The fall and financial destruction of 2008 launched a brand-new era for the credit markets. An era marked by government intervention and outright manipulation all committed in broad daylight under the protection of financial apocalyptic prophecies. Our self-styled financial superheroes (Treasury Secretary Geithner and Fed Chairman Ben “Helicopter” Bernanke), wield their collective financial imagination and money printing press like Thor’s hammer on any and all areas of the credit markets they deem worthy. Think of this behavior, if you will, as a massive financial game of ‘Whack a Mole’: When a certain sector of the credit markets pops its head out of its hole and refuses to behave, Batman and Robin fly in on a Mil V-12 and pummel accordingly. We can rail against this free market destroying and dangerous ethic, or we can take advantage of this obscene ritual and profit.

I, for one, choose profit over catharsis and along that vein offer you the following illustration of credit market evolution by our very own Credit Guru, MJ:

Near the height of the credit crisis Capital One announced that were buying back their ABS Auto bonds. They indicated that the returns available in the secondary market exceeded the returns they could earn by originating new car loans. They continued to buy back bonds in the secondary market until secondary market prices increased to the point that it became more profitable to originate new car loans rather than simply buy secondary market loans. Once the economics favored originating new car loans over buying older vintage ABS bonds….credit flowed back into the car financing business…… and car sales began to increase as pent up demand was unleashed.

The recovery in the Auto Finance market and its ability to attract investment dollars has caused Auto finance credit to materially loosen for even non-prime borrowers. The power of this trend manifested itself in GM’s decision to acquire AmeriCredit.

A similar trend materialized in the airplane leasing business. As the credit markets recovered, bonds issued by airplane leasing companies rebounded strongly. Intermediate ILFC bonds were trading in the mid-50s in February 2009 but are now trading strongly through par. Similar to the Auto Finance business, once pre-credit crisis airplane leasing bonds approached par airplane leasing companies were quick to tap the market for new financing. This new financing allowed them to order new planes and pay for planes already on order. As we have stated numerous times since the spring 2009, the reestablishment of an airplane leasing credit market has facilitated a pick-up in aircraft purchasing that we believed would benefit the entire manufacturing industry.

This same basic premise also seems to be working its way through other structured credit asset classes…although it is and has occurred at different paces. In our opinion, CMBS is in the middle of this same cycle. The rally in many pre-crisis CMBS deals and the issuing of new deals will continue to accelerate and deal spreads will tighten as investors use leverage to build their portfolio size. Current 8x-10x leverage will increase and capital raises will provide managers with a great deal of buying power. The expected increase in leverage availability and the high rates of return still available in this market will allow it to continue to attract investment. As demand for CMBS investments increase the market will once again begin to finance an increase in commercial building…..

The RMBS sector is following the CMBS sector’s lead. Although we believe that government driven uncertainty regarding GSE shrinkage and increase regulatory risk is slowing the RMBS sector’s recovery, we do not believe that there is anything in the market at this point that will actually reverse the RMBS Sector’s recovery. The aggressive leveraging of RMBS securities in Hedge Funds, REITS, and other investment vehicles is in the process of driving RMBS prices higher. We expect that the demand for RMBS paper is going to materially grow and outstrip the amount of secondary market bonds readily available as the year progresses. This is one of the reasons the FED is dumping their bonds. By the end of this year we expect a sizable increase in non-GSE related RMBS debt that will begin the process of materially loosening homebuyer credit. This would lead to an increase in residential construction work in 2012 as the loosening facilitates the release of pent up housing demand.

Tags: ABS bonds, auto finance, ben bernanke, cmbs, Credit Guru MJ, credit markets, Fed, Fed Chairman, Geithner, GSE, REIT, rmbs, Thor's Hammer, treasury secretary

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Stock Market Strategy: All signs point to a continuation of the current rally. We will continue to use the direction of liquidity and the behavior of the credit markets as our fundamental guides to equity investing.

The primary news story making the rounds today involves the European bank stress test results. I have included the official results and accompanying statement below for your perusal. If you would rather the cliff notes I will summarize: Completely worthless nonevent.

CBES releases results of the EU Stress Test — 7 banks fail test

The exercise includes a sample of 91 European banks, representing 65% of the European market in terms of total assets, in coordination with 20 national supervisory authorities. It has been conducted over a 2 years horizon, until the end of 2011, under severe assumptions. In total, aggregate impairment and trading losses under the adverse scenario and additional sovereign shock would amount to 566bn € over the years 2010-2010. The aggregate Tier 1 ratio, used as a common measure of banks’ resilience to shocks, under the adverse scenario would decrease from 10.3% in 2009 to 9.2% by the end of 2011 (compared to the regulatory minimum of 4% and to the threshold of 6% set up for this exercise). The aggregate results depend partly on the continued reliance on government support for currently 38 institutions in the exercise. The aggregate Tier 1 ratio incorporates approximately 197bn € of government capital support provided until 1 July 2010, which represents 1.2 percentage point of the aggregate Tier 1 ratio. As a result of the adverse scenario after a sovereign shock, 7 banks would see their Tier 1 capital ratios fall below 6%… See release here.

