The T Report: ECB, SMP, ESM, and Fed

Stocks and stock futures are generally better today though the IBEX (Spain) has been a noticeable outlier.  German confidence seems to have given a boost, but the German’s were just as confident last month and that wasn’t a good indicator of anything in the European economy.  Ignore the confidence as just a sign that the markets have done reasonably well.

More important is that Spanish 10 year yields and Italian 10 year yields are still both better on the day.  They have managed to continue the gains sparked by rumors of ECB renewing the SMP purchases of bonds of these countries.  That isn’t surprising and we will see if they can continue to hold the gains as the day grinds on.  I remain skeptical about the willingness of the ECB to do much here.  Rumors of activity and even some actual activity may occur, but I don’t think it will be enough in the face of mounting economic problems – that aren’t going away because of firewall talks or ECB bond purchases.  With German bonds selling off today, the spread has improved more than yields indicate and CDS is reflecting that, with both Spanish and Italian CDS 15 tighter (though off their best levels of the morning).

Germany has mentioned the possibility of letting ESM run in parallel with EFSF.  They were originally designed that the guarantees provided by the countries could be used by either EFSF or ESM, but the combined usage couldn’t be above the amount originally given to EFSF.  This would effectively double the guarantees provided (depending on the fine print), but most, if not all countries would have to go back and get approval for this.  It sounds good, but is a long way from being approved.  The rating agencies may also choose to react if this is the path the Europe decides to go, as it will hurt the credibility of the strong countries, as they are yet again pledging more money to the weak ones as though it doesn’t affect their own credit.  With Netherlands being “expelled from the core” by Citi, they would be a country that bears close scrutiny as to their willingness to continue to debase their own credit for results that seem less than obvious.

So with the ECB, SMP, and ESM, giving Europe a boost, we look to Ben to speak today.  Strong hopes that he will indicate a willingness to pursue a mortgage related QE3.  It certainly seems like PIMCO is expecting that, given their portfolio positioning and constant tweets on the subject.  He is stubborn and believes it is the right strategy, so he may well make a push for it, but his latest round of testimony sounded shaky.  Not only was he as exasperated as ever with the questions he was receiving, but he actually sounded less confident in the questions he did answer.  He may not be wavering in his faith in his policies, but maybe even he realizes he is sounding a bit like the boy who cried wolf and his policies don’t seem to be doing what they should – helping the economy – while things like inflation seem less transitory than he makes them out to be.  I think his comments today are a roll of the dice, but suspect that he doesn’t say enough to provide yet another QE3 anticipation surge.

There is very little away from more government and central bank support that is helping the market.  The housing data was weak to close out the week, and little has happened in China that is truly encouraging that they have figured out how to get the almost mythical soft landing.

Fixed Income had a mixed day here.  The IG CDS index was weak, the HY CDS index recovered from early weakness and closed strongly, and the HY, IG, and Muni ETF’s were mixed, but basically unchanged.  We continue to like being short via IG18, like HY17 long vs HYG short, would not be long HYG, JNK, or LQD, with LQD primarily a concern about overall yields rather than credit quality.

We have started to look at some things that are being offered as “fixed” income investment to retail.  Frankly they scare me.  From what we have seen, they are very complicated and wall street as a whole is making this big push.  Both the sellers and buyers should be careful.  Actually the sellers don’t need to worry, because nothing ever really comes back to haunt them, no matter how inappropriate.  We are digging deeper into this, but are seeing “range notes” “inverse floaters” “CMS” linked notes etc.  If you want “fixed” income, stick to the basics and stick to the ETF’s or individual bonds if you can.  When people say these products are designed for retail, they mean that they are designed to appeal to retail investors in such a way that maximizes the issuers profit.