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Bond Sales Fall to Least in Decade, Yields Soar: Credit Markets

By Bryan Keogh and Sonja Cheung

May 28 (Bloomberg) — Companies sold the least amount of bonds in a decade this month as concern Europe’s sovereign debt crisis will slow the global economy drove up relative borrowing costs by the most since the aftermath of Lehman Brothers Holdings Inc.’s collapse.

Borrowers issued $66.1 billion of debt in currencies from dollars to yen, a third of April’s tally and the least since December 2000, according to data compiled by Bloomberg. At least 14 companies withdrew offerings, including New York-based retailer Jones Apparel Group Inc. and theater chain operator Regal Entertainment Group.

“There’s still a lack of risk appetite for company debt,” said Ben Bennett, who helps manage the equivalent of $125 billion of corporate bonds as credit strategist at Legal & General Investment Management in London. “There needs to be a couple more days of stability before we see green shoots. At the moment it’s a small, straggly weed.”

The extra yield investors demand to own corporate bonds rather than government debt soared the most since at least November 2008, according to Bank of America Merrill Lynch index data. Spreads widened 44 basis points to 193 basis points, according to Bank of America Merrill Lynch index data.

Corporate credit has lost 0.65 percent this month, including reinvested interest, snapping four months of positive returns, index data show.

‘Volatility’ and ‘Uncertainty’

“The biggest issue is the volatility and the uncertainty about where financings can get completed and which ones can’t,” said Robert Harteveldt, global head of leveraged finance at Jefferies Group Inc. in Stamford, Connecticut. “You’ve started to see deals get pulled and there’s no question money has left the market.”

While conditions improved this week, spreads will have to tighten before companies can sell debt again, Bennett said.

Elsewhere in credit markets, credit-default swaps soared this month, while a benchmark for leveraged loan prices is poised to fall for the second straight week, the longest slump since Feb. 12. The London interbank offered rate shows signs of stabilizing after rising to the highest since July.

“Investors are looking to park their money in safe names at the moment as market conditions are so volatile,” said Harpreet Parhar, a credit strategist at Credit Agricole SA in London. Issuers may need as much as 10 days of market stability before they consider benchmark-size bond offerings, he said. Many “investment grade issuers prefunded last year, so there’s no pressure to come to the market,” he said.

Default Swaps

Credit-default swaps on the Markit iTraxx Europe Index of 125 companies with investment-grade ratings, which investors use to hedge against losses on corporate debt or to speculate on creditworthiness, surged 30 basis points this month to 117.5, according to Markit Group Ltd. That’s on pace for the biggest monthly increase since October 2008. The gauge rose 0.3 basis point today as of 5:46 p.m. in London.

The Markit iTraxx Asia index of 50 investment-grade borrowers outside Japan rose about 30 basis points this month, according to CMA DataVision. The Markit CDX North America Investment Grade Index climbed 25 basis points this month to 116.6, and traded as high as 127.8 May 6, Markit Group prices show.

Credit-default swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt. The indexes rise as investor confidence in credit markets deteriorates.

Loans, Libor

Prices on the Standard & Poor’s/LSTA U.S. Leveraged Loan 100 Index, which tracks the 100 largest dollar-denominated first-lien leveraged loans, closed yesterday at 89.06 cents on the dollar, down from 92.72 cents at the end of April. Leveraged, or high-yield, high-risk debt, is rated below Baa3 by Moody’s Investors Service and BBB- by S&P.

About $19 billion of U.S. leveraged loans have been arranged this month, compared with $35 billion in all of April, according to Bloomberg data.

The rate banks say they pay for three-month loans in dollars stabilized after rising for 12 days. Libor was little changed at 0.5363 percent today, according to the British Bankers’ Association, near a 10-month high.

U.S. swap spreads widened, snapping the first three-day decline since March 24. The difference between two-year Treasuries and the rate to convert fixed payments to floating added 6.05 basis points to 46.31, more than double the rate a month ago.

Upgrades vs. Downgrades

S&P said the chance of downgrade for U.S. non-financial companies is the lowest since July 1998, as the nation’s improving economy outweighs European debt strains threatening global growth.

