by Peter Tchir, TF Market Advisors
In the movies there are these great battles fought out between the transformers and decepticons. As cool as the battles are, there must be some innocent bystanders wondering what the heck is going on amid all the destruction. That to me is how the credit markets are trading right now.
None of the core stories have changed. Europe is a mess and has gotten weaker. The U.S. economy is doing okay, and ZIRP is here to stay even if QE3 isn’t imminent. Into that already complex world we have thrown the JPM trade into the mix. There seems to be a battle between JPM and those against JPM. That battle is causing carnage across the credit markets. We are seeing big and weird moves on a regular basis. IG gaps out while stocks do nothing. MAIN goes wider while XOVER is tighter, only to go back to moving in lock-step. JNK saw its single biggest share redemption. Both HYG and JNK chug along all day only to have big fades late into the day. MUB has a steep drop only to bounce right back. Whatever battle between the big guys is going on drags everyone else into it. Stop losses are being hit. The price move is causing concern that this is just like 2011 again.
It isn’t like 2011 right now for a couple of key reasons. The transformers and decepticons aren’t battling over the fundamentals, they are battling over positioning. That is real and has consequences, but once that battle is over, the market will look at the fundamentals. So that is one key difference, that in addition to the usual fight between the bulls and the bears, this massive unwind, or potentially fake unwind, or unwind of the hedge of the alleged unwind, or something, is adding to the volatility and making the fixed income market seem more scary than it is.
LTRO is the other big difference. For all the talk about LTRO being a “carry” game to buy sovereign debt, LTRO at its core was designed to ensure that banks have enough money. While the debate rages about what Greece will do, and how bad the situation in Spain and Italy is, there is virtually no talk about banks not being able to fund themselves. People can look at 2 year swap spreads for signs of stress, and they are there, but be careful not to over-react. LTRO is there so that we don’t see a “run” on the banks. I doubt another LTRO would be created merely to try and support sovereign debt, but if there is a need to get money to banks, the ECB will do that. The ECB, without a doubt, is lender of last resort to banks, and is happy and able to fulfill that functions, so that is a big difference between now and 2011.
Greece leaving the Euro would be a big deal because of what it would do for all the corporate loans that have been made. That is yet another reason that leaving the Euro will take more time than people want to think. Even if it was easy at the sovereign level, which it isn’t, and the corporate level it has the potential to cause immense confusion. All of this can be addressed over time, but real plans need to be put in place and solutions to problems thought out, and some resources set aside to deal with unexpected problems. While that preparation is going on, look for the ECB, and the Troika to soften their tone as they decide that they cannot easily deal with the losses they would face on their own Greek exposure.
So, I would be looking to add exposure to credit, particularly U.S. high yield, and possibly in IG, as I think the market has been driven around too much by noise of this alleged unwind (I still think there is a real possibility that prior to the press conference JPM prepared themselves well for the obvious market reaction and is benefitting greatly from the widening and the volatility).
The fact that we tried to rally and then failed yesterday is a sign of how tenuous the overall market is, but right now I can’t help but think the same stories will have less of an effect, and that we are close to the point where Europe manages to take some steps that at least seem to help the problems, if not resolve them.