Once again traditional financial news outlets fail to focus on issues that actually move the markets and instead waste time and energy on government sponsored propaganda. The typical word on the street from this story is as follows: ‘Street expected 10-11 banks to fail test and only 7 failed so things are better than expected.’

Enough said about the theater of the absurd a.k.a. European banking stability. Please follow me into the realm of reality as I focus on events that are actually having a tangible impact on the equity markets. Committed RCM blog readers will recall this quote from my July 14th post, “The above chart also suggests a change in trend may be in the offing”. At week’s end, it would appear suggestion has turned into sage advice as the rally that began July 7th makes new highs.

Tangible event number one:

Quantitative Easing round #2 is currently underway. How do we know this you ask? The Fed made no comment in the FOMC minutes release and Ben Bernanke said nothing of note to Congress. So how do we know Q.E.2 has begun? The answer lies in the chart below. As you will see, worldwide liquidity is once again on the upswing. This rise and fall of liquidity has been and should continue to be the single biggest factor determining market direction. Close scrutiny of the graph will reveal the selloff of assets in 2008 was led by liquidity contraction, the rally of 2009 occurred on the heels of liquidity expansion and the first 6 months of 2010 suffered from another reduction of liquidity. However, in the last three weeks worldwide liquidity has expanded progressively, hence a rally in asset prices should not surprise. We can expect further asset gains, equity, commodity or otherwise, as long as this liquidity trend continues….

Tangible event number two:

The credit markets are the first to be effected by the liquidity situation. Our credit guru, Mike Johnson, spotted the positive behavior of the credit markets at the end of June. The liquidity expansion began, credit markets immediately stabilized and true to form equities followed. Another review of MJ’s thinking seems appropriate…  

…intraday credit market volatility continues to decline and this indicates that equity volatility is biased to continue to decline. This is clearly a positive for the broader equity indices.  

One of the reasons we became bullish at the end of June was because of the improvement in bank CDS spreads, the normalizing of GS’ CDX credit curve, improvements in consumer credit losses, and improving CDX IG spreads. COMPARING THE PERFORMANCE OF THE CREDIT MARKETS TO THE EQUITY MARKETS (SPX) would indicate that SPX has the potential to rise to the 1150-1175 range QUICKLY. The steepening of CDX IG credit curve further indicates that this 1150-1175 range is even more likely to be reached relatively soon.

Tags: ben bernanke, CDX index, commodities, Credit, credit markets, equity markets, EU Stress Test, FOMC, liquidity, Q.E.2, Quantitative Easing, stock market strategy

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Guest Post by Don Coxe (courtesy of Zero Hedge)

Don Coxe Dissects Gold, As “The Oldest-Established Store Of Value Moves To Center Stage”

…We think that future historians may well report that the moment when gold once again became a store of value was when the dollar began soaring in response to the stench of seared Greece—and gold climbed right along with it. The asset classes that have been inversely correlated since Keynes’s time suddenly united….

… So why didn’t inflation come roaring back when Bernanke doubled the Monetary Base and M-2 was climbing at double-digit rates?

And why didn’t inflation come back when central banks across the OECD were growing their monetary bases and money supplies were climbing? And why did gold take off to record levels when money supply growth began to dwindle and actually turn negative?

… What we believe is unfolding is a rush into gold by individual investors who look at the astronomic growth in financial derivatives—particularly collateralized debt swaps—and government deficits at a time when the effects of demographic collapse are finally being understood. According to some guesstimates we have heard, the supply of outstanding financial derivatives may be in the $70 trillion range, dwarfing the combined value of money supplies and debts. The total value of gold is so minuscule in comparison to the supply of these software-spawned instruments that it cannot be any real help in stabilizing global finances—but it can be a haven for investors seeking to protect themselves against an implosion of majestic proportions.

… So…as a store of value for future generations,

If you can no longer believe in residential real estate,
and you can no longer believe in bank deposits,
and you can no longer believe in the dollar,
and you can no longer believe in the yen,
and you can no longer believe in the euro…
What can you believe in?
How about gold?

It’s so old, it’s new again.

… Among the arguments routinely adduced against it is that it pays no interest—but with interest rates in the zero range, the opportunity cost is minimal.