The proportion of corporate debt issuers with a negative outlook or on watch for a potential downgrade fell to 19 percent at the end of March, the ratings agency said in a report. Ratings upgrades outpaced downgrades 105 to 70 this year through May 19, said S&P, a unit of New York-based McGraw-Hill Cos.

In emerging markets, yield spreads increased 1 basis point to 318 basis points, according to JPMorgan Chase & Co.’s Emerging Market Bond index. The spread has widened from this year’s low of 230 on April 15.

Global corporate bond issuance plunged this month as Europe’s leaders failed to convince investors they can tame the region’s debt crisis and Bill Gross, manager of the world’s biggest bond fund, said a Greek restructuring is inevitable.

‘No Way Out’

“The growth required in order to shoulder Greece’s debt burden is so excessive” and fiscal restrictions are so great “there will be no way out,” Pacific Investment Management Co.’s Gross said in a May 26 interview with Bloomberg Television.

Companies issued 8.75 billion euros ($10.8 billion) of debt in Europe in May, the slowest month on record, as investors shunned riskier assets and sought so-called safe haven securities. Sales in the U.S. fell to $33 billion, the least since November 2008, when issuance totaled $45.8 billion, Bloomberg data show.

Kajima Corp., a Japanese contractor, delayed its first public bond sale in two years due to deteriorating market conditions, according to three people with direct knowledge of the matter. The builder initially planned to raise 10 billion yen ($110 million) this week and hasn’t decided when to reschedule the sale, said the people, who declined to be identified as the information is private.

Hanwa Pulls Bond

Hanwa Co., a Japanese steel trader, also delayed a bond sale because of market conditions, sale manager Daiwa Securities Capital Markets Co. said in an e-mailed statement. Orix Corp. a financial services company, said it postponed a sale of at least 20 billion yen of bonds to international investors that was planned for next week.

Companies that sold debt this week included Abbott Laboratories, the maker of the arthritis drug Humira, and Goldman Sachs Group Inc. Abbott offered $3 billion of bonds in a three-part offering and Goldman Sachs, the New York-based bank, issued $1.25 billion of debt due in 2020.

Abbott’s $1 billion of 10-year notes priced to yield 90 basis points more than Treasuries, compared with the 220 basis- point spread it paid when it sold $2 billion of debt due 2019 in February 2009. Goldman Sachs paid a spread of 280 basis points, compared with 175 when it sold $750 million of 10-year, 5.375 percent notes in March, Bloomberg data show.

European Banks

European banks sold $12.6 billion of debt globally this month, the least since at least 1999, Bloomberg data show. The financial primary market in Europe has been “slammed shut” since April 15, according to Suki Mann, head of Societe Generale SA’s credit strategy group in London.

Banks globally may have a capital deficit of more than $1.5 trillion by the end of 2011 and some may require state support, according to Independent Credit View, a Swiss rating company.

Banks “must feel like the lepers of the financial markets,” Mann wrote in a report.

Spreads on investment-grade bonds widened 44 basis points in May to 193 basis points, the biggest monthly increase since they soared 108 basis points in October 2008, according to Bank of America Merrill Lynch index data. The average premium reached 196 basis points on May 25, the widest since October.

“Market sentiment remains fragile,” said Simon Ballard, a senior credit strategist at Royal Bank of Canada. There’s “little evidence of any fundamental change in the outlook for risk assets.”

High-yield spreads widened 135 basis points to 708 basis points, the index data show. Overall yields on the debt jumped to 9.54 percent this week, the highest since February.

“We know it cost us a little bit in rate, because we would have gotten a better rate if we had not come out during the turmoil,” said Eric DeMarco, chief executive officer of San Diego-based Kratos Defense & Security Solutions Inc., which sold $225 million of seven-year 10 percent notes on May 12. “By the time we priced, we understood that practically every other deal had been pulled.”

–With assistance from Abigail Moses and Caroline Hyde in London, Tim Catts, John Detrixhe, Shannon D. Harrington and Richard Bravo in New York, Paulo Winterstein and Francisco Marcelino in Sao Paulo, Ed Johnson in Sydney, Jungmin Hong in Seoul and Yusuke Miyazawa and Takashi Ueno in Tokyo. Editors: Charles W. Stevens, Paul Armstrong

To contact the reporters on this story: Bryan Keogh in London at bkeogh4@bloomberg.net; Sonja Cheung in London at scheung58@bloomberg.net

To contact the editor responsible for this story: Paul Armstrong at Parmstrong10@bloomberg.net

Bond Market Will Never Be the Same After Goldman: Michael Lewis

April 22 (Bloomberg) — If you happen to be sitting on the Goldman Sachs bond-trading floor life must feel horribly unfair.

