The T Report: Attack of the Killer E’s, Ease, and Eeze Updated

Posted by on May 25, 2012 in Uncategorized | No Comments


My view from earlier this week remains intact and seems to be playing out. Project bonds are coming. The ECB (except for Weidmann) continues to say positive things and act as though there is more to do. The Fed has been quieter than I expected, but I still believe they will do something, bank credit spreads remain too wide for their comfort level, on top of what was definitely weak economic data across the globe. We have not really had a capitulation move up, so the squeeze remains a potential.

Risks remain that the policy responses are underwhelming, but I think they will do enough. Bankia is being fully nationalized by the looks of it. Some pressure on Spain who will need money to do that, but may calm the markets.

Europe is planning for a Greek exit which is good in case it happens, but I remain convinced that as they plan, they will realize the magnitude of the issues and decide to come up with solutions that allow everyone to claim victory and have longer to prepare.

Finally, the anger at U.S. banks and JPM in particular seems to be diminishing. Fewer rants against them, and am noticing more comments that complain about the articles being too over the top negative. Still an issue, but as people question the drop in market cap versus what has really changed, the banks can be a catalyst for a strong move higher.

HYG has managed to not see outflows offering a sign that retail is not yet ready to end their love affair with credit – an important difference compared to last year.

It’s also a long weekend which generally seems to be bullish for markets. I’m not sure it will play out that way today, but it could. In a bizarre note, I’m happy that we already faded Europe’s earlier rally. Needed to let doubts creep back in, but for now nothing has really changed my conviction that E’s, Ease, and eeze are coming and not fully played out.

The original report from Tuesday…


The ECB will be the driver as it is the only entity in Europe that can make money appear and lend to “banking” entities with wide latitude. The EIB is suddenly stepping up its involvement. Look for “infrastructure” projects to be announced throughout Europe. There will be a focus on the countries in trouble, but also project given to the smaller countries that have been taken along for the ride. It won’t be a big amount, but it will be targeted to create immediate jobs and economic activity – ie, growth. The EIB can borrow from the ECB as far as I can tell and has the added advantage that figuring out who is on the hook for EIB losses, if any, is even more difficult than some of the other programs.

The EFSF may or may not get a banking license, but the ESM definitely will. This negates the need to tap the bond market for money, which is good, because that does cannibalize funds that could otherwise go to sovereign and corporate bond purchases. It also makes it easier to leverage. It ensures that the ECB will be the fulcrum of any future problem, as it is the mechanism that losses spread from the weakest countries to the strongest. But arguing that it won’t really work and that it causes more problems down the road than it resolves won’t stop the market from being happy, at least for a little while, especially in combination with other projects.

A lot of this is being done to prepare for a possible Greek exit. It is clear that Europe now realizes exactly what we have been saying since the elections – that Europe is not ready for a Greek exit in any shape of form at this stage, and Europe would be hurt more than Greece because all of the interconnectivity of commerce and more importantly, lending to Greece.

The ECB is also working on some form of deposit insurance. If that has some form of conversion protection, it would be truly useful, and shocking. If it only protects against default, it is less useful as depositors are pulling money from banks out of fear of conversion more than fear of default. The EU was fighting a solvency issue with liquidity and now runs the risk of fighting a forced conversion risk with solvency measures. Any form of deposit insurance would be beneficial, but to be truly long term meaningful, it has to protect against redenomination.


The Fed is likely to have a series of very dovish speakers this week. The economy is showing signs of weakness. Whether it was a strong as the seasonally adjusted numbers showed earlier this year is debatable, but there is a clear slowing. I actually think the economy is doing “okay enough” for the Fed to be on hold under normal circumstances, but the performance of the markets, and banks in particular could give the Fed the ammunition it needs to launch an initiative sooner rather than later. Morgan Stanly stock is back to levels seen last October. Even more worrisome to the Fed, is the credit crunch banks are facing. MS CDS started the year at 415, got as tight as 245, and is now at 440, having breached 450 last week. With all the focus on JPM and their disastrous stock price movement (which I think is very overdone), people haven’t focused on these credit spread moves. The Fed keeps a close eye on bank spreads in CDS and the bond markets and those are sending a warning signal that the system is at risk of “gumming” up again. As much as the Fed doesn’t want to be seen to help too big to fail banks, it has little choice. We still have TBTF banks with huge balance sheets and it is in no one’s interest to see them constrained. The Fed is also, hopefully, painfully aware of how markets have reacted to the end of prior programs. With Twist nearly done, the desire to avoid a repeat of the sell-off seen when other programs have expired will be too much for the Fed to risk.

Expect dovish comments and it will be directed at mortgages. I’m hopeful it might come with some tweaks, such as only buying mortgages originated in 2012 or something that spurs new lending and isn’t just a big gain for those who front ran the policy by loading up on old mortgages.


With bearish sentiment everywhere, those policies should be enough to spur a pretty significant rally. The market is as bearish as I’ve seen it since Thanksgiving. People can point to the VIX being low, but longer dated vol never got that cheap, and the VIX has moved aggressively as investors bought up puts. Across the board, indicators are flashing that the market is very oversold.

Add to that, my belief that JPM has moved to the stage where it is actually cutting the risk – turning IG9 tranche positions into correlation positions, cutting the HY short, and selling the AFS book, we should see far less volatility in the CDS and underlying bond markets. I tend to believe that the move wider benefited JPM more than the market knows and that some fast money will now be caught on the wrong side of the trade and are too short, and too short the wrong things (the guys who figured out the trade in the first place won’t make that mistake, but people who tried to pile in after the fact are likely to have).

With E’s, Ease, and Squeeze in play, I’m the most bullish I’ve been in a long time. Reversals will be a big part of the trade and I like Spain, Euro, Banks, and HY the most.