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Over the past 4 years when I first got to know Forex trading, I've traveled a long way. My interest and passion lies in cross-asset and inter-market analysis for major asset classes encumbering the macro landscape. My macro views often change a I read more and developing thinking and critical... More
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  • The European Circus & The Global Trainwreck

    I'm back after a 2-month hiatus. So much has happened but the markets haven't moved much. Yes, day to day volatility and the implicit price of volatility has been high but something tells me that the markets have been immensely opaque recently. Fundamental developments (or the lack thereof) haven't been priced in (or should I say inaccurately reflected). I wanted to dissect the edifice of my thoughts into a few distinct groups: 1) Europe; 2) America & China; 3) Financial markets in general and the macro opportunities that may ensue.

    The EUROphoria

    Everything about Europe has gone nuts. It seems Mario Draghi has thrown a monkey wrench into the pit: Southern European sovereign credit; Equities and the Euro itself have gone haywire. Posterior to Thursday's ECB announcement of its new SMP ver.2 (outright monetary transactions - OMT), Southern European sovereign credit had already started rallying (looking at the 10 year part of the curves since anything shorter would be heavily distorted). Bunds were falling steadily, OATs were rallying, GGBs were rallying... basically concentric European risk was on and funds were flowing out of the safe havens.

    Nothing has changed in Europe. Fundamentally, insolvent governments need cash to cover borrowing costs (interest payments) and thus had to issue more debt to cover existing debt. Financial contagion, private sector leverage, new capital adequacy requirements remained the main factors to the great operational impasse. These economies were stagnant in terms of productivity and innovation from the start of their individual cycles; current unemployment rates are rising, GDP growth is negative, real wages are falling, social unrest is reaching fever pitch. Countries like Greece, Ireland, Portugal have lost their competitive advantages of labor and technological innovation, the two distinct dimensions of output growth. Spain and Italy are entering this abysmal zone.

    Politically, no one was and is willing to lend these troubled nations. The money has to come from somewhere but Germany, the last powerhouse of Europe knows best that whatever money that it lends the Southern Nations will likely vanish in the supermassive black hole. Losses have to be borne regardless of the jawboning and the baton passing. Absent an orderly restructuring, the only two outcomes of solving Europe's sugar high are deleveraging (a protracted depression/deflationary spiral) and hyper inflation (debasing the currency and hence the value of debt; at the same time boosting growth of nominal GDP). Germany's constitutional court is set to vote on the legislation of the European Stability Mechanism this coming Wednesday but expectations are pessimistic. Germany's Bundesbank, the largest and most influential member of the ECB has consistently opposed to unconventional monetary policy (money printing, financing SPVs that gobble up bad sovereign debt et al).

    Angela Merkel, the chancellor of Germany still believes in a European Union and a fiscal pact where by there is a single set of rules that govern fiscal prudence per each member country. Although austerity is a widely abused and misused term, it remains the only legitimate way of resolving Europe's current enigma. Europe's version of austerity involves promising to slash the size of deficits by reducing government expenditures and raising taxes. What isn't told is that these promises will always be broken and new promises will almost always subjugate them. Austerity is a promise to break promises. However, troubled nations like Spain and Greece receive previously negotiated bailout money conditional on these promises. Moral hazard is real and alive in Europe.

    The newswires reported that the fourth wealthiest man in the world, the CEO of LVMH holdings based in France has decided to take up a Belgium citizenship and is filing a request to the French immigration for approval. Why? A few months ago, France's new president François Hollande proposed a new law that would tax the 1% of its citizenry (those with annual personal incomes above 1mn Euros) 75% of their incomes. Backfire, next story please...

