Thursday, December 24, 2009

Happy Holidays

May I offer my sincerest wishes for Christmas and the Holiday Season. I will take a break from posting for a week or so - unless there are serious developments, of course.

All The Best.

A Christmas Tree For Troubled Times

Friday, December 18, 2009

The Euro's Trojan Horse

'Tis the season of giving, so it should come as no surprise that at this time Sudden Debt invokes Troy's Laocoon in Virgil's Aeneid: "Timeo Danaos et dona ferentes" (beware of Greeks bearing gifts).

Why? Because as crafty inventors of the Trojan Horse Greeks may once again become infamous for yet another inside job: the euro's downfall - or, at least, its fall from grace.

Beware of Greeks Bearing Euros

If you have been following European financial matters at all, you know by now that Greece is in dire straits. It is beset by that trio of trouble that gives finance ministers white hairs by the hundreds: huge public debt (~120% of GDP), huge budget deficit (~13% of GDP for 2009), huge current account deficit (~10% of GDP for 2009). Oh, and its private sector debt went from 38% of GDP to 100% in less than a decade, mostly because households jumped on the debt wagon: their debt went from 15% to 50% of GDP in the same period, mostly on mortgage borrowing and higher housing prices.

Does the pattern sound familiar? Of course it does... this model of "economic growth", which substituted increased borrowing for earned income, was repeated all over the western world.

The immediate result is that rating agencies have now cut their marks for Greek government debt to BBB+, the lowest in the eurozone (S&P and Fitch. Moody's is still A1 but will soon downgrade) and borrowing costs have soared. Greek government 10-year bonds are currently yielding 5.74%, 271 basis points (2.71%) over the equivalent German bunds. In the years of the credit boom, of easy money and bubbly assets, this spread was a mