Thursday, 23 June 2011

Markets and Macro update - "Risk Off" mode is truly on.

The balance sheet recession is still lean and mean. Macro picture remains weak. It will be essential to monitor the next ISM print on the 1st of July. If it points below 50, the US will be again in recession territory.

Great question by Steve Keen and great analysis:

Dude! Where’s My Recovery? - by Steve Keen on June 11th

The fears expressed in my blog of the risks of a double dip in the US are coming closer to realisation unfortunately.

New Home Sales in May at 319K, down from 326K in April. New Home Sales are still in the dumpster:
Graph of New Homes Sold in the United States

Take a closer look on a 5 year scale, it ain't pretty:
New One Family Houses Sold: United States
FRED Graph

Average Sales Price for New Houses Sold in the United States - Volatile:
FRED Graph

Initial claims going up again in the US, it isn't going to help President Obama's re-election:

Initial Claims for Unemployment Insurance rose by 9000 last week to 429000. Worse than the expected level of 413000.
FRED Graph

In the rates and credit spaces, we had another volatile session.

Huge movement on the 10 Year German Bund government bond today, signifying a huge flight to quality move:
The 10-year German bund yield fell eight basis points to 2.86%, getting very close to a 5 months low. September bund future made a new contract high of 127.04.

Meanwhile Portuguese 2 Year notes reached a new record to 14.39%, 70 basis points wider.

Irish yields widened by 46 bps to 13.70%.

Spanish 2 Year notes widened by 16bps to 3.59%.

iTraxx SovX 5 year index reached 233 bps (record was reached on the 16th at 236bps). Greece represents 1/15th of the index as a reminder.

For Standard & Poor’s and Moody’s, a rollover of Greek debt would mean default.

And to add to the nasty sell-off Moody's warned it could downgrade 16 Italian banks including Intesa Sanpaolo, Banca Monte dei Paschi di Siena, Banca Nazionale del Lavoro and Cassa Depositi e Prestiti.

Italian Banks CDS trading wider today:
[Graph Name]

A classic scenario we've seen before, first the shots are fired accross the Sovereign country, then the banks get impacted next. Why? Banks are like second derivatives of an economy, if a country gets downgraded, so will its banks, pushing them even more into difficulties.

Whatever happens to Greece, as I posted in "European issues and the Greek jinx - Macro update, a focus on Iceland and more", its banks are in big trouble:

The ECB has threatened not to accept Greek government bonds as collateral if Greek debt was restructured. If the ECB follow through its threat, a liquidity crisis in Greece, bank runs and other social unrest on a big scale will occur, make no mistake. The AESE Greek equity index would get smoked in similar fashion as the ICEXI icelandic index got whacked given its composition and bank weighting.
A reminder from my previous post - ICEXI got obliterated:

EUR/CHF still displaying the ongoing flight to quality mode, breaking another record today: EUR/CHF hit 1.1902 during European afternoon trade, the pair's all-time low...

Also today, Oil fell 4.6% as the International Energy Agency announced the release of 2 million barrels a day for 30 days beginning next week. Looks like they want to release the pressure on US households finances with this move. A very little too late?

Thursday, 16 June 2011

Blood in the Credit Markets - Game on - Greece, that Lehman feeling?

On the 26th of November I posted : European Sovereign Debt - There will be blood

Was it visionnary? Hardly so.

European politicians are running out of options. They can't keep kicking the can down the road, because the road has an end.

Greece Sovereign 5 year CDS is now trading upfront, following it's stratospheric rise to around 2190 bps (+435 bps on the day!), implying more than 80% cumulated probability of default:

2 years Greek yield hovering around 28.25%. It sounds like game over for Greece, at least that's what the market is telling us.

Ireland and Portugal 5 years Sovereign CDS widened by 34 and 25bps to 815 and 810 bps.

ITraxx Financial Senior at 171.5 bps and Itraxx Fin subordinated index was at 310 bps.
Itraxx Main Europe 5 year, representing 125 corporate investment grade names at its highest since January 10 at 112 bps.