    Also crucial to note is the massive fund outflows from the Spanish banking sector. Retail depositors and clients have been withdrawing funds at a staggering rate. I don't have the exact numbers but total YTD fund outflows amounted to roughly 15%-20% of total bank assets. Ring a bell? Yes, it's an orderly bankrun. Funds are flowing into safehavens and are being converted into anything but the Euro. Redenomination of European assets into other currencies like the Greek Drachma or the Italian Lira in the unlikely event of a EMU breakup would mean massive unrecoverable losses on assets, deposits and life savings. Better safe than sorry I guess.

    Enough of the past. The present isn't much different. The political chasm hasn't been bridged and we know the Euro was an invention motivated by political incentives. Let's talk about the OMT for one moment. The market expect Spain to request for a "bailout" in a few weeks due to scheduled principal repayments on its debt. Spain is currently on the verge of being cash-less and doesn't have access to the credit market. The only ways Spain manages to repay maturing liabilities is through fund transfers (target 2) and issuing new debt at prevailing market yields (which have fallen a great deal). The OMT is conditional on a nation requesting help from the ESM and will hence have to meet prerequisites of deficit reductions under the ESM legislation. Once under the ESM bond buying program, the OMT facility will monetize the nation's bond issuances, effectively lending money to that sovereign. Operationally, the ECB would credit the ESM with money and then would arrange reverse repurchase agreements with the various NCBs (Bundesbank, Banc de France et al) so as to "sterilize" the entire process (ie: no new money has actually been created as existing money offsets the ECB transfers to the ESM).

    If we short circuited the entire process of the OMT, it would inexorably boil down to NCBs (read Germany) funding the purchases of sovereign debt, be it new issuances or secondary market purchases. Yes, mark to market risk will be reduced to mark to model risk on the ESM's balance sheet but as I've tautologically hemorrhaged on, the credit bases hasn't expanded one single bit. Without credit growth, Europe (actually all economies) can forget about growth. Basically, pray and hope that the OMT lowers the effective borrowing rate for these sovereigns and stems any form of black swan event involving a blow up of these nations an the Euro. We all know the quagmire Europe is currently in but the more optimistic point is that if no bad events occur from now till things improve, things will stabilize and markets will adopt to the new standard of a depression. This is basically the ultimate aim of can kicking, to postpone once imminent problems until the market's threshold has advanced to an extent that it is able to absorb those negative shocks without sparking a major crash.

    The Euro's suffering from some schizophrenia: Sov yields lower but Euro's lower

    QE & End of China's Exuburance?

    The foremost reason for US equity's reluctance to fall may well be the persistent hope for the NewQETM . Just to recap, the FED extended its Operation Twist (Maturity Extension Program) a few months back to continue selling at the short end of the curve (3 years and under) and buying at the longer end (7 years, 10-30 years) to the tune of roughly $40bn/month. There is an apparent problem as highlighted by the quants over at Zerohedge: The FED has nearly run out of short term paper to sell and will have to include longer term debt (probably up to 5 years) if it was to continue with Twist. The primary goal of Twist was to flatten the yield curve to try boost the housing (refinance market) market. So far so bad, Twist hasn't done anything but to increase the FED's DV01 (duration risk) by ever so slightly. There's one other thing Twist might have succeeded in doing: pump priming the stock market to current exorbitant heights. Twist might have been QE3 (after the $600bn QE2 program). Yes, Twist was sterilized and is a flow program (ie: reinvesting proceeds from maturing and liquidated paper). But as the market's have pointed out, it is the flow and not the stock that motivates risk appetite. There comes a time when the flow gets huge enough to be considered new stock. If Twist was indeed QE3, the market is either expecting a stock program (something around the lines of $500bn of MBS purchases) or an increase in the monthly purchases under Twist (say from $40bn to $60bn).

    Zerohedge recently brought to light a limitation of what the FED can actually do when it comes to unconventional monetary policy. At the current rate of bond buying, the FED is effectively monetizing all of the Treasury's long bond issuance. Remember that the presidential elections are just round the corner and the fiscal cliff will soon ensue Washington. Possible implications may include a reduction in long term debt issuance (10-20 years). The FED may be forced to monetize other assets besides treasuries; and this might be why the entire TSY curve has shifted higher in the past week or so. Is this a case where the FED through the many years of gargantuan purchases grown bigger than the treasury market itself?