You did nothing worse than live by the ethical assumptions of your market — any money-making event short of obviously illegal is admirable — and now your own grandfather thinks you’re some kind of monster. Your world feels upside down: What was right is now wrong; what was good is now bad; what once felt like winning now feels like losing.

You are probably wondering: What next? What will the angry rabble — all those ordinary people who can never really understand your business — now demand that you explain to them, so they can disapprove of you all over again?

A few possibilities:

No. 1 — Full knowledge of the inner workings of your proprietary trading desk.

In particular: the moment-to-moment dealings of your correlations traders from late 2004 (when they first exploited American International Group’s idiotic willingness to sell cheap insurance on pools of subprime mortgage loans) until the end of 2007, when they would have taken most of their profits from the total collapse of the subprime bond markets.

Your bosses claim to have lost almost $100 million on the Abacus trade for which your firm is being sued. This seems, to put it mildly, disingenuous. In March 2007, the time of this particular Abacus trade, your prop traders were already short the subprime market. Would they really have taken a naked long position in a deal you helped to construct precisely so that it would fail without offsetting in some other way on their books?

Ritual Sacrifice

Sadly, it will not suffice to offer up Fabrice Tourre as a ritual sacrifice. No one is going to accept a then 27-year-old Frenchman, whose job was apparently to keep sweet the patsies on the other end of your trades, as the world’s authority on your trading positions.

His name isn’t even on the top of the list of Goldman traders listed on the $2 billion Abacus deal for which you are being sued. The name on top of that document is Jonathan Egol. Egol appears to have been the bond trader at the center of your Abacus program. The same Jonathan Egol who told fellow traders in 2006 — a year before this transaction — that the subprime market was doomed.

The public eventually will ask: Who is Jonathan Egol and what exactly was his game?

No. 2 — A far better understanding of your relations with the inaptly named “CDO manager.”

Clearly Clueless

In this case the manager was ACA Management, but there were other CDO managers at least as pliable as ACA. The SEC suit charges you with using ACA as a shill: the end investors in your CDO assumed that it was ACA’s job to figure out whether the bonds inside the CDO were intelligent investments.

But ACA quite clearly had no idea what it was doing — and you quite clearly understood that.

The telling details here are the e-mails between your French salesman and ACA, in which ACA feels it needs to understand exactly what John Paulson’s interest are in this new CDO. Paulson, who had done a great deal of analysis on the underlying bonds, was of course picking the ones he wanted to see inside the CDO. (Hard to understand why it didn’t disturb you that he was even in the room, by the way, but that’s another conversation.)

The SEC accuses you of lying to ACA, by suggesting Paulson was a long investor in the deal when he was in fact selling the deal short.

Good From Bad

But what’s interesting here is what you appear to take for granted: that ACA has no talent for evaluating the bonds picked by Paulson. After all, if ACA was doing its job it wouldn’t have cared one way or the other what Paulson (then a little-known hedge fund manager) was up to. ACA would have known which bonds were good and which were bad, and picked the good ones.

In their anxiety about Paulson’s motives we can all glimpse their incompetence. They want to know that Paulson has an interest in picking the good ones because they themselves have no clue which ones they are.

But if a CDO manager had no independent ability to select the bonds inside a CDO what, please explain to us, was his financial function? Why did you select ACA to manage your deal?

No. 3 — A far better sense of why, and when, you ceased completely to concern yourself with the consequences of your actions.

The masses will be curious to know, for instance, how you became blinded to the very simple difference between right and wrong. The more moralistic among them will ask the question mainly to fuel their own outrage; the more tactical will ask the question because they sense that the financial system doesn’t function unless you have the incentive to think in these terms – - and you clearly do not.

Soul-Changing

What begins as an effort to change your business may well end up as an attempt to change your soul.

Among the many likely consequences of the SEC’s decision to sue Goldman Sachs for fraud is a social upheaval in the bond markets.