Vix index which has been too complacent for too long, suddenly woke up today to move straight to around 24% before coming off slightly:

We need to monitor closely VIX, to see if it breaks above 30, which was the highest point reached on March 16th.

In relation to Greece, David Goldman has an interesting proposal to resolve the ongoing issue: "Europe Needs One Horrible Example"

An entertaining read to say the least!

In relation to US Banks CDS, still widening today:
S&P’s LCD group gave an update, surge in demand for default protection = Not the best sign.

"After a brief respite Tuesday, five-year protection costs for bank, broker and consumer financial companies rose another 4-6% today after widening a similar amount yesterday, with latest levels representing near or full retracement of net tightening moves across the sector over the first four months of the year, trade data show."

"Significant percentage moves wider in five-year CDS spreads since the end of May include Wells Fargo (up 31% to 107 bps), Merrill Lynch (up 29% to 182 bps), Bank of America (up 27% to 178 bps), Capital One Financial (up 25% to 125 bps), Morgan Stanley (up 23% to 176 bps), Citigroup (up 22% to 156 bps), American Express (up 17% to 85 bps) and Goldman Sachs (up 11% to 158 bps)."

I am sticking with my previous recommendations of avoiding US banks stocks.

It is still "Risk Off" mode for now.

Wednesday, 15 June 2011

Credit jitters - Market Update on Ireland - the game is changing

Big sell-off in late afternoon on Irish Banks senior debt thanks to the comments from the Finance Minister:

"Finance Minister Michael Noonan has said Ireland will go to our European partners with a plan to impose significant losses on the senior bondholders in Anglo Irish Bank and Irish Nationwide Building Society.

He was speaking in Washington after meeting the IMF and the US Treasury Secretary Timothy Geithner.

Mr Noonan said the Government will seek to impose losses on senior bondholders in Anglo Irish Bank. He said that around €3.5 billion in senior unsecured, unguaranteed bonds issued by Anglo Irish Bank and Irish Nationwide Building Society should have losses imposed on them.

Mr Noonan said he had discussed this with the IMF, who supported the strategy.

The Finance Minister said these banks are no longer normal entities and are more like warehouses for bad debts. In that context, he would be going to our European partners to propose significant cuts in the money to be paid to the bondholders.

Mr Noonan also revealed that he had asked Mr Geithner to support Ireland's effort to cut the interest rate paid on the European parts of our bailout programme. He said Mr Geithner agreed to support Ireland's effort and would speak to the French in connection with this."

Senior bonds for both entities got whacked after these comments:
Source: the market...

Anglo Irish has 3.1 billion euros in unsecured senior bonds not covered by a state guarantee.
Irish Nationwide Building Society, (which by the way is being merged with Anglo Irish), has 601 million euros worth in unsecured senior bonds not covered by the state guarantee as well.

Both have already cost 35 billions euros worth of bailout funds courtesy of the Irish taxpayer.

Ireland seeks to go after Anglo's senior bondholders - Reuters
From Reuters:
"No euro zone government has imposed losses on senior bank bonds, which are ranked on a par with depositors, but senior unsecured debt amounting to 320 million euros was subjected to a 41.2 percent haircut when Danish bank Amagerbanken failed in February."

The game is changing.

Meanwhile all is not well at Bank of Ireland either:

Shareholder Anger Erupts At Bank Of Ireland Meeting - WSJ

"The bank, which is already 36% owned by the Irish government after receiving EUR3.5 billion in bailout aid, needs EUR5.2 billion more in capital and new buffer reserves, mainly to make good lending excesses during the boom years."

I wrote in December 2010 in Europe - The end of the Halcyon days that:
"Either bondholders of Irish banks debt agree take a haircut on both the sub and senior debt, or the Irish Goverment will have to cut more spending, which means more austerity for the Irish people."

We have reach that point.