Read More…

Stock Market Strategy: Follow Up – Credit Check

Michael Johnson (a.k.a Credit Guru) weighs in on recent credit market performance and shifts his stance:

Last Wednesday we turned from tactically bearish to neutral. We went completely bullish Friday morning. The equity market’s ability to ignore the recent improvements in bank and non-financial CDS profiles appears to be faltering…. and this could lead to a sustained equity rally… …Credit market performance so far this morning indicates that the SPX should be trading in the +25pt range….that would match the note we sent out Friday morning

Bears About to be Gored

Summary:

We now believe investors should be Tactically Bullish as well as fundamentally bullish

Bears should be getting nervous…credit market is improving

GS Credit curve has steepened

New Issue Market reopened

Bank CDS Spreads tightening

Credit market volatility decreasing

How many times do you think credit will tighten before the equity markets jump on the bullish bandwagon? It’s probably sooner rather than later…

Gored… As our readers know, during the recent sell-off we have remained fundamentally positive while turning tactically bearish. We have written numerous pieces highlighting the differences between the feared “sovereign credit crisis that will never be” and the onset of the 2007-2009 credit crisis. The fear of Greece and of Euro viability concerns short-circuiting the global economic recovery is wishful thinking by the bears. This is like the bank nationalization argument….politicians will allow the Euro to fail because they know it will cause global havoc….politicians will nationalize the banks because they know it will cause global havoc…investing based on the hope that politicians will make stupid mistakes does not seem appropriate.

However, the ability of FINREG to destabilize the bank’s access to the credit markets is a truly scary, and much more likely to happen, in our opinion. The inversion of the GS credit curve and the widening of larger US bank credit spreads began a week before the overall equity and credit markets began to sell off. In our opinion, the weakness in the money center bank’s credit profiles made it a lot easier for sovereign risk concerns to find a willing audience.

The combination of the sovereign credit crisis headlines along with money center bank credit fears caused the correlation between banks CDS spreads and CDX IG Index spreads to increase. Credit market volatility materially increased and appeared to spill over into the equity markets. Many of the equity market’s worst sell-offs immediately followed large credit market sell-offs.

However, the reason we are becoming tactically bullish at this point is the reduced likelihood that FINREG will be passed with its most destructive portions. This opinion is working its way through many of the money center banks CDS credit curve profiles and credit spread volatility is decreasing. Additionally, continued improvements in nearly every consumer loan asset class will likely force even the most bearish bank analysts to reduce their loss estimates….

Conclusion:

Being fundamentally bullish and tactically bearish has been a relatively solid approach to the recent sell-off in our opinion. However, the recent decrease in credit market spread volatility and the stabilizing of money center bank CDS profiles makes it difficult to remain tactically bearish when we remain bullish fundamentally. We are now fundamentally and tactically bullish. The recent trend in which the equity markets ignore credit market strength is not likely to last.

Tags: CDS, Credit, credit market volatility, credit markets, euro, finreg., gold, GS, Michael Johnson, precious metals, stock market strategy, Zero Hedge

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No need to stalk anymore, the Grizzly is now in plain sight and gorging itself on hapless bulls.  I started the ‘Stalking’ series on March 30th with the intention of raising the awareness of readers to the dangers lurking in the financial forest. From the April highs to the recent May low, the S&P500 dropped 14.6%, NASD Comp. 15.6% and the Dow 13.2%.  I trust you used the knowledge imparted to protect and profit during the month of May.

For a picture of what a grizzly looks like please see the chart below. I emphasized the importance of the NYSE Composite in Part 4 of this series. We believe the NYSE Comp. experiences less interference (manipulation) from futures and ETF derivatives than does the big three (DOW, S&P500, NASD Comp), hence offering better insight into true direction. True to form, the NYSE Comp. (depicted below/each bar = 60 minutes) led on the downside dropping 16.2% and remains weaker than the big three trading firmly below the 200-day moving average…. 

The debate now rages about whether this selloff is simply a correction in a Bull market or the return of the Bear. I have made my opinion abundantly clear over the last 2 months. However, I will offer up the following two charts as an exclamation point.

Both charts focus our attention on the credit markets. For some time now, credit markets have been leading equity. I dedicated Part1 of the ‘Stalking’ series to this basic credit leads equity theory. To place a finer point on it, if credit markets are relatively stable then equity selloffs can be viewed as merely necessary pullbacks in ongoing Bull markets. However, if credit market volatility explodes, CDS spreads widen dramatically, interbank lending rates skyrocket, etc., then something more sinister is afoot. And no doubt that foot is covered in fur and has claws.  

