Posted by on Nov 14, 2011 in Uncategorized | No Comments

A dull day all around. Stocks were weak all day with European sovereign debt struggling – Italy, Spain, France and Belgium were the focus with Spain hitting the 6% mark for 10-year bonds.

France is interesting. At Bunds + 165 it is starting to look interesting. It is either way too cheap or this is about to get ugly. I would suspect that this could impact demand for investment grade bonds. Italy and Spain might be a substitute for high yield (or at least being out some sellers who are facing cash pressures) but that wouldn’t impact IG much. France is getting cheap enough, that even with the FX risk it might be an interesting trade. It is trading tighter than LQD but I’m trying to figure out how much of the LQD yield is driven by financials and more and more the sovereign debt seems appealing relative to banks. The sovereign ceiling may not be applicable for big diversified corporates but it probably is relevant for financials. The UniCredit earnings were abysmal and yet it was mostly a write down of goodwill while continuing to hold their sovereign debt holdings at cost.

I have mentioned before on Greece that many banks “asset swap” their bonds – they enter into interest rate swaps to turn the fixed rate bonds into floating. Given the relatively small size of Greek debt and the huge mark to market losses on the bonds, that fact felt more like salt on the wound than useful in its own right.

That may not be the case with Italian debt. Banks would have asset swapped their holdings there too. The position sizes are bigger and the derivative losses are similar to the outright losses. This adds another twist to the problem, particularly for banks holding longer term debt they asset swapped.

Whatever the result is on the sovereign side, the banks are not fixed and may instantly move to the forefront again.

Decisive action. I must have heard “the need for decisive action” a hundred times today. But decisive action doesn’t mean make a decision it means flood the market with Euros and hope for the best. Decisive action may be in the works – but it may be cutting some countries out of the Euro and battening down the hatches in preparation for a rough ride. Be careful what you wish for – but there is a growing sense that decisive action may not deliver the action markets want.

It was nice not to have any big rumors today – which explains why volume sucked across all products – but it gives time to reflect on the “grand plan”. Two new heads of state, no actual IIF plan let alone agreement, and EFSF is being redesigned, while ESM is being pushed off, being kicked out of the Euro has gone from being a threat to a concept worth thinking about.

How much better off would we be if Greece had been allowed to default in 2010?