Portugal and Ireland drifting wider still:
Source CMA

French banks as well today have been put under pressure by the rating agencies due to their exposure to Greek debt.
Moody's Investors Service placed the three largest French banks on review for a possible downgrade.
The three banks are:
BNP Paribas, down 2.55%.
Credit Agricole, down 2.49%.
Societe Generale, down 2.48%

French banks CDS wider on Moody's rating threat:
Source CMA

EUR/USD is down 2% today on these news to around 1.4165:

Itraxx 5 Year Financial Senior CDS was wider today by 16 bps at around 178 bps whereas the Itraxx 5 Financial Sub widened by 26 bps, market being around 304-310, 6 bps bid-offer spread...ouch.

"It is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning."
Henry Ford

Monday, 13 June 2011

European issues and the Greek jinx - Macro update, a focus on Iceland and more.

New week, new records on the CDS front, new downgrades...

As I am typing this evening, Greece got whacked to CCC by S&P.
with negative outlook...

Greece 5 year CDS now standing above 1600 bps, at 1612 bps according to Markit, up from 1510 bps from my last post from the 9th. New day, new record.
Spain 5 year Sovereign CDS at 283 bps.
Italy 5 year Sovereign CDS at 178 bps.
Portugal 5 year Sovereign CDS at 763 bps, wider now than Ireland at 736 bps.
SovX western Europe 5 year index at 215 bps, top level was 222 bps on the 10th of January (as I posted previously, Greece's weight in the index is 1/15th of the whole index).

Iceland is now trading tighter than Spain, Ireland, Portugal and Greece at 266 bps as of the 10th of June, cumulated probability of default for Iceland amounts to 21.82% according to CMA. Iceland decided not to bailout its banks and went for massive short term pain. Iceland went back to fishing:
Iceland GDP Growth Rate
"The Gross Domestic Product (GDP) in Iceland contracted 1.5 percent in the fourth quarter of 2010 over the previous quarter. From 1997 until 2010, Iceland's average quarterly GDP Growth was 0.71 percent reaching an historical high of 8.41 percent in March of 2004 and a record low of -5.07 percent in December of 2007."
Source Trading Economics

Deep pain for Iceland but a tamed inflation:

With lower interest rates than before the crisis:

But unemployment rate is still stubbornly high:

Iceland's stock market has been obliterated...
"Iceland's main stock market index, the ICEXI, declined 59 points or 10.53 percent during the last 12 months. From 1992 until 2011 the ICEXI market value averaged 2001.82 points reaching an historical high of 8174.28 points in July of 2007 and a record low of 314.93 points in May of 1993. This page includes: Iceland Stock Market Index chart, historical data and news."
Source Trading Economics

Obliterated back to 1996 levels...

And in the process its currency divided by two versus the USD:

Any similarities with what's happening with Greece's stock market?
"Greece's main stock market index, the ASE, declined 232 points or 15.62 percent during the last 12 months. From 1987 until 2011 the ASE market value averaged 2019.58 points reaching an historical high of 6355.04 points in September of 1999 and a record low of 97.36 points in January of 1987."
Source Trading Economics.

20 Stocks in the ASE Greek index, guess how many banks?
Alpha Bank
ATE Bank
Bank of Cyprus Group
National Bank of Greece (exposure to Greek Government bonds = 218% of equity)
EFG Eurobank Ergasias SA
Marfin Laiki Banks (exposure to Greek Government bonds = 72% of equity)
Marfin Investment Group
Piraeus Bank

As I stated before, banks are like second derivatives of an economy, if Greece gets downgraded, so will its banks, pushing them even more into difficulties.
You can draw from the above list where the ASE Greek index is heading...

For more on the subject on Greek Banks:
Banks Are Greece's Achilles' Heel - WSJ

And by the way Allied Irish Bank just defaulted. I was expecting it for a long time "Bye Bye Irish Bank Debt".
Junior bond holders are getting a 90% haircut on their holdings. CDS Sub to be triggered. As reminder, last year, sellers of CDS for Anglo Irish Bank paid out around 82%. That was 8% more than for Allied Irish Bank.
Roman Abramovich's family office Millhouse just took a big hit following a stupid gamble. I commented on this very subject last year - "Ireland in the need of a lucky Shamrock..."
This is what I wrote at the time:
"Subordinated bonds pay higher yields than senior debt to reflect the fact that they are more likely to take losses if the issuer gets into difficulties."

