According to the FT, John Paulson, the billionaire hedge fund manager who made a fortune betting against U.S. housing but whose funds have been decimated last year is extremely bearish on Europe. As many, he believes the Spanish problems will spread to Europe's core. But what is extremely strange is his way of betting against Europe. He is buying Germans CDS and shorting the German Bund, which is making a record high every day. German yields have been NEGATIVELY correlated to EU stress. In fact, the best way to play EU stress until now has been to buy that Bund. You can see on the chart below of the German and Spanish yields that they are nearly perfectly negatively correlated.
In fact the only time the German Bund has been dropping (and yields go up) is during periods of relief. He had the trade on for a while apparently and despite things going from bad to worse in the eurozone, that trade is not working. In fact the German 2 year yield is about to go negative, yielding lower than its Japanese counterpart. As we have already mentioned, the Bund is one of the only safe haven left. It is trading 90bps below the ECB's benchmark rate which means yields should normalize and go up, if things improve, not if they get worse.
Obviously Mr. Paulson must have noticed this pretty obvious correlation, and from what he says he is not betting on things improving. He therefore must have something else in mind. It could be that Ze Germans will have to pay up and hence the country risk profile will go up. That makes sense but then why call the Armageddon as this is the solution. Or it could be that he is playing the Total Armageddon in which case the "Domino Effect" will even reach Germany, but then why even bother? Who is going to pay the underwritten CDS since there would be no banks left? Or maybe he thinks the ECB will have to open the printing press and Ze German will have another Weimar. Who knows? But it is definitely weird.