Indeed, the social effects of the SEC’s action will almost certainly be greater than the narrow legal ones. Just as there was a time when people could smoke on airplanes, or drive drunk without guilt, there was a time when a Wall Street bond trader could work with a short seller to create a bond to fail, trick and bribe the ratings companies into blessing the bond, then sell the bond to a slow-witted German without having to worry if anyone would ever know, or care, what he’d just done.

That just changed.

(Michael Lewis, most recently author of the best-selling “The Big Short,” is a columnist for Bloomberg News. The opinions he expresses are his own.)

Click on “Send Comment” button in sidebar display to send a letter to the editor.

To contact the writer of this column: Michael Lewis at mlewis1@bloomberg.net

Albert Edwards: At 500% Net Liabilities To GDP, It Is Too Late To Prevent The Collapse Of The G-7; Greece Is Irrelevant, We Are All Now Insolvent

Submitted by Tyler Durden

For Greece, with on and off balance sheet liabilities at over 800%, it’s game over. For the Eurozone, with the same ratio at about 500%, it is also game over. For the US, at 500%+, it is, you guessed it (sorry Joseph Stiglitz), game over, but since we have the printers, it will simply take a little longer. Following up on yesterday’s popular post on prevailing delusions as captured by Albert Edwards’ colleague Dylan Grice, we present Albert’s latest outlook. Please don’t read this if you want to keep believing there is any hope left for the (developed) world.

But first some aeral photography from Dylan Grice, indicating just how far the US government is willing to go to get the population stoked about owning fixed (shouldn’t it be called broken really?) income. With British QE over, and the country still to implement the same criminal annuitizing of 401(k)s that Uncle Sam is contempltating in order to make “Buy Bonds” a “voluntary” option one can’t really decline, maybe letters on modern architecture building blocks is all that would works. As Edwards says: “I’m not sure leaving man-sized building blocks around the City of London is really going to make an awful lot of difference, but I suppose when your public sector deficit is around 13% of GDP, every little bit helps!”

So back to Greece, the Eurozone, and policy response in general, Edwards places the causes (and “solutions”) of the escalating problem precisely where it belongs: at the core of the Keynesian systemic outlook flaw.

A major divergence of views in the market at the moment concerns what governments should be doing with their outsized fiscal deficits. Economists seem to be polarised between those who think governments should be rapidly cutting fiscal deficits to avoid impending insolvency and/or a surge in bond yields, and those who believe this will be totally counterproductive and that deficits should stay very large. Behind this controversy probably lies the key to the economic outlook.

To Edwards, and to ever more hedge fund investors judging by the jump back in Greece Bund spreads which just broke the most recent technical resistance level of 300 bps, Greece is nothing more than Russia and LTCM (or Bear Stearns as the case may be).

The situation in Greece following hard on the heels of similar solvency issues in Dubai feels to me very much like the Russian default and LTCM blow-up in 1998. For the blow-ups that year were a direct follow-on from the Asian crisis a year earlier a different chapter in the same book. There will be more crises to follow Greece, both inside and outside of the eurozone.

The outcome of broken Keynesian policy (by definition) will be ugly, and will destroy the eurozone. We said it some time ago, and SocGen has now also confirmed this bearish perspective.

My own view of developments, for what it is worth, is that any “help” given to Greece merely delays the inevitable break-up of the eurozone. But, for me, the problem is not the size of the government deficit and the solvency or otherwise of the governments in the PIGS (Portugal, Ireland, Greece and Spain – we deliberately exclude Italy).
The problem for the PIGS is that years of inappropriately low interest rates resulted in overheating and rapid inflation, even though interest rates might well have been appropriate for the eurozone as a whole. Rapid inflation has led to overvalued bilateral real exchange rates (they do still notionally exist) for the PIGS and in most cases yawning double-digit current account deficits. With most trade done with other eurozone countries, the root problem for the PIGS is lack of competitiveness within the eurozone – an inevitable consequence of the one size fits all interest rate policy. Even if the PIGS governments could slash their fiscal deficits, as Ireland is attempting, to maintain credibility with the markets in the short term, the lack of competitiveness within the eurozone needs years of relative (and probably given the outlook elsewhere, absolute) deflation. Hence the PIGS public sector deficit will inevitably remain large as a direct consequence of this weak growth outlook.

