Yesterday was one of the strangest days in a while – and that is from a long list of strange days. The most confusing part is that over the weekend Dexia went through some form of nationalization – the details of which and the need for which remain sketchy. Erste decided to take some big write-downs on CDS positions it had written, and Merkel and Sarkozy yet again held a joint press conference to announce that now they were really serious about saving everything and everyone.
European stocks and credit had a relatively muted reaction. Stocks were up small. The DAX for example was drifting from slightly down to up less than 1%. SOVX was a touch wider and MAIN was a few bps tighter. Then the US came along and told Europe that they didn’t realize how good they had. Yes, US equity players came along and told Europeans they didn’t understand what had happened in their own backyard. The US stock market dragged Europe higher and tighter with it. Investors who were short IG17 or HY17 were hitting bids in MAIN, XOVER, and buying JNK, LQD, and HYG, along with SPX.
Today, Europe was basically treading water and tried to do better at 7am as the US opened for business. Since then we have started to drift wider and lower. Part of this is going to be funds getting their positions squared away as they can now sell some IG17 and buy back their other hedges. Credit traders who are left scratching their heads about how things were “fixed” over the weekend are back and fading this rally.
Bond yields in Europe, which were higher yesterday, are even higher today. Italian 5 year bond yields have moved from 5.06% on Friday out to 5.16% today. German 5 year bonds, which were weaker yesterday as part of the “risk on” trade are actually rebounding today, demonstrating that there is some fear in the market.
The correlation between assets class continues to remain close to 1 (or -1). The only thing about correlation that is worth mentioning is that on down days, the TV is filled with people lamenting the correlation and how everything moves together, but on the up days, everyone talks about specific stocks and no one really bothers to point out it is just the same trade as the day before, but in the other direction.
Europe is busily working on plans to save the world. I hope they hire some useful advisors. Somehow I doubt it, because although the problems are credit market related, they seem much more comfortable getting advice from investment bankers, Bund traders, FX traders, and even some stock guys. If a credit trader tries to tell a trader from another market what they could do to “fix” their market, what trades should be done to push a market to a certain level, they look at us like we are cross-eyed geeks with drool dribbling down our chin (I saw enough of those looks in high school, that I’m good at recognizing it). If they deign to respond at all, they quickly poke holes in the argument and show how quickly their market would figure out the manipulation and how little lasting impact would be achieved. But, if they have a plan to “fix the CDS market” they still look at credit traders as though we should go into our little corner. I have an issue with that. Too many people who know nothing about structured products, bonds, CDS, defaults, restructuring, have been involved in the prior plans. That is part of the reason they don’t work. Someone needs to be in these meetings providing a dose of reality. Explaining how something really would work, not what some I-Banker says should work. The meetings might be more acrimonious, but the outcome is a plan that may actually work.
In the end, I expect that we will get more of the same. More announcements that make the markets go higher initially. The further the market is away from the core problem, the more pronounced the rally will be, as it will take longer to figure out, that once again the solution won’t work. And every time I get worried that I’m too bearish, or that the market is too bearish, I just need to listen to a couple of famous commentators foaming at the mouth how great of a buying opportunity this is, to realize that there are people just as bullish, and primarily are bullish on catch-phrases like “Europe Gets It” and “2008 is off the table”. It is too much to hope Slovakia says no, but regardless of the outcome of the vote, it is important to note that any new and improved solution is likely to be pretty much just France and Germany sucking it up and hoping it’s enough for the PIIGS and banks, without being too much for their own debt issuance needs.