So, what is credit telling us now? Well, on May 24th our favorite credit Guru, Michael Johnson of M.S. Howells, had this to say, “CDS spreads are today as bad as they were in Sept. ‘08.” That’s certainly not a good sign. How about the interbank lending market? LIBOR rates in ‘08 spike higher offering an early warning sign of big trouble to come. The chart of today’s LIBOR rate (shown below) offers a classic example of the proverbial picture that is worth…

In conclusion, I am posting a chart of  high yield bond spreads. This chart is indicative of the destruction occurring across the spectrum of corporate and sovereign credit…

Bottomline: Rates are rising at an aggressive pace and unless or until this trend dissipates equity will have a hard time sustaining a rally. Expect volatility to remain elevated. Remember, the biggest up days on record occurred during Bear markets. Please don’t allow the cheerleaders in the financial media to confuse you on these up days. Instead, view them as you would the little guy in the Lotto commercials. He grabs the microphone and screams about the possibilities. Do you really want to be the type that runs with the mob to buy a ticket?

Tags: credit markets, DOW, High Yield bonds, libor, NASD Composite, NYSE Composite, sove, sp500, Stalking the Bear

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Time to check in with the Greek narrative. The hysteria has quieted down as new backroom deals to avert a meltdown are reported with some regularity.  However, the attempts to sweep Greece’s problems under the proverbial rug are occasionally sidetracked by a pack of rioters, or as is the case below, by the bond vigilantes. If rates continue to creep higher for Greece no amount of posturing will suffice to avert this funding crisis…

Greek borrowing costs imperil budget plans – WSJ

WSJ reports the high interest rates Greece must pay to borrow money are threatening the county’s ambitions to cut its deficit, raising again the specter it may need external aid. Many in Europe breathed a sigh of relief last week when Greece successfully sold €5 billion ($6.85 billion) in government bonds in an auction that saw investors clamoring for the debt. The sale was seen as a key test: The country needs to borrow about €54 billion this year. But debt buyers are demanding higher premiums than officials in Athens anticipated when they planned the 2010 budget, and when they proposed to European Union authorities in January a plan to trim last year’s €30 billion budget gap by €9 billion this year. Indeed, Greece’s filings with the EU rest on assumptions implying that this year and next the country will pay an average interest rate of about 4.7% on its new debt. That figure is consistent with the rates paid on existing Greek bonds, mostly issued in better times. But in last week’s auction, Greece had to pay 6.25% for a 10-year loan—about three percentage points above what Germany pays for similar debt. 

…While the bond vigilantes are alive and well in Greece they are apparently asleep everywhere else.  As the story below describes, credit liquidity has rebounded significantly from the veritable seize up in January and February, which in turn has facilitated an equity market recovery….

Credit market springs to life – WSJ

WSJ reports companies are aggressively borrowing in the debt markets once again—a sign of renewed confidence in the world economy following recent fears that struggling European countries could have difficulty financing their budget deficits. In the U.S., bond sales by companies such as Bank of America Corp. and GMAC Financial Services are on pace to conclude their busiest week since the beginning of the year. In Europe, borrowing by companies so far in March is already more than 60% of February’s totals. “It tells us that financial liquidity is very much on the rise,” said John Lonski, chief economist at Moody’s Investors Service. “No longer do corporations suffer from a dearth of liquidity. This puts them in a better position to take advantage of opportunities that arise.” So far in 2010, U.S. corporations have issued $195.2 billion of debt, excluding government-guaranteed bonds, according to data provider Dealogic, up from $166.8 billion during the same period in 2009.

…In fact, credit investors are so desperate for product it seems anything with a yield will do, as evidenced by the story below….

Buyers scramble for California bonds – LA Times

LA Times reports robust investor demand allowed California on Thursday to increase the size of a bond offering to $2.5 billion from $2 billion. The tax-free general-obligation bonds, which will fund voter-approved infrastructure projects, attracted orders totaling $1.38 billion from individual investors Tuesday and Wednesday. With just $620 million of the original $2-billion deal left, the state took in $3.3 billion in orders from institutional investors Thursday. To fill more of those orders, Treasurer Bill Lockyer raised the deal to $2.5 billion.

Tags: bond vigilantes, California, credit markets, EU, Greece, greek

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The equity markets dropped on average 1.5% Monday and this morning another 1.5% decline is underway.  I mentioned, in A Review of the RCM Investment Strategy, the defensive posture we at RCM have taken. I said, “We have deployed our assets in a manner we feel most appropriate for the environment we are experiencing.”

The following news items should help illustrate what was meant when I wrote, “…the environment we are experiencing.”….

Lending falls at epic pace – WSJ

WSJ reports U.S. banks posted last year their sharpest decline in lending since 1942, suggesting that the industry’s continued slide is making it harder for the economy to recover. While top-tier banks are recovering at a faster clip, the rest of the industry is still suffering, according to a quarterly report from the FDIC. Banks fighting for survival, especially those plagued by losses on commercial real estate, are less willing to extend loans, siphoning credit from businesses and consumers. Besides registering their biggest full-year decline in total loans outstanding in 67 years, U.S. banks set a number of grim milestones. According to the FDIC, the number of U.S. banks at risk of failing hit a 16-year high at 702. More than 5% of all loans were at least three months past due, the highest level recorded in the 26 years the data have been collected. And the problems are expected to last through 2010. FDIC Chairman Sheila Bair said banks are “bumping along the bottom of the credit cycle” and that the number of bank failures in 2010 will likely eclipse the 140 recorded last year.

If “Banks fighting for survival, especially those plagued by losses on commercial real estate, are less willing to extend loans” then what do you think will happen when the following development gains steam?….

SAN FRANCISCO (MarketWatch) — Just when they thought the worst of the mortgage crisis was behind them, billions of dollars in bad loans from the debacle may be rising from the dead and creeping back on the balance sheets of the largest U.S. banks.

Big lenders including Bank of America, J.P. Morgan Chase and Wells Fargo may be forced to repurchase troubled home loans from insurers and mortgage-finance giants like Freddie Mac that had agreed to take on risks associated with those assets during the real estate boom.

The banks are setting aside more reserves to cover the potential costs of such repurchases, cutting into earnings….

Read More…

Of course, we can spend all day debating the reasons for banks’ lack of desire to lend, but the real crux of the issue remains the employment picture. The American people, due in large part to the horrible jobs market, are reigning in spending hence needing less credit….

Mass Layoffs Surge In January, Highest Since July 2009

The BLS has reported Mass Layoff Statistics for January 2010 – the result is plain ugly, and kills any hope for sustained improvement in unemployment data. Not seasonally adjusted Mass Layoff Events (defined as at least 50 persons being laid off from a single employer) surged in January to 2,860, from 2,310 in January, from a 12 month low of 1,371 in September 2009. This is the biggest monthly surge since July when the Mass Layoff Events hit a 12 month high of 3,054. In terms of actual workers, January saw 278,679 initially laid off people. The deterioration was mirrored in the much less credible seasonally adjusted data. Obviously companies were waiting for the end of the year to dump as many people as they could.

ECONX Initial Claims Report Suggests a Much Weaker Labor Sector

The initial claims data weakened for the week ending Feb. 20 as the claims figure increased from 474,000 to 496,000. The consensus expected claims to decline to 460,000. Many analysts, including us, believed that inclement weather conditions across the U.S. would prevent many workers from filing new claims. If this scenario is true, then the actual initial claims figure would be much closer to 550,000… Continuing claims rose a modest 6,000 to 4.617 mln for the week ending Feb. 13. The figure for the week ending Feb. 6 was revised up from 4.570 mln, and the consensus expected claims to remain at that previous level… The job creation data looks to be minimal. The unadjusted claims data from Feb. 6 was down by 85,842 claims while the emergency benefits figure declined 317,933 claims. The decline in original claims is mostly due to workers running out of benefits and it seems the weather made it difficult to process extended benefit applications.

Meanwhile, the health of the credit markets remains the number one issue facing the equity markets today.  You may recall my Feb. 18th post ‘Credit Markets Warning Signal, Foreign Demand for US Treasury Falls ‘ in which I outlined the very real possibility that European credit constriction was migrating across the pond. Well, the following stories add credibility to that concern…

Greek Treasuries Pancake As Bond Vigilantes Chant Death Chorus

Ah, curve pancaking – better known in bond parlance as the death rattle. The Greek 4 Year GGB just traded wider of the 15 Year at a spread of -4bps (yup, negative). This, to continue the parlance lesson, means the bond vigilantes are now pretty sure how the Greek situation will play out. Oh, and Greece, all the best with that €5 billion10 year bond issuance. The 1 Year spot his exploded from just over 200 bps on January 1, to just under 5%, a rout for all short-term GGB holders. We are anxiously awaiting RBS’ rebuttal.

Read More…  

California postpones bond sale – WSJ

California One Step Closer To Insolvency After State Cancels $2 Billion General Obligation Bond Sale

Five days ago a great white hope appeared for the great bankrupt Golden State (Baa1/A-), in the form of $2 billion in GO bonds, which were supposed to be promptly syndicated via underwriters JPMorgan and Morgan Stanley. This would have been the first bond sale for California since November: a critical milestone as the state creeps ever closer to a full-on default. Unfortunately, the creeping just turned into a casual jog after Jane Wells (@janewells) just tweeted that California has cancelled its bond sale “after legislature fails to approve cash management flexibility bill [the] Treasurer said he needed to attract investors.”And seriously, did California think it would succeed where so many other high yield issuers have recently failed?