As noted earlier on Zero Hedge, in Europe the population is a little less brainwashed by the moronic happenings on prime time TV, so while in America the destruction of the economic system, as trillions are transferred to the kleptocracy which knows fully well the end game is nigh, results in some sighs of desperation at best, in Europe the outcome will be somewhat more violent.

In my opinion this will not be tolerated by the electorates in these countries. Unlike Japan or the US, Europe has an unfortunate tendency towards civil unrest when subjected to extreme economic pain. Consigning the PIGS to a prolonged period of deflation is most likely to impose too severe a test on these nations. And the political “consensus” within the PIGS to remain in the eurozone could falter in the face of another of Europe’s unfortunate tendencies -the emergence of small extreme parties to take advantage of any unrest. My own view is that there is little “help” that can be offered by the other eurozone nations other than temporary confidence-giving “sticking plasters” before the ultimate denouement: the break-up of the eurozone.

And in case you were wondering why all European leaders are powerless to provide a bailout proposal that actually has a snowball’s chance in hell of doing something/anything to help Greece, read on. Alternatively, if you want to find out why any plan suggested on Monday will be thoroughly useless and once digested by the market will cause another major crash, read on as well.

The pressure to tighten fiscal policy from current nose-bleed levels of deficits is not just an issue for crisis hit Greece. It is an issue for virtually all economies. It is a particular issue for the US and UK with structural (cyclically adjusted) general government deficits of almost 10% of GDP (according to the OECD)! There is a ferocious debate ongoing between those who believe there needs to be a rapid reduction in these deficits to avoid some combination of insolvency/default/rapid inflation and those who believe that there should be even more fiscal stimulus. The debate is loud and opinions are tending to be polarised.
My own view on this is that obviously we should never have got into this wholly avoidable mess in the first place. But having got here, there really is no way out that does not trigger a major market-moving upheaval. Ultimately economic prosperity over the past decade has been a sham: a totally unsustainable Ponzi scheme built on a mountain of private sector debt.GDP has simply been brought forward from the future and now it’s payback time. The trouble is that, as the private sector debt unwinds, there is no political appetite to allow GDP to decline to its “correct” level as this would involve a depression. So burgeoning public sector deficits and Quantitative Easing are required to maintain the fig-leaf of continued prosperity.

And here is the topic that will dominate over all pundit round table discussions in the next weeks: the entire world is insolvent, although some are more insolvent than others. Greek total net liabilities (on and off balance sheet) to GDP are 800%! EU: at 470%, the US, at over 500%. There is no way out but default.

Edwards’ poignant summation.

I am persuaded by my colleague Dylan Grice’s analysis that, including unfunded liabilities, most governments are already insolvent with debt to GDP ratios closer to 500% of GDP instead of around 100% for most G7 countries . It is too late.
Nor were Dylan and I persuaded by recent comments from Nobel Prize Winner Joseph Stiglitz that it is absurd to suggest that the US and UK governments might default on their debts as they could just print money. Indeed. But a client pointed out to us that Weimar Germany did not default on its debts during its hyper-inflation. How reassuring!
I am persuaded though by Richard Koo’s book about the lessons from Japan’s balance sheet recession. The crux of his analysis is that governments have no option but to stimulate aggressively all the while the private sector is de-leveraging. ANY attempt at fiscal cuts simply results in renewed recession and a further loss of confidence, thus making it even harder and more costly to sustain any subsequent recovery – and hence the budget deficit ends up bigger than before (e.g. see chart below). This is exactly the outcome I expect.

The take home is very, very simple: we can delude ourselves that the game can be won (it can’t), or we can prepare for the imminent collapse when delusion finally fails.

As everyone is engrossed by assorted groundless Christmas (and other ongoing bear market) rallies, and oblivious to the debt monsters hiding in both the closet and under the bed, Zero Hedge has decided it is about time to present the ugliest truth faced by our ‘intellectual superiors’ and their Wall Street henchman who succeeded in pulling off Goal #1 for 2009 – the biggest ever bonus season (forget record bonuses in 2010… in fact, scratch any bonuses next year if what is likely to transpire in the upcoming 12 months does in fact occur).

If someone asks you what happened in 2009, the answer is simple – two things. There was a huge credit and liquidity crunch, and then there was Quantitative Easing. The last is the Fed’s equivalent of band-aiding a zombied and ponzied corpse, better known as the US economy. It worked for a while, but now the zombie is about to go back into critical, followed by comatose, and lastly, undead (and 401(k)-depleting) condition.