    The above chart provides a simple linear-scale visualization of the SPX. We are technically quite extended and according to the venerable Elliot Wave Theory, SPX is threading on Wave 5 (the last impulse before corrective A-B-C). The FED might be the harbinger of its self-destruction; besides, I was always of the opinion that policy makers were near or at their wit's ends.

    Across the Pacific, the once furnace-hot Chinese growth has waned to a much more manageable level of 7.4% YoY for Q2'12. As tempting as lowering RRR and repo rates might be, the PBoC knows if it continues with loose policy, inflation will supersede any gains of growth. Inflation for the low income Chinese means alot because around 30% of their monthly income goes into food and staples. As premier Hu Jintao's 10-year term draws nigh, an angry population is one of the last thing he needs when the Chinese political system gets a shakeup towards year's end. Inflation is the greater of the evils in China. A YoY7.4% growth is still immensely impressive considering how the other developing economies are coping.

    Delving beyond the superficial, some analysts are already cutting corporate outlooks due to increasing margins due to sticky energy costs and rising employee wages, and weakening exports to Europe and the West. Such downward revisions to corporate outlooks are general associated to slowdowns. Chinese firms have quite a bit of inventory to clear because of the over supply of certain raw commodities like steel and copper. Many Chinese steel makers have been suffering losses for the past few quarters but still continue to operate. The reason for such is that municipal governments have been offering incentives and strong oppose to laying off workers, something that is inevitable when production is halted.

    Iron ore prices have been an accurate barometer of global infrastructure development and that translates to GDP growth. Prices have risen north of tenfold over the past decade but have probably peaked early this year. The Baltic Dry Index (BDI) is another useful indicator of global maritime trade; although it has bottomed out somewhere late last year, current levels are unindicative of progression (the index is basically flat as shipping prices remain suppressed and stagnant). As previously stated, global growth is a novelty without credit creation and money velocity. The consumers of exports (America, EU) from labor and commodity rich economies such as China, India and Brazil have been stunned by falling real wages and high unemployment. Aggregate demand hasn't recovered when adjusted for government stimuli.

    In order for China to achieve that proverbial soft-landing everyone is hopping for, it needs to moderate growth, hence exports and trade surpluses will fall/turn negative. I wouldn't be surprised if the government enacted new laws that impede personal saving habits and induce spending/consumerism, in a bid to transition from a foreign investment to a domestically fueled economy. Such forces might quell fears of a vacuum once capital flees China's property markets.

    Some FX Charts:

    Yen: Shorting the Yen will probably be the investments of the decade... but everything about those returns is contingent on your timing

    Aussie: FX carry risk hasn't been as ebullient as European sov risk and US equity risk. Clearly, not every market is buying into the ECB bazooka scheme...

    Swiss: The Yen, Dollar and the Franc are probably the only currencies that are considered safe-havens due to their market depth amongst other reasons. Recent Swiss strength against the Greenback contradicts general risk-on ramp fest

    Gold: If anything should excite it would be Gold. Implied volatility on Gold exchange traded options spiked 9%+ on Friday. Current price action strong hints of a successful breakout and continuation of the secular trend. Strategically, market would be expecting some form of money printing or systemic black-swan type of tail event if Gold were to surpass the indicated supply areas

    Sep 09 1:24 PM | Link | Comment!
  • Understanding JPM's Blunder That Cost It $2bn & Counting