Read More…

I will rest my case today with a request to review my post titled ‘Looming Defaults and the Effect on Currencies, US$ vs. Euro’.  In this post I describe the competitive devaluation process unfolding and the similarities between Greece and California.

Tags: bad loans, California, commercial real estate, credit markets, euro, FDIC, Greece, initial jobless claims, Treasury, unemployment, US Treasury, US$

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The following story represents perhaps the largest obstacle facing equity market integrity today.  The previous statement is not hyperbole. The collapse of equity prices in 2008 was presaged by a python-like constriction of credit. If the private sector cannot access credit then business grinds to a halt and as we saw in 2008 economic cataclysm ensues… 

Credit markets flash hottest warning signal since crisis

European credit markets are flashing the most serious warnings signs in a year as the yields on risker bonds rise sharply and a string of companies cancel share flotations, raising fears that the recovery may falter in coming months.

The Markit iTraxx Crossover index measuring yields on lower-grade debt has jumped by almost 130 basis points since mid-January to 514, while the main index of investment grade bonds has jumped by a third to 93. “This is the biggest move since the financial crisis in early 2009, said Gavan Nolan, Markit’s credit analyst.

The rating agency Moody’s said market ructions have led to a “material” rise in borrowing costs over the last month, prompting the cancellation of debt issues by the Dutch energy group New World Resources, Italy’s Snai betting group, and the UK’s Travelport. Sixteen companies wordwide have pulled debt issues worth a $7.3bn (£4.66bn) since mid-January, including Canada’s Bombardier.

Read More…

…Will the Sovereign debt issues of Europe migrate across the pond?  The following story suggests the answer may be yes. The lack of foreign demand for US debt will have the effect of increasing rates. However, since an increase in rates would be the death knell of our supposed economic recovery we would expect the Fed to attempt to fill any gap foreigners create. These actions would be, of course, US$ bearish. So while the talk of an end to Q.E. intensifies reality of the situation suggests otherwise….  

Foreign demand falls for Treasuries – Financial Times 

Financial Times reports foreign demand for US Treasury securities fell by a record amount in December as China purged some of its holdings of government debt, the US Treasury department said on Tuesday. China sold $34.2 bln in US Treasury securities during the month, the US Treasury said on Tuesday, leaving Japan as the biggest holder of US government debt with $768.8 bln. China overtook Japan as the largest holder in September 2008. The shift in demand comes as countries retreat from the “flight to safety” strategy they embarked on upon during the worst of the global economic crisis and could mean the US will have to pay more to service its debt interest. For China, the shedding of US debt marks a reversal that it signalled last year when it said it would begin to reduce some of its holdings.

“Credit is a system whereby a person
who cannot pay gets another person
who cannot pay to guarantee that he can pay …”
Charles Dickens (1812-1870)

Tags: China, Credit, credit markets, equity markets, Q.E., sovereign debt, US Treasury, US$

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After a week of credit market histrionics, Monday morning ushers in a moment of calm…

Greek spreads ease; Portugal under pressure – WSJ

WSJ reports European sovereign CDS spreads were generally tighter Monday, with the cost of insuring Greek and Spanish debt against default falling, although Portugal remained volatile with spreads widening. According to CMA DataVision, Greece’s five-year sovereign credit-default swap spreads—a key measure of credit risk—moved back below 4.00 percentage points in early trading Monday to be quoted at 3.97 percentage points. That’s around 0.1 percentage point tighter than Friday’s close of 4.07 percentage points. That means the annual cost of insuring €10 million ($13.7 million) of Greek government debt against default for five years had fallen €10,000 to €397,000. The pressure on Spain also eased slightly, with the country’s CDS spreads tightening around 0.05 percentage point to 1.61 percentage point, according to CMA. Portugal, however, bucked the trend with the cost of insuring the country’s debt against default for five years rising to 2.34 percentage points, against a close Friday of 2.27 percentage points, according to CMA.

However, this calm is most likely the eye, as opposed to the end, of the hurricane. Speculation runs rampant as to the cause of the Greek tragedy…

 Two Hedge Funds One Bank? Is There A Concerted Effort To “Destroy” Greece?