In 2009, total supply of all USD denominated fixed income, net of maturities, declined by $300 billion from $2.05 trillion to $1.75 trillion. This makes sense: the abovementioned crunches stopped the flow of credit from January until well into April, and generally firms were unwilling to demonstrate to the market how clothless they are by hitting the capital markets until well into Q2 if not Q3. What happened was a move so drastic by the Fed, that into November, the worst of the worst High Yield names were freely upsizing dividend recap deals (see CCU) – the very same greed and stupidity that brought us here. Luckily, so far securitization and CDOs have not made a dramatic entrance. They likely will, at which point it will be time to buy a one-way ticket for either our southern or northern neighbor, both of which, in the supremest of ironies, transact in a currency that will survive long after the dollar is dead and buried.

Back to the math… And here is the kicker. Accounting for securities purchased by the Fed, which effectively made the market in the Treasury, the agency and MBS arenas, but also served to “drain duration” from the broader US$ fixed income market, the stunning result is that net issuance in 2009 was only $200 billion. Take a second to digest that.

And while you are lamenting the death of private debt markets, here is precisely what the Fed, the Treasury, and all bank CEOs are doing all their best to keep hidden until they are safely on their private jets heading toward warmer climes: in 2010, the total estimated net issuance across all US$ denominated fixed income classes is expected to increase by 27%, from $1.75 trillion to $2.22 trillion. The culprit: Treasury issuance to keep funding an impossible budget. And, yes, we use the term impossible in its most technical sense. As everyone who has taken First Grade math knows, there is no way that the ludicrous deficit spending the US has embarked on makes any sense at all… none. But the administration can sure pretend it does, until everything falls apart and blaming everyone else for its fiscal imprudence is no longer an option.

Out of the $2.22 trillion in expected 2010 issuance, $200 billion will be absorbed by the Fed while QE continues through March. Then the US is on its own: $2.06 trillion will have to find non-Fed originating  demand. To sum up: $200 billion in 2009; $2.1 trillion in 2010. Good luck.

As we pointed, the number one reason why 2010 is set to be a truly “interesting” year is a result of the upcoming explosion in US Treasury issuance. Fiscal 2010 gross coupon issuance is expected to hit $2.55 trillion, a $700 billion increase from 2009, which in turn was  $1.1 trillion increase from 2008. For those of you needing a primer on the exponential function, click here. But wait, there is a light in the tunnel: in 2011, gross issuance is expected to decline… to $1.9 trillion.

And while things are hair-raising in “gross” country (not Bill…at least not yet), they are not much better in netville either. Net of maturities, 2010 coupon issuance will be about $1.8 trillion, a 45% increase from the $1.3 trillion in FY 2009 (and the paltry $255 billion in 2008).

Now everyone knows that the average maturity of the UST curve has become a big problem for Tim Geithner: nearly 40% of all marketable debt matures within a year (a percentage that has kept on growing). In fact, the Treasury provided guidance in its November 2009 refunding, in which it stated that it intends “to focus on increasing the average maturity” of its debt after relying heavily on Bill issuance in H2. Once again, we wish Tim the best of luck.

Why our generous best intentions to the US Treasury? Because unless the US consumer decides to forgo the purchase of the 4th sequential Kindle and buy some Treasuries (and not just any: 30 Year Bonds or bust), the presumption that the Bond printer will have the option of finding vast foreign appetite for its spewage is a very myopic one. We already know that China is a major question mark, and will aggressively be looking at pumping capital into its own economy instead of that of Uncle Sam’s – at some point the return on investment in its own middle class will surpass that of funding the rapidly disappearing US middle class. That tipping point could be as soon as 2010.

As for Japan – the country has plunged into its n^th consecutive deflationary period. Whether or not the finance minister announces yet another affair with the Quantitative Easing whore on any given day, depends merely on what side of the bed he wakes up on. The country will have its hands full monetizing its own sovereign issuance, let alone ours.

Lastly, the UK – well, with the country set to have zero bankers left in a few months, we don’t think the traditionally third largest purchaser of US debt will be doing much purchasing any time soon.