    I feel it is imperative for all market participants to have a general understanding of how JPM's hedge blew up, something that some espouse as a black swan (think LTCM in 1998 & probably the exposing of MFGlobal's corzining of investor capital to cover losses on sour speculative bets). The MSM has been quick to cover this story on JPM's alleged felony with regards to its risk management and how a "hedge turned speculative". Whilst there are bits of true facts and opinions presented, a good chunk of it is quite literally bosom-dung. Zerohedge has put up a meticulously detailed analytical piece on how things went wrong and puts the CIO (chief investment office) decision making tree in soft focus - A must read for folks who want the fresh juice of the entire edifice on a grand scale. I'm merely going to share my analysis which contains alot of the stuff in Zerohedge's piece but also delve deeper into where more explanation is warranted. This isn't child's content, it is deep stuff (think quantitative finance) so take some time to really understand every sentence in this post and in Zerohedge's piece.

    What was JPM Hedging?
    Although no non-insider knows for certain, point and shoot guesses would likely be commercial loans on the books of JPM's commercial banking arm. I think this is an aggregated book meaning the portfolio of loans originated from US corporations and probably a few hundred million Dollars in consumer loans. Reasons for this is because due the CIO's hedging instrument of choice (read on for more details later). The size of this portfolio is unknown but should be huge, very huge (large enough that risk models weren't able to detect micro seismic faults before the markets turned against their hedge. I read that Jamie Dimon (JPM's CEO) has expressed willingness to testify infront of congress (remember Goldman's "$hity deal" buzzword during hearings on allegations of conflict of interest; "Timberwolf securities" ect...). Let's hope more light will be shed on this very elusive subject on what was actually being hedged and in what quantities.

    The Hedging Instrument of Choice
    As Zerohedge pointed out, the CIO probably wanted a cheap hedge against extreme tail risk (think global systemic risk; ie: Europe falling apart; non-idiosyncratic credit risk (non-company specific credit risk); many corporates defaulting at once) that would payoff (covering/lowering cash losses on the underlying loan book) amidst utter chaos and financial cataclysm. It is much cheaper to hedge such risks in aggregated form rather than buying protection on individual names.

    Zerohedge rightfully opines the CIO's sole intentions were to protect against adverse market movements which risks' cannot be immunized through conventional covered loan risk management strategies.

    To wit:


    Originally Posted by Zerohedge

    2) JPM traders/risk managers are not stupid - can manage curves/levels in 'normal' market but firm needs 'extreme' risk hedge.

    Critically - these guys are not dummies - they don't simply buy/sell index protection or curves (as some have suggested) in ultra-massive quantities (since risk models would flash) unless there is an edge. More importantly, they can manage risk at desk levels on term structures and exposures (and even jump-to-default risk to some extent) but on the aggregate portfolio there is a lot of un-covered risk of an extreme event (which seems ever more present) occurring.

    The CIO decided to long the super senior tranche

    (a cocktail mix of 5Y, 7Y, 10Y maturities) of the


    index. CDX.NA.IG is a composite CDS index of 125 individual US corporates (reference this back to the underlying portfolio being hedged).

    Zerohedge explains that the CIO chose the super senior tranche due to its relative cheapness over subordinated tranches (junior, mezzanine, equity) due to the higher leverage it offered (less funding requirements, somewhat resembling a SS tranche of a synthetic CDO where upfront payments aren't necessary because potential losses will be buffeted by the lower tranches),

    but more importantly SS offers

    "(sensitivities) to spread movements (low), volatility (medium - due to hedging gaps), and

    correlation (high)


    Correlation risk

    was what the CIO was implicitly hedging against. A rise in correlation indicates increasing latent systemic risks; hence the hedge needs to be highly sensitive to correlations.


    SS tranche also protects against conterparty risk

    (risk that the writer of the CDSs fail to payup in a credit event). Conterparties can include SPVs that structure synthetic CDOs. Losses due to such risk will be passed to the lower tranches before it hits the SS tranche (if the losses are huge enough). Hence the CIO's decision to be long the SS tranche was based on their prescient knowledge that only deep shocks would require such hedging and the SS tranche was perfect for this purpose.