In the pre-math of the Greek collapse, conspiracy theories are swirling about who keeps blowing Greek CDS spreads wider. The answer, so far completely unconfirmed, is that a large US investment bank (we “wonder” just which US investment bank dominates the sovereign CDS market), and two major hedge funds are behind the CDS “attacks” on Greece, Portugal and Spain. According to Jean Quatremer, and his Coulisses de Bruxelles, UE blog, the plan involves blowing spreads to record levels, and is prompted by the hedge funds’ anger at not having been allocated substantial amount of the recent €8 billion GGB issue, in order to lock in profits from their CDS long exposure. Being thus unhedged with a short bias, their alternative is to continue buying protection else risking to mark losses on their extensive CDS short risk exposure. Read more…

While the previous story sounds plausible and is certainly entertaining, a more pressing and definitive issue plagues Greece….

ZeroHedge: The latest escalation in the Greek crisis comes courtesy of Greek daily Banking News which notes that the latest nail in the Greek coffin comes from formerly major Greek players, Deutsche Bank and Unicredit, which over the past 2-3 weeks have ceased accepting Greek collateral and have pulled out of the Greek repo market altogether….

…Yet even as Greece is concerned about collateral eligibility with the ECB in 2011, the sad truth about its precarious and increasingly non-existent collateral exposure will come much earlier than that. Gradually, the country is becoming financially isolated: if the repo market collapses it is certainly game over as no semi-developed country can continue to exist without this core pillar of the shadow economy. In the meantime the vultures keep on circling.

Tags: CDS, credit markets, Greece

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The equity and commodity markets get rocked as Sovereign debt woes resurface.

The burning question: Will the dramatic widening of credit spreads in Sovereign debt, beginning to resemble the CDS collapse of 2008 in the private sector, lead to a revisit of a 2008 type credit crisis and all the fallout associated with it?…

Greece, Portugal woes intensify – WSJ The Wall Street Journal reports the cost of insuring the debt of euro-zone members with large budget deficits against default rose Thursday, dashing hopes that the European Commission’s qualified endorsement of Greece’s budget plan would calm investor fears. Greece, Portugal and Spain were in focus, with their five-year sovereign credit default spreads moving sharply wider. Greece’s five-year sovereign credit default swap spreads were recently at 4.14%, compared with Wednesday’s closing level of 3.97%, according to to CMA DataVision. Portugal’s five-year sovereign CDS spreads were at 2.09 basis points—their widest level ever—after closing Wednesday at 1.96%. Spain’s sovereign CDS spreads widened to 0.12 percentage point to 1.64%. The moves followed news Wednesday that the European Commission had put Greece under more pressure to cut its deficit; that the Portuguese government sold only EUR 300 million of treasury bills at an auction, compared with an indicative offer of EUR 500 millon; and that the Spanish government had raised its budget deficit forecasts for 2010 through 2012. Spanish and Portuguese stock markets fell sharply for the second consecutive day, with banks leading decliners on sovereign debt worries.

…The jury is still out on the above question but market participants are voting today.  As usual, voting like this is detrimental to long term investment decision making.  I would suggest all take a step back relax and reassess after the smoke of today’s battlefield clears. In the meantime, tomorrow’s employment report may shed some light on the absurdity or validity of  today’s flight into the US$. I stress the word, may, because government released employment numbers are notoriously manipulated.  For those who wish to debate this manipulation issue and wish to cast aspersions about conspiracy theorists please view the following story…

Explaining The Government’s 1.8 Million Job Overestimation In Pictures

Last October the BLS announced it would revise historical payrolls lower by 824,000 on February 5 (this Friday’s NFP release). While this number will not impact the actual January NFP report (a loss of nearly one million jobs in a month would probably even take out the persistent SPY algo that has been hugging the bid for the past 10 months), it will be prorated across all months in the 2008-2009 reporting period. The reason for this adjustment has to do with a huge glitch in the birth-death model, which is exactly the same problem that the rating agencies faced when housing prices plummeted: the birth/death model assumes, in the long-run, jobs are created, not destroyed. Any period of excess volatility in the stock market therefore translates into major prior downward revisions to already disclosed payrolls. And while we know what the current revision will be, the scarier prospect is that the next historical adjustment, due out in early 2011, will be even larger, at least 990,000. This means that the government has overrepresented running payroll data by over 1.8 million jobs over the past 20 months. Read More…

Today, world equity markets suffer, the “risk” trade is reduced and scared investors run into treasuries and the US$.  Meanwhile, the underlying fundamentals of the US$ continue to deteriorate….

Zerohedge: It’s Official: Congress Passes Debt Ceiling 231-195; All Republicans, 20 Democrats Vote Against Raise.  Congress Democrats have just signed off on the US hitting 100% debt/GDP.  About 140% if one adds GSE liabilities which also should be on the budget.

