rise, from new record to new record:

VIX index - Houston we've got a problem...

Some other risk indicators
Our friend Ted Spread is cooling off a bit:

But it isn't the case for OIS Libor spreads in Euro:

European Government Bonds update:
Shock and awe doctrine in full force on 10 year Italian and Government bonds!
Italian BTP 10 year bonds

But most of the action was on the Spanish 10 year bond!

Is it going to restore confidence in the markets? We still need long term solutions which have yet to be addressed by European politicians. The EFSF will have to be increased or spell the demise of the Euro.
Greece 2 year Government bonds - Zombie Zorba is staying put:

Since the ECB started buying Greek bonds, the 5 year Sovereign CDS for Greece went from 617 bps to 1690 bps according to Bloomberg.

In the credit is getting crushed and liquidity is extremely poor in the cash market.
CDS spreads continue to widen significantly, making everyone feeling extremely nervous. That Lehman feeling all over again...Not good.
Itraxx Crossover 5 year index, drifting wider and wider:

In the sovereign 5 year CDS space, France is widening still:

Australian Banks have also started widening in this sell-off:


Unintend consequences of the US dowgrade = global repricing of risk.

Since the downgrade, U.S. government bonds rallied, with
the yield on the benchmark 10-year note tumbling to an 18-month
low of 2.28 percent. Flight to what is still seen as a safe haven in this brutal environment.
S&P followed up with the downgrade of Fannie Mae and Freddie Mac, DTCC and others, and municipals bonds.
Fannie Mae’s current-coupon 30-year fixed-rate mortgage-backed securities rose 0.14% point to 1.22% points more than 10-year U.S. government debt, according to Bloomberg. A gap of 0.87%, highest gap since April 2009.
Fannie and Freddie have so far received 170 billion USD in federal aid since being placed in conservatorship in September 2008.
AA+ has been assigned by S&P to municipal bonds, a market of 2.8 trillion USD.
The premium paid by European banks to borrow in dollars through the swap market has increased the most since January this year according to Bloomberg. The cost of converting euro-based payments into dollars as measured by the one year cross-currency basis swap fell to 43.6 bps below the euro interbank offered rate (EURIBOR) yesterday according to Bloomberg.

Banks are therefore affected the most by the US downgrade because of the implied support of the US government since 2008. Also given the economic slowdown, they are indeed more affected.

The Markit ABX index tied to subprime-mortgage bonds rated AAA when issued in 2006 fell 2.8 point to an equivalent cash price of 47. The biggest fall since May 2010 according to Markit.

Leveraged Loans, the S&P/LSTA US leveraged Loan index 100, declined by 1.77 cents to 90.66 cents on the dollar, the 11th consecutive fall and lowest level since October. The highest point was 96.48 cents to the dollar on February 14 according to Bloomberg.

Emerging Markets: The JP Morgan EMBI Global Index, mostly used benchmark for Emerging Markets bond funds jumped 34 bps to 354 bps, highest level since 2010.

Basel III is raising capital standards for banks, so quite a few banks need to raise capital. But, with the current market sell-off, the new issue market is essentially shut down, meaning down the line, it is going to be very crowded at some point when the markets cool-off and opens up again. Given countries, banks and others will be coming hard to the market to raise capital, it is going to cost more. Simple as that.

Companies are still hoarding cash and sitting on a hefty pile of 963.8 billion USD in the US according to S&P data. Companies are in great shape to weather the storm. They have paid down debt and are to some extent quite lean with healthy balance sheets.

Finally, unintended consequences on China - Bloomberg:
The Yuan and the Dollar index

Charts of the day - Bloomberg:
Portuguese citizens like Irish citizens, are leaving their countries for a new life, leaving behind their battered and bruised economy:

Migration might fall in negative territory in Portugal unless the government can end the exodus of workers seeking employment abroad. But it isn't only happening in Portugal, it is also happening in Greece and in Ireland.

And as a conclusion, Bank of America's market cap as of yesterday's close was 73 billion dollars, Apple has enough cash to buy it outright in cash with 76 billion USD in the bank account...
Bad news keep piling up for Bank of America since the very ill-fated acquisition of Countrywide...