    Originally Posted by Zerohedge

    These characteristics appear fantastic at first glance - not too sensitive to spread movements overall (ceteris paribus), volatility will cause some drama (as the position will need to be rebalanced), and while correlation is a big sensitivity it is directionally in our favor and has relationships in line with spreads that should help us.

    The hedge would appreciate in price as spreads widen along with SS tranche correlations

    (IG index falls). There would be some form of payouts if any component defaults and will filter through the SS tranche before running down to the junior tranches. I would believe the CIO paid a slight upfront payment (a small percentage of the initial notional) and periodic interest payments (since CDX.NA.IG is trading on a conventional spread rather than upfront; again

    offering more leverage and making the hedge cheap


    Informed guesstimates of the initial notional (in the SS tranche) ranges from $200bn-$300bn. Again, no one knows the exact figure but from the monthly Depository Trust & Clearing Corporation (OTC:DTCC) report on outstanding notionals one can make a ballpark guess.

    So What Went Wrong?

    The CIO's hedge fared relatively well in Q1-Q3 '11 courtesy of European contagion and the Greek spillover, and the downgrade of US by S&P. Remember the panic ensuring the proverbial US downgrade (recruit pitting at Hitler's face)? Yes, as Zerohedge intelligently points out, that was just about the peak of tranche correlations as the markets settled down in a consolidation before beginning their arguably benign march higher - the bears would reminisce how odious it was.

    To Wit:


    Originally Posted by Zerohedge

    10) Nov2011: Fed/ECB start coord. global easing program -> starts to crush correlation as systemic risk is 'supposedly' removed from system.

    And here comes the critical aspect of our story! The actions of the Fed/ECB/rest-of-world with massive and unprecedented easing efforts was perceived by the market as a tail-risk crushing event - i.e. they removed the systemic risk from the system once again.

    11) JPM CIO office forced to sell IG9 protection to manage tranche position as correlation drops (think: delta rebalancing).

    What this meant was very important. The tranche - which had been purchased as a hedge for JPM's aggregate (likely long) book required rebalancing as the 'models' used to price and risk manage such positions would have demanded some hedging of the hedge. This is similar to maintaining a delta-hedge on an option position as the market moves one way or another and volatility (a secondary parameter) changes. The trouble is - these systemic risk tranches are HIGHLY sensitive to this somewhat 'magical' measure.

    The gist matters have already been succinctly presented by Zerohedge. The FED's Operation Twist (Maturity Extension Program) and cross currency swap lines with the ECB, and the ECB's 3Y LTRO having commenced in Dec11 proved detrimental to credit tranche correlations. IG credit (proxied as CDX IG9) rallied along with equities post the binary collusion of the two central banks. Zerohedge likened correlations to deltas (ie: RoC of an option's price relative to the underlying's). Although there are broad similarities, I would meekly note that deltas have either positive/negative empirical relationships to price whilst credit tranche correlations do not have -

    their relationship can be described as slightly idiosyncratic (meaning correlations may rise even if IG spreads compress, not necessarily when spreads widen)

    . Regardless, the CIO wasn't concerned about IG spreads rising or falling but about correlations tanking to never seen before levels.

    This is the bane of hedging via tranched credit products

    as the CIO undertook - correlations have to be dynamically managed. What was just described above marked the inflection point for matters over at the CIO's desks. As a result of a very rapid decline in correlations, the CIO needed to neutralize a good part of its 'short' credit exposure by shorting IG9 or by writing CDS protection on IG9 (same ends, different means). Zerohedge believes that the CIO did almost all of the re-balancing by shorting IG9 outright.

    The extreme RoC of correlations meant that the CIO couldn't sell IG9 protection in a gradual fashion that would preserve market normalcy; but rather frantically offer heavily into the index day after day after day

    ... So much so that this operation created a gaping skew between the IG9 index and its intrinsic fair value (summation of individual names).