Initial Claims 480K vs 455K consensus, prior revised to 472K from 470K

Continuing Claims rise to 4.602 mln from 4.600 mln

NY Fed’s Dudley says “nothing is on automatic pilot” when asked about ending MBS purchases in March, according to AP – Reuters (The expected end of Q.E. in March has been a major factor in the strong US$ theory since Dec.. Now we see, at the 1st sign of trouble, S&P500 down 3%+ today, the Fed begins to backtrack – surprise, surprise.)

Tags: CDS, commodities, credit markets, credit spreads, employment report, equity markets, Fed, Greece, initial jobless claims, sovereign debt

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The economic news continues to be terrible. The knee jerk reaction; sell off the equity markets run into U.S. treasuries. This type of action would only make sense to the person who ran directly from his cabin into the galley on the Titanic and felt he had gained safety. Furthermore, this fatuous trade into T-bonds has place a brainless bid into the U.S.$.

Allow me to be extremely clear, the worse the economic numbers are the more stimulus will be needed leading to an even bigger debt burden. This is ultimately not good for T-bond prices. However, when T-bond prices ultimately collapse is not easy to foresee because of Fed intervention. On the other hand, for the U.S.$ the picture is vivid. Negative economic news means further Fed intervention which strengthens the case for an even weaker U.S.$….

ECONX Employment Report Weakens Significantly
The employment report came in worse than expected in September. The consensus expected the labor situation to improve and projected payrolls to decline by only 175,000. Instead of an improvement, payrolls fell 263,000 — worse than even the ADP employment report projected.

The unemployment rate declined 0.1 percentage points to 9.8%, exactly what the consensus was expecting. However, the unemployment rate is very misleading. The civilian labor force declined 571,000 in September compared to an increase in the labor force of 73,000 in August. If the labor force held steady in September, the unemployment rate would have increased to 10.2%! …

Total private weekly hours worked declined 0.1 hours to 33.0, below the consensus expectation of 33.1. Further, hourly pay only increased 0.1%, also below consensus expectations. The drop in hours worked and the lack of a strong increase in pay pushed weekly earnings down 0.2% and will lead to lower consumption from people that have maintained their jobs over the last month…

Looking at the payrolls a little more closely, there is no sign of an improvement in employment in the near future. Government payrolls declined 53,000 as state and local government budget cuts forced out workers. Construction and manufacturing employment declined by a combined 115,000. Service-providing firms shed 147,000 jobs as retail trade lost 39,000 jobs, business and professional service lost 8,000 jobs, and leisure and hospitality employment declined 9,000. Only the education and health service sector posted positive employment gains, but the increase was extremely small with only 3,000 new jobs.

…So, after a week of hawkish comments from various Fed governors what do we hear in the wake of these negative economic numbers? Don’t forget, the G20 meeting is now a distant memory….

Fed’s Pianalto says pace of Fed pullback depends on how econ conditions unfold - DJ

DJ reports the pace at which the Federal Reserve will withdraw its support from the economy when the time is right depends on how economic conditions evolve, said Sandra Pianalto, President of the Federal Reserve Bank of Cleveland.

Responding to audience questions after delivering prepared remarks at the Down Town Association in New York, Pianalto reiterated her view that the Fed’s current accommodative policy is appropriate, and said that at this point it is difficult to determine just how fast the Fed will eventually remove its easy policy. “It’s going to rely on how economic conditions unfold,” she said. “We’ll continue to monitor how economic conditions unfold and then act appropriately.” Pianalto reiterated comments from her prepared remarks that she anticipates a gradual recovery and bumps along the road. She said she hopes “they’re just bumps and not shocks,” because “another shock could be very detrimental.”

Fed’s Rosengren says Fed will stay until clear econ can keep improving without help - DJ
Rosengren says expects to see positive growth in Q3, Q4

…All of the above thoughts lead us to the obvious question: what is next for the equity markets? Is the sell off on the negative news a beginning of an October rout or simply another normal retracement? Well, we will of course need to monitor the uptrend and see if support holds. However, for now I will simply comment that the credit markets are not confirming the weakness in equities as of yet. Mike Johnson form M.S. Howells says it best when he wrote this morning….

….Credit sell-off confirmation is nearly non-existent. TARP-Supported Preferred Equity Index (TSPEI) was only down 0.05% on Thursday with KEY, JPM, HBAN, GS, BK, C, and USB preferred equity members all posting gains. Given the low after tax cost of debt financing and the minuscule returns available to executives hoarding cash, we expect to see an increase in the number of executives announcing new debt-financed equity buybacks this earnings season.

Tags: credit markets, employment report, Fed, pianalto, rosengren, T-bonds, US$

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