None of this is merely speculation: October TIC data confirmed these preliminary observations. It will only become more pronounced in upcoming months.

How about that great globalization dynamo: emerging markets? Alas, they have their hands full with issuing their own record amounts of both sovereign and corporate debt as well: in 2009 gross EM debt issuance reached an astounding $217 billion, $29 billion higher than the previous record in 2007. Gross EM issuance was particularly high in the last quarter at $73 billion, with October breaking the record for the largest ever monthly gross issuance of emerging market global bonds at $38 billion (January is traditionally the busiest month of the year.) With $81 billion, 2009 was notably a record year for sovereign bonds, while gross issuance of corporate bonds amounted to $136 billion, the second highest level after that of 2007 with $155 billion.

Bottom line: everyone has major problems at home, and is more focused on the supply than the demand side of the equation.

What options does this leave for the administration? Very few, and all of them are ugly. As we stated earlier on, the options for the Fed are threefold:

1. Announce a new iteration of Quantitative Easing. This will be met with major disapproval across all voting classes (at least those whose residential zip codes do not start with 10xxx or 068xx), creating major headaches for Obama and the democrats which are already struggling with collapsing polls.
2. Prepare for a major increase in interest rates. While on the surface this would be very welcome for a Fed that keeps hinting that deflation is the biggest concern for the economy, Bernanke’s complete lack of preparation from a monetary standpoint (we are surprised the Fed’s $200 million reverse repos have not made the late night comedy circuit yet) to a forced interest rate increase, would likely result in runaway inflation almost overnight. The result would be a huge blow to a still deteriorating economy.
3. Engineer a stock market collapse. Recently investors have, rightfully, realized there is no more risk in equities, not because the assets backing the stockholder equity are actually creating greater cash flow (as we demonstrated recently, that is not the case), but simply because taxpayers have involuntarily become safekeepers for the entire stock market, due to Bernanke’s forced intervention in bond and equity markets. Yet the President’s Working Group is fully aware that when the time comes to hitting the “reverse” button, it will do so. Will the resultant rush into safe assets be sufficient to generate the needed endogenous demand for Treasuries is unknown. It will likely be correlated to the size of the equity market drop.

If the Fed decides on option three, we fully believe a 30% drop (or greater) in equities is very probable as the new supply/demand regime in fixed income becomes apparent. We hope mainstream media takes the ideas presented here and processes them for broader consumption as indeed the Fed is caught in a very fragile dilemma, and the sooner its hand is pushed, the less disastrous the final outcome for investors. Then again, as Eric Sprott has been pointing out for quite some time, it could very well be that the US economy has become merely one huge Ponzi, and as such, its expansion or reduction on the margin is uncontrollable. We very well may have passed into the stage where blind growth is the only alternative to a complete collapse. We hope that is not the case.

Merry Christmas and Happy Holidays to all readers.

Submitted by Leo Kolivakis, publisher of Pension Pulse.

Henny Sender of the FT reports that top hedge funds bet on big rise in yields:

The
recent rise in long-term US interest rates comes as good news for
several leading hedge fund managers, including John Paulson, who have
positioned their trading books to benefit from higher yields on US
Treasury securities.

 

Mr Paulson, who
made big gains earlier this decade by betting against the subprime
mortgage market and whose firm, Paulson & Co, manages $33bn, has
said he believes that government stimulus efforts would inevitably lead
to higher inflation and a corresponding rise in rates.

 

“It will
be difficult for the government to withdraw the economic stimulus,” Mr
Paulson said in a speech. “An increase in the monetary base leads to an
increase in the money supply, which leads to inflation.”

Bond
prices fall as yields rise, and Mr Paulson told the Financial Times
last week that he has been hoping to benefit in the Treasury market by
buying options that would become profitable if rates headed higher.
TPG-Axon’s Dinakar Singh has been making similar options trades,
according to a person familiar with the matter.

Julian Robertson,
the hedge fund manager, has pursued a related strategy, hoping to
benefit from a bigger difference between short-term and long-term
interest rates, known as a steeper yield curve, a person familiar with
his trades said.

The yield on the 10-year Treasury, which hit a
crisis low of 2.055 per cent last year, has moved from 3.2 per cent
last month to 3.75 per cent on Tuesday.