    To wit:


    Originally Posted by Zerohedge

    13) Mar/Apr 2012: JPM CIO corners IG9 index market as forced protection seller on tranche tail-risk hedge position.

    This meant that the JPM CIO office began to sell more and more protection at the index level which forced the index to trade differently to its intrinsic or fair-value. These kinds of disconnect are often arb'd by sophisticated hedge funds - but this time the arbs were being frustrated by a SIZE player dominating the market and soaking up their demand for protection (the funds would be buying protection on the index - the opposite of JPM CIO - while selling the underlying names protection).

    Note: Iksil (the "London (wriggly sperm) whale") was inherently "long" IG9 index because he was selling IG protection (ie: short the spread, long the index). The Zerohedge description pertaining to the arbitrage opportunities simply means that the arbitrageurs would buy IG9 protection and sell individual protection (hence "short" IG9 index and "long" corporate credit) hoping that the basis would narrow when IG9 spread eventually widens.

    What happens next is from the devil within all flesh: Greed. What was a "hedge of a hedge" (IG9 protection selling) turned into a market chasing, momentum trade which Iksil was overly effervescent about. He was chasing his own tail; the more he sold protection, the harder the index was bid, the larger the 'profits' on his hedge trade, the more he sold... ad infinitum in a vicious circular reference spell.

    And then things start to change fundamentally; the mirage vanished while Iksil and the entire CIO realized the hideously obscene blunder they have committed being one of the top prop trading desks on Earth. I'm going to quote Zerohedge for the following sequence of events that makes me cringe.


    Originally Posted by Zerohedge

    15) European sovereign, China slowdown, and US growth risks spur deterioration in credit risk - meaning losses on IG9 index position.

    Between his huge size and the velocity of the shifts in the index as things began to go wrong fundamentally, Iksil was in trouble. Not only that but 'correlation' began to pick up and so the hedge of the hedge needed to be unwound...

    16) JPM CIO faces huge losses from small move in spreads since they have sold so much protection and tranche unbalanced.

    He found himself the dominant long player in a market in which fundamentals, technicals (arbs), and his own models (correlation) were saying unwind/short - which starts the pain trade for Ina and Bruno and more than likely this is when the bells started to go off in risk manager's ears and Dimon got the call...

    The vulture phenomenon kicks in: The Hedge funds that knew the plight JPM was in started to short the basis and with much passion indeed (not only did they buy tons of IG9 protection along side the CIO but also shorted all other related credit indices, adding more pressure to the CIO's overloaded long exposure whilst also squeezing every last but of liquidity from the IG9 market like a blood thirsty daemon in a wild, unfathomable hallucination. In the days preceding Dimon's call to inform the world about JPM's $2bn material loss, IG9 spreads started soaring ad Iksil started to unwind his then-turned speculative trade. The spike in spreads accelerated post Dimon's call. Add the broad risk-off environment that has been buffeting global equity and credit markets for the last 2-3 weeks and one would see why actual losses would uncountably surmount $2bn. Zerohedge estimates losses will be north of $3bn.

    And to end things off with the FED's curse:


    Originally Posted by Zerohedge

    22) Summary: JPM tail-risk hedge imploded thanks to Central Banks' Systemic Risk reduction - unintended consequence...

    The key factor is that if systemic risk had remained in even a 'normal' range of possible regions based on history, then the JPM CIO office would have had no need to over-hedge their tail-risk hedge position, no greed-driven need to press the momentum, and no need for such an epic collapse as we are seeing now.

    The point is - this was a trader/manager with a good idea (hedge tail risk) that was executed poorly (and with arrogance) but exaggerated by the unintended consequences of the Central-Banks-of-the-world's actions (and 'models behaving badly' as Derman would say).