There are some greedy people, they are some stupid people, and they are also some stupid greedy people.
There is no free-lunch when you buy risky sub debt...If his team had done a proper risk assesment of their investment (which they are supposedly paid for...), they would have seen that the government guarantee's expiry was running out on the Thursday 30th of September.

There should not be bailout for stupid investors....

In addition to my previous posts where I indicated why I strongly feel it is not time to be buying bank common stocks, you can read some additional very valid points from the excellent David Goldman here - One More Time: Why You’re STILL Not Supposed to Buy Bank Common Stocks.

Or you can disregard my comments and agree with Otto Waser, chief investment officer at R&A Research & Asset Management AG, who made recommendations to buy Wells Fargo and JP Morgan stocks on the 8th of June as reported by Bloomberg.

But Otto, you might want to look at this bloomberg article:

Maiden Lane Sales Trigger Stampede to Dump Risk: Credit Markets

"Default swaps on the six largest U.S. banks have gained an average of 19.4 basis points to 137.2 basis points since May 31, according to data provider CMA".

It is still "Risk-Off"...

Thursday, 9 June 2011

Greece - Cleaning the Augean stables - updates on the macro picture

Greece CDS is still on the forefront of the news in Europe.

1st quarter GDP was down 5.5 percent year-on-year versus the previous flash estimate of a 4.8 percent contraction for Greece.

Greek Sovereign CDS 5 year reached a record 1510 bps on the 9th of June as I am writting, whereas Portugal reached another record at 720 bps and Ireland at 693 bps.

Please note Greece represents 1/15th of the SOVX index currently traded.

Europe Sovereign CDS are trading wider on the 9th of June:
Source CMA

Interesting to see Santander Senior 5 Year CDS trading tighter than Spain Sovereign CDS 5 year. Note the close correlation at the beginning of the chart and the evolution.
Source CMA

US banks as well are drifting wider, due to US rating concerns, and the ongoing fight about tighter regulation between the FED and the banks:
Source CMA

I am still very cautious on banks stocks in general. It's better to own preferred shares than common stock. There are additional risks for dilution for European banks shares, given some needs to raise additional capital.

Thursday, 2 June 2011

The UK conundrum - Stagflation redux and other housing/banking issues

UK mortgages approval fell to their lowest level in April since record began in 1993.

As I pointed out in relation to the US housing mess in my recent posts, this will directly affect the UK Banking system where the "Extend and Pretend" game is still very much alive in relation to the increase in non performing loans.

There is a direct correlation in how the economy is doing and housing and bank earnings. UK banks face big headwinds.

Forecasters predict that 25% of the most affected Lloyds Banking Group's mortgage book, GBP 90 billion, will be negative equity by the end of 2012. The UK taxpayer has a 41pc stake in Lloyds Banking Group
Source : - Market Data
For RBS, impact is expected to be GBP 11 billion and GBP 6.1 Billion for Barclays according to an article from the Telegraph:

"UK mortgage approvals hit record low in April"

The Telegraph also reported this week that "up to 300,000 cash-strapped households have switched more than £60bn of home loan debt from repayment to interest-only loans to help cover their living costs".

"Banks accused of using mortgage debt leniency to flatter numbers" - Philip Aldrick

Extend and pretend, UK style...

"Lender forbearance – where banks shift homeowners onto interest-only deals, extend their mortgage term, or even permit payment holidays – now accounts for 63pc of all troubled home loans, according to the Financial Services Authority (FSA)."

Philip Aldrick goes on in his article:

"According to research by Fathom Consulting, write-off rates on lending to UK households – currently a fraction of one percent – are no higher than in 2001 despite the recession and a 20pc fall in house prices. In the US, write-off rates have increased fivefold to 9pc since its housing bubble burst in 2007."

