"Audentes Fortuna Juvat" - Virgil

The volatility “echo” – We find ourselves at something of a crossroads in the ongoing credit saga of the EMU.  If we close CDS spreads for the week at current levels we’ll reset the all time wide on Spanish CDS.  This comes in the wake of over €1 trillion of LTRO and hundreds of billions of € spent by the ECB to buy up bonds of the “periphery” countries in order to sop up excess supply and keep spreads  in the cash markets from ballooning ever higher.  To date the Rajoy government hasn’t been able to stuff the genii back in the bottle as the budget deficit in Spain appears set to spiral out of control given that austerity measures taken so far have only served to worsen the dire economic state of affairs for the country (20+% unemployment rate and a likely 5+% budget deficit for 2012, well above the 3% Maastricht Treaty prescribed level).  Does the EMU leadership continue to press for ever more austerity and risk a complete political and social meltdown in Spain similar to that seen in Greece or does the ECB throw caution to the wind and print euro like a maniac to buy up Spanish and Italian debt, because make no mistake…if Spain goes, Italy is right behind them and the current EFSF/ESM will amount to using a garden hose to put out a forest fire….oh yeah, it’s Friday the 13^th.

 

Equity Markets – Equity markets are slumping this morning following the news overnight that Chinese Q1 GDP growth was below expectations…the early closing markets in Asia performed well following the rally yesterday but performance deteriorated as we moved into the European opening.  European indices are at or near their lows for the morning session with Spain continuing to underperform the other markets (the IBEX is down over 14% YTD) on concern that the budget situation there will worsen and the ECB will need to fire up the printing presses once more to buy Spanish and Italian debt as market participants shun paper from the periphery of the EMU.  Here in the states we look to open lower after a rally yesterday…with markets starting to respond to each piece of data out and speculation about macro data releases, this says to me that we’re heading back toward a volatility driven trading environment which puts spread product at risk given the embedded “credit put” options’ sensitivity to market volatility.

 

Macro, News & Events

Economic Releases – I’d  have to say that taken on balance, yesterday’s releases were something short of inspirational…the core PPI numbers were +0.3% on a sequential basis and +2.9% annualized, producer price increases start to get passed on to the consumer or you’ll certainly see either profit margins decline or headcount decline or potentially both.  Speaking of jobs, the weekly claims number came in at a disappointing 380k some 25k higher than expected and last week was revised up 10k to 367k.

·         March CPI (MoM)…+0.3% v. +0.4%

·         March CPI ex-food & energy (MoM)…+0.2% v. +0.1%

·         March CPI (YoY)…+2.7% v. +2.9%

·         March CPI ex-food & energy (YoY)…+2.2% v. +2.2%

·         April UofM Consumer Confidence Index…76.2 v. 76.2

Earnings – today we get the two largest banks by market cap in the US…

Asia, Europe & USA

·         Q1 growth in China came in at a lower than anticipated 8.1% in Q1 ’12 (estimate was for 8.4%)…of course this could bring out the “bad news is good news” crowd who will expect the PBoC to revisit monetary stimulus.  The primary consideration in China is inflation so until we see a break in foodstuff inflation, I doubt that we’ll be seeing much in the way of monetary stimulus.

·         It appears that Sony will throw in the towel on TVs and concentrate on mobile devices, games and digital imaging…

·         Home sales in China fell by 17.5% year over year in Q1…Office sales were up 11.4% and commercial property sales were up 5.9% (both on a year over year basis)

·         The DPRK’s launch of a satellite bearing rocket failed shortly after takeoff…
·         The Bank of Korea (central bank of the RoK) kept rates unchanged for the 10^th consecutive month amid concerns about global growth prospects…the 7-day repo rate will remain at 3.25%...
·         Inflation in Germany slowed in March as the increase in energy prices was down on a year-over-year basis…as reported, inflation was +2.3%, up from +2.5% in February….

·         ECB executive board member Asmussen said that the central bank could start to raise rates to curb inflation if the economy picks up…this points out the problem in some instances with “transparency”…just because there’s transparency doesn’t mean that things still aren’t opaque.

·         The PPI in the UK were up +0.6% in March  above the median forecast of +0.5%....driven by the prices of raw materials that were up 1.9% vs. a 1.4% estimate…the Bank of England governors continue to debate the merits of scaling back on the QE program and/or raising short term rates from their current 0.5% level.  The rise in producer prices was the 3^rd straight.  One upside was that while prices were up 3.6% vs. last year, they were down sequentially from the +4.1% rate (year over year) in February.

·         The residential property market remains “frozen” as there are few if any lenders.  Consequently, rents are rising and the National Asset Management Agency is in the process of trying to sell multi-family assets that it took off of bank balance sheets when it was set up as the state-controlled “bad bank”

Credit Markets –

·         A survey of economists suggests that the ECB will be forced to start up the SMP (Securities Market Program) again to help contain yields (should be called the “No Buyers Program” and in case you haven’t noticed, they’ve been in buying Spanish debt again.  Other prognostications are that the ECB is unlikely to restart the LTRO but if they did it would be a 1 or 2-yr program and not a 3-yr program.

·         Following the announcement that Chinese Q1 growth was below estimates the A$ declined against all 16 major currency counterparts

·         The potential for continued weakening macro data has large fixed income managers like Doubleline and PIMCO predicting that the Federal Reserve will likely be back in the mode of QE before the year is over

·         The FRBNY is preparing to auction off $7.49 billion in real estate related debt that it assumed in 2008

·         The Federal Reserve said that corporate CP continues to decline, down $3.1 billion in the week ended April 11^th…companies continue to elect to term out the debt component of their capital structure with rates at or near all time lows…

·         Spanish banks borrowed €300 billion from the ECB in March, a 50% increase to the highest on record as the ECB opted not to extend the LTRO program…as credit market funding sources dry up, Spain has to turn more and more to the ECB…this is unfortunately an all too familiar situation in the EMU.

·         The EFSF will auction €2 billion of 6-month bills next week

Sovereign CDS – spreads are relatively unchanged this morning as the market assesses the potential impact of Chinese Q1 GDP growth that was lower than the median estimate by 30 bps and lower than some whisper numbers out late yesterday by almost 100 bps.

 

US Corporate Credit – The high yield CDS index led the way yesterday tightening by 33 bps to +593 bps amidst the rally in equity markets in anticipation of outperformance by China…oops.  Meanwhile the leveraged  loan index was in by 14 bps (+319) and the investment grade index (5-year) was in by 5 bps to +97 bps.

Energy Markets – crude is down this morning with the news out of China that Q1 GDP growth was below forecast and the news that the Saudi oil minister Naimi said that the kingdom views crude prices as too high and is determined to see them decline.  The WTI / Brent spread is back over $18 / barrel in what has been a volatile week in the oil markets.

 

·         The Baker Hughes rig count numbers are out today at 1300…last weeks number for active drilling rigs in the US was 1,979 as the declining trend continues amid the excess supply situation in natural gas (see chart below)

 

Futures – with spot natural gas at $1.88 from the Henry Hub in Louisiana and the 1 year strip average at $2.67/Mcf the energy equivalence ratio has spiked to over 6.5x.