    My synopsis of this tragedy? Over reliance on mathematical modelling (on hedging and risk management premises), human psychological weaknesses (greed), and sheer unfortunate luck. What could have been better done? Contrary from that MSM squawk about, JPM did the right thing initially. The hedge was operationally sound (loan books need to be hedge in out current environment of heightened credit and default risk) and the dynamic management of the hedge was routine and somewhat rudimentary. However, the trimming of the initial hedge exposure should have been conducted on a broader scale. Rather than performing this operation on a single OTC and relatively illiquid credit index, it could have been diversified through shorting protection on individual names, going long synthetic CDOs on similar IG credit and then having a much smaller position outright long IG9. It is not the sole error of over positioning a trade and the posterior consequences but the decision making dynamics behind the CIO's path actions. Risks of human error were not spread out, per se and that is one of the key take away points of this saga.

    May 18 1:18 PM | Link | Comment!
  • Is Europe's Exodus Nigh?

    Is the Exodus for Euro project indeed nigh? Anti-bailout voices have vehemently espoused so but there are two sides to every coin (or drachma). The fundamental picture hasn't changed by a great deal since I started writing about Europe's extreme pilgrimage through fire and brimstone. However with the passage of time and the very recent rhetorical jawboning and haranguing, the schism between the world's delusional make-believe and reality has shrunk; the gap is being bridged further by fast paced developments in the political arena of Greece and France, serving as a catalyst for the truth. Reality was always there, it was merely the market's stubbornness and perhaps idiocy that alluded it to the facts and allowed participants to be massaged with alot of hot talk by the Eurocrats and overly optimistic chaps who like to believe that all is very well. Although the fundamental synopsis remains very much grounded in a decade's worth of bad policy, the markets will choose to act it out in different ways, and quite creatively indeed. There have been frequent interludes; but they serve as mere distractions. These interludes were namely the ECB's LTRO in December 2011 and late January 2012, and the Greek PSI operation which placated most global risk markets. Now that the markets have had a fair share of a breather, the big bear is back and with rage.

    Just last week, the world was supposedly rather hampered by the center-left electoral results of France and a political stalemate in the Greek parliamentary theater. I discussed about the implications of this electoral outcome and likened it to a grey, rather than a high contrast black & white event. It seems I was wrong (at least as the week progressed and intraday vol was spread further out); European equities, credit, the Euro, European iTraxx Crossover at record wides for 2012 (similarly for the 5Y Spanish CDS)... I could go on forever. Last week was a very bad week for most long-only equity funds in Europe. America was rather shielded from the directional carnage in Europe with obvious intraday European Pre/Post close oscillations which should raise more than an eyebrow as to what, not who is actually trading in American stocks. Global market have been hit once again today and Europe is in a sea of red pixels. Why?

    Were the anti-bailout, anti-fiscal consolidation (a sleeker term for austerity) mandates of France's newly elected president the primary catalyst? Did this lead to a long squeeze and capitulations of overly sanguine positions? It really seems so but we will never know. What is certain however is that the market has run out of hopium (for things to settle down in Europe or for more extraordinary central bank stimulus/print fests/backstops).

    To wit, most risk-inverse assets are deep in the green, some are even at 2012's best levels. As of today (1000 EST): 10Y TSYs @ 1.77% (-7bp), 10Y Bunds @ 1.43% (-8bp & the lowest yield on record), 10Y JGBs @ 0.85% (-1bp), 10Y Swiss @ 0.54% (-7bp & best performer for the day).

    And the bad sovereign debt? 10Y GGB2 @ 26.27% (+255bp /sic), 10Y BTPs @ 5.71% (+23bp), 10Y Bonos @ 6.22% (+26bp & highest in 2012). 10Y CACs are up 3bp at 2.82%.