"Banks should be making much larger provisions because the current status is artificial," Danny Gabay, a Fathom director, said. "We have lower foreclosure rates than during the boom. It's just not plausible." UK banks are currently holding about £1.6bn in provisions against the country's total £1.2 trillion mortgage book.

With prices going up with inflation at around 5%, interest rates close to zero at 0.5% and Real Wages getting squeezed, no wonder why households finances are stretched to the limit and beyond and switching to interest only mortgages with banks much obliged to accomodate.

"Cash-strapped families switch £60bn-worth of mortgages to interest-only" - Philip Aldrick

"With the average UK mortgage at £109,000 and average borrowing costs at 3.5pc, switching from repayment to interest-only saves households roughly £230 a month. But although the move may help families with their immediate cash-flow problems, concerns have been raised about how the debts will be repaid. Darren Winder, UK economist at Oriel, said: "For someone who's trying to alleviate monthly cash flow pressure, moving to interest-only makes sense. But it does raise questions about how that loan gets repaid."

There you go, same for US banks with "squatter rent", UK banks are doing as much as they can to avoid foreclosures and recognising losses. As I posted recently, "squatter rent" in the US is boosting US consumption artificially. By switching struggling UK households to interest only mortgages, the same recipe is in fact being applied in the UK, to maintain UK consumption to some "acceptable" level.

Banks are also racing to shed their commercial real estate exposure according to the FT:

"Banks in race to shed commercial property debt"- FT

Like in the US, like for Greece, in the UK, you can call this strategy "kicking the can down the road".

You can add to this situation, the rising risk of importing inflation from China, in the US, in the UK and in Europe. This will cause in the very near future margin compression to corporate earnings.

SocGen: "The China Domino Has Fallen!", Big-Time Inflation Coming All Around The World

Read more:

Slow Growth, rising inflation, high unemployment = Stagflation for the UK.

This is what I had forecasted for the UK previously and it is all working according to plan so far :

Fixed Income - Floating Expenses - Inflation still creeping up in the UK

UK inflation for December: 3.7% - QE is creating inflation as I expected.

Current inflation picture in the UK:

UK GDP Growth Rate:

UK unemployment, a longer perspective, 1990 to today:
Not has high as in 1992 but not falling fast enough yet.

"The unemployment rate in the United Kingdom for the three months to March of 2011 was 7.7%. From 1971 until 2010 the United Kingdom's Unemployment Rate averaged 7.22 percent".
Source -

Bank of England wil have to stay accomodative for longer than expected, given two thirds of UK mortgages depend on short term rates. This mean that the UK households will continued to be battered by a declining real income, meaning an absolute decline in the standard of living.

At the same time UK banks are piling on Gilts like US banks are piling on US Treasuries, not lending, shrinking their balance sheet but earning a nice spread in the process by borrowing close to zero and locking the spread on Government bonds.

There is a clear negative outlook for the UK economy and GBP currency.

EURGBP, trending up again:

Bank of England Paul Fisher said in an interview with the Daily Mail newspaper that he would consider voting for another round of QE if the economy worsened: "I would consider it and I've said I still hold that possibility open".

I still believe GBP could fall to parity with the Euro.

So QE2 for the UK and QE3 for the US?

The race in debasing the currency is still on. The ECB hasn't capitulated yet:

"The arrogance of officialdom should be tempered and controlled, and assistance to foreign hands should be curtailed, lest Rome fall."
Marcus Tullius Cicero

Sub-par recovery - Macro Update and outlook - Risk off...

Complacency could not last that long.

Sooner or later the markets had to take a close look at the weaker than expected data released recently and the implications.

ADP came yesterday at a very weak 38K, meaning that all economists forecasters had to revised agressively their estimates for Friday's NFP.
Everyone was expecting 175K and we got 38K. This is a major slowdown from the December-April average of above 200K, according to the ADP private employment report.

