A Risk-Meh Morning (Tchir)

by Peter Tchir, TF Mar­ket Advisors

Credit Mar­kets Mixed: Spi­taly vs Cor­po­rates

The first thing most peo­ple are notic­ing today is the weak­ness in Span­ish and Ital­ian bond yields. Span­ish and Ital­ian CDS are both wider as well. There is a lot of talk about what it means to hit 7% on 10 year bond yields. For Por­tu­gal, Ire­land, and Greece that was more or less a trig­ger of worse to come. Ire­land actu­ally crossed 7% again in May hav­ing been below that since Jan­u­ary. Since it spiked above 7% on the 15^th it has been sta­ble. Italy, last year’s poster child, went above 7% are returned below mul­ti­ple times. Yes, 7% does make a nice head­line, and it is the pre-fee return a hedge fund has to make before the investor starts earn­ing more than the fund, but it is far from clear that it is the point of no return for bond­hold­ers, espe­cially after the EU and ECB appar­ently learned their les­son last year.

It is def­i­nitely a big con­cern, and yet MAIN and XOVER are both basi­cally unchanged this morn­ing, and IG18 and HY18 are both tighter. I’m not sure what the expla­na­tion is. IG and HY prob­a­bly got over­sold into the close, but it is far from obvi­ous why MAIN and XOVER would be so calm in the face of ris­ing yields in Spain and Italy.

Other “Risk-On” Assets Mixed As Well

Euro­pean stocks are down on aver­age, but Span­ish stocks are up. It is just a strange sig­nal to see weak­ness in sov­er­eign debt yet for the stocks to do well.

Greek bank stocks have been up solidly, though why any­thing would be left for exist­ing share­hold­ers no mat­ter who wins the elec­tion is beyond me.

JPM was up solidly yes­ter­day, and XLF was almost unchanged, yet the broader mar­ket sold off hard into the close, which again seemed to break with the idea of finan­cials being a leader.

Oil is down, but gold is up, though I have been los­ing track now of whether gold is a risk-on or risk-off asset.

Even the Euro is some­how bet­ter today, which is in line with U.S. stock futures but not mov­ing as you would expect given the mess in Spain and Italy.

Weak Data vs Pol­icy Inter­ven­tion

Noth­ing has changed in this respect. The global eco­nomic data con­tin­ues to come in weak and is not sup­port­ive at these lev­els. Small pol­icy steps have been taken and the threat of more pol­icy action is sup­port­ive of the mar­ket here.

Is “whale trade” done trend­ing?

Mr. Dimon’s tes­ti­mony seemed to go about as well as one could hope. They tone wasn’t as acri­mo­nious as peo­ple feared and with only a cou­ple weeks left in the quar­ter the esti­mate of a “solidly prof­itable” quar­ter is prob­a­bly pretty accu­rate. By the end of the tes­ti­mony, many pun­dits were ask­ing what the point was? Exactly, there was no real point. This is a pri­vate com­pany that had a trade that mor­phed into some­thing big and wrong, but it still prof­itable and never put any “tax­payer” money at risk.

If the scape­goat­ing is over, and the trade is under con­trol (and I believe it is), then this should be a chance for JPM to start a recover back to at least the lev­els of when the made the announce­ment. In a nor­mal world, I would expect it to drag other risk assets with it.

Bailouts, Sub­or­di­na­tion, and SMP

There remains a lot of con­fu­sion about what is going on in Europe. Asides from the con­fu­sion over how “sub­or­di­nated” Span­ish bond investors will or won’t be, there is even greater con­fu­sion about how the bailout is funded. Yes­ter­day we explained how Italy isn’t bor­row­ing at 6% to lend at 3%. We also once again look at the errors in how peo­ple are look­ing at subordination.

There are a lot of very influ­en­tial peo­ple out there neg­a­tive on the bailout. I can under­stand that, but many are bas­ing it on incor­rect infor­ma­tion (how EFSF and ESM work) or overly pes­simistic views – that Spain is the bor­rower and gets no value while sub­or­di­nat­ing every­one else. Just like in the past, peo­ple have decided to be opti­mistic and not dig into details, now peo­ple have decided to be pes­simistic and not dig into details. That didn’t work out well when peo­ple thought the orig­i­nal EFSF deal was good, it may not work out well now think­ing that the use of FROB is trivial.

On the other hand, I have heard peo­ple ask­ing about SMP today with yield hit­ting new highs. SMP will not be used by the ECB. If peo­ple are wor­ried about sub­or­di­na­tion, the worst tool is for the ECB to use SMP. The ECB spends money that doesn’t even go to the sov­er­eign, and sub­or­di­nates all hold­ers. SMP is real sub­or­di­na­tion as the bor­rower receives noth­ing, and the exist­ing hold­ers are in worse shape.

If any­thing, look for EFSF to assume the role of sec­ondary mar­ket pur­chases. That would have the ben­e­fit of tak­ing prices higher with­out the de facto sub­or­di­na­tion of remain­ing bondholders.

It is more likely that they let yields hang out up here for a bit. It really doesn’t cost the coun­tries any­thing and may be a good strat­egy to get remain­ing longs out and cre­ate a solid short base ahead of some new EFSF pro­gram or new LTRO. If the LTRO was designed to cre­ate a “carry” trade, now is much bet­ter time than in February.

We may even seen some inter­ven­tion in the pri­mary mar­kets, but I sus­pect they would wait until ESM is launched because ESM has a much eas­ier time get­ting lever­age, espe­cially if it is finally given the bank­ing license so many want it to get.

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