    Spain nationalized Bankia (one of the biggest banks in Spain & a consolidation of 7 community banks 6 quarters ago), buying up 45% of its equity. A shatter to any residual confidence/hope left in Spain's cajas' and large banks' abilities to recapitalize without external assistance (be it from the government or from the Troika). Total non-performing loans are unsurprisingly at a historical record and some speculate that a paltry circa 20% of all delinquent corporate loans and real estate mortgages have been written down. In other words, it is quite a bottomless pit for these banks because they would be essentially bankrupt the moment they mark these bad assets to the market's harsh reality. I noted Greece was a gone basketcase. Spain may soon get that title if nothing continues to be done. I guess it is only a matter of time before the deathknell for Spain is sounded. When that happens (10Y BTPs above 7%?), expect liquidity to be created on a draconian scale. Forget €1trn, Europe would need twice that just to stem contagion.

    And if the ECB doesn't print? Well then Germany foots a huge portion of the charity, pardon bill. Talk about China saving Europe with its $2trn in Forex reserves is just ludicrous. 1) To fund Euro liabilities, China would have to sell a good portion of its US TSY holdings, thus shooting itself in the foot; and 2) China understands the risks that its contributions may NEVER be repaid if any nation chooses to renounce Euro denominated debt. The Chinese aren't that dumb. Also notice that Asia has relatively little to do with Europe? The same can be said for America. It seems the world's 'firewall' to Europe's direct toxic sludge is paradoxically not to be financially involved in it (heck, America didn't contribute a cent to the IMF's recent global fund raising tour). Alas, we aren't immune to Europe's cold.

    So why do I question about Europe's Exodus? Basically because the path of least resistance and pain is to exit the Euroarea (hence de-legalizing the use of the Euro currency) and not years/decades of depressionary doldrums. But haven't I written about this for the umpteenth time? The catch: Greece seems to be moving along that path, a stark notion a few weeks ago. The second catch: Defacto God, Germany is loosing coercive power over the periphery sovereigns. Merkel suffered her largest 'loss' since WWII after her CDU conservative party scored a measly 26% (falling from 35% in 2010) in the North Rhein-Westphalia state election yesterday. Germany has already lost the full-fledged support from France despite Merkel claiming that she could turn Hollande back to the glorious light of forming a fiscal compact. With two distinct actors going in polar opposite directions as they did 5 weeks back, a shakeup seems prescient. Once the political impasse is complete breached, I reckon the Exodus out of the Euro currency can commence.

    The MSM and various financial blogs (and yours truly!) have been questioning whether Greece will exit the Eurozone. As such I wouldn't place too big of a bet on this possibility right now. Regardless of the sometimes senseless monkey-see-monkey-do elocution by the new wires, such utterance can sometimes be condensed into a "yes, but not now" reply. Greece is without doubt the wildcard because its parliament is currently in a 'neutral' position. Remember New Democracy (top voted party) announced its failure to form a coalition one day after it was granted permission. Just today, Syriza (the far-left and second top voted party) also announced that attempts to form a coalition have failed (despite talks with PASOK making some headroom over the weekends). Greece will this likely hold another election. I leave you to speculate on the results (whether you think anti-bailout or serfdom ad infinitum will garner more reception).

    Note: All parties are flawed in their own ways. Take Syriza for instance. They may be radically opposing to austerity and staying in the Eurozone but it doesn't offer a ruck of a pragmatic solution to the fallout. It applies for Hollande... and for US president hopefuls. I feel politics is almost always a grey subject as there is no one size fits all solution to the grand scheme of issues.

    Another anecdote: €450mn of foreign law GGB1 matures tomorrow (15 May). If Greece fails to pay, CDSs trigger and another mountain will be made out of a molehill, again.

    I might have over simplified things here; because even after a currency is de-legalized in a sovereign nation, it needs to introduce a new currency or adopt a currency of another sovereign nation. What happens to all existing debt denominated in Euros? What happens to all bank deposits? Will foreign held assets have to be repatriated before the transition? There are tons of other factors to consider just so anyone thinks it's as simple as smearing mortar on a brick. We're going to be in a surreal game of Charade in the coming few weeks/months but the focus would ubiquitously still be on Europe, America and China.

    May 14 11:12 AM | Link | Comment!
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