Everyone expecting a short term sell-off of UST 10 year due to discussions around the debt ceiling and budget debates, earlier this year have been hugely mistaken including myself. Mea culpa.
I posted earlier this year that I was expecting a continued surge in the TBT ETF in my post
"Dumb and Dumber - QE2 and the risks linked to global rising Yields in 2011". I got it badly wrong. When facts change, I have to change my facts (ProShares UltraShort 20+ Year Treasury ETF, NYSE:TBT).
Global bond market returned 0.93% in April and another 1.1% in May. US Treasuries returned 1.46%.
Given the weaker than expected US economy, the FED is in no position to raise rates. That's what you have in a balance sheet recession when you are facing still very strong deflationary forces.

Given Mr Market latest sell-off and risk-off mood, I would expect further tightening in UST. The economic recovery is just too weak.

Last week I indicated the issues still surrounding the US housing market and the implications for bank stocks. I advised last weak to stay clear. US Banks stocks have in fact so far reached their lowest point in 2011.
Bank of America down 4.3% to USD 11.24.
Wells Fargo down 5% to USD 26.84.
JP Morgan fell 3.4% to USD 41.76.
Citgroup down 3.7% to USD 39.65

In addition to the housing drag on the economy in general and for bank stocks in particular, rising US Treasuries isn't going to help them as well. It could further reduce bank profitability, by reducing the income banks receive on loans they make.

S&P/Case-Shiller nationwide home price index for the U.S. fell 4.1% y/y in Q1...a new cycle low:

Falling house prices will affect banks, translating in higher loan losses as collateral values fall and subdued mortgage loan growth. As I said before watch out for rise in loan provisions in future bank earnings report.

So what do we end up with according to the latest data?

We have weaker growth than expected, weaker job creation than expected, weaker housing market than expected and very weak loans to the private sector, private equity and venture capital activity. And consumer confidence is in the dumpster...

David Goldman in his Inner Workings blog is painting the situation it bluntly in his latest post:

"Here’s the String, As in “Pushing on a String”

ISM index for U.S. manufacturing activity fell as well sharply in May from a strong 60.4 to 53.5. Lowest since September 2009. Costs pressure from the rise in commodities? Most likely. Given surge in inflation in China caused by a surge in wages, how long is it going to take to have inflation
exported back to the US and starting to bite corporate margins?

A PMI reading above 50 percent indicates that the manufacturing economy is generally expanding; below 50 percent that it is generally declining.
If PMI falls next month below 50, we will come closer to a double dip. Simple as that:

Time for QE3?

Interesting comments in zerohedge about David Rosenberg's views:
In Preparation Of The Fed's Last Doubling Down: David Rosenberg Believes QE3 Will Be Nothing Short Of "Operation Twist 2"

This week winners:

  • Poland's GDP Grows 4.4% in Q1 2011.

  • Canada's economy accelerated to an annualized growth rate of 3.9% q/q in Q1 2011.

  • Russia's gross domestic product (GDP) has grown 4.1% year-on-year in the first quarter of 2011.

This week losers:

  • Australian Economy Contracts 1.2% in Q1. Biggest contraction in 20 years...

  • India GDP Growth Slows to 7.8%. Slowest pace in five quarters.

  • Japan's Economy Contracts 0.9% in Q4.

  • UK's mortgage approvals, fell to 45K (peak was November 2006 at 129K approvals).

Same story for some of the peripherals.

  • Greece downgraded by Moody's from B1 to Caa1, outlook negative.
According to Markit, Greek 5 year Sovereign CDS is now around 1470 bps and Portugal at 700 bps.

Europe issues are yet to be resolved and the game still being played by European politicians is kicking the issues down the road. Time is running out fast.

Given's very recent price action in the market, it doesn't look like we are going to have a nice and quiet summer. Brace for more trouble ahead. Core solvency issues for Greece have yet to be adressed and politicians are desesperately trying to keep kicking the restructuring can down the road.The macro picture is weaker than expected. Risk-off...
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