Hedge fund managers,
however, have been hesitant to engage in short sales of Treasury bonds
to profit from the rising yields – and falling prices – because of the
Federal Reserve’s heavy involvement in the market. This has led some to
buy options – dubbed “high strike receivers” – that would enable them
to profit from sharply higher Treasury yields, hedge fund managers say.
These trades, which are relatively cheap to execute because they are so
out of the money, are based on the thesis that yields could hit 7 or 8
per cent.

“If they are right, and the world ends, they will make
a fortune,” said one fund manager who is sceptical of the idea. “If
they are wrong, they haven’t lost much.”

Some traders are
cautious because many peers lost large sums betting that rates would
rise in Japan in the 1990s – as yields fell to less than half a
percentage point. The trade was termed the “black widow” because it left so many victims.

“Nobody
understood the extent of deflation and economic weakness in Japan,”
said Dino Kos of Portales Partners, a research consultancy, who was
then a Fed official. “More money was lost on that trade than on any
other single trade. Everyone piled in when rates were at 3 per cent and
then at 2.5 per cent and then at 2 per cent.”

So
is it time to place big bets on rising yields? I could easily see a
backup in yields in the near term as economic reports surprise to the
upside, but I don’t believe that bonds have entered a long-term secular
bear market. I think the hedgies are right, best to play interest rate
directional calls though options.

Also, given the increase in
liability-driven investing by pension funds worried about their funding
status, there is an upper cap on bond yields. I don’t know what the
exact magic number is, but at a certain level (say 7%), you’ll have
pensions scambling to lock in rates. Bond bears tend to ignore this
when predicting doom and gloom on bonds. All they do is focus on the
“pending collapse” of the US dollar, which won’t happen .

I keep trying to warn people…..

LONDON, Dec 16 (Reuters) – Standard & Poor’s on Wednesday put about 1.46 trillion euros ($2.127 trillion) worth of covered bonds on credit watch negative or developing, based on new criteria for rating such securities.

$2.12 trillion worth of covered bonds?!

What is a covered bond again?

Covered bonds, usually rated triple-A, are regarded as low risk because they are backed by mortgage assets or loans that remain on the issuing bank’s balance sheet, but the credit crisis prompted S&P to revisit the way it rated them because of concerns over what would happen in a bank default.

Oh, mortgages and loans eh?

“AAA” eh?

Is this sort of “AAA” the same sort that our subprime MBS got?

So let’s see.  Instead of selling the loans we keep them and then sell bonds against them, thereby “covering” them with the “asset.”  This works great until the underlying collateral quality goes to hell and the borrower defaults, at which point the bondholder has recourse against the issuing bank!

When that issuing bank is geared at 60:1 (as some in Europe are) guess what happens?

This is the definition of “AAA” right?  A bank that is geared up 30, 40, 50, 60:1 – and that’s the ultimate recourse on the bond? 

How do you say “debt pyramiding” – an act that every competent underwriter or credit analyst knows is a serious risk?  But no!  We should rate this eurotrash “AAA” so we can find suckers, er, “investors”, who will soak up this trash and make even more risky lending possible!

I think we need a new rating: TOP – for “Triple Ocular Penetration” (thanks to the forum but I can’t find the person’s login to credit him or her properly :-> ) – and we should definitely assign these “covered bonds” this new rating.

Oh and these crafty bankers would never get themselves into a duration mismatch problem would they?  You know, sell short-term bonds against 20 or 30 year loan obligations – thereby putting them at risk of a rollover problem (where rates have spiked in the interim), making them instantly underwater (and remember, they’re levered 30, 40, 50 or 60:1 over there – with no transparency – too!)

The bonds have relatively short maturities, but the pool of underlying mortgages backing them are usually 25-30 years. This raised concerns that in a default the mortgages would not raise enough to repay the bonds.

Oh, they did do that.  Geez these bankers are really smart!

“Heh sonny, hold this thing for me while I pull the pin out…. and RUN!”

All the pumpers and media shills tried to tell us that the problems were behind us, and the economy and banking system would all be ok….. let’s see, we have the PIIGS problem, we have Dubai, and now we have over $2 trillion of supposedly-”AAA” bonds that not only are the epitome of debt pyramiding but they’ve got duration mismatch problems – into an almost-certainly rising-rate environment – as well!

What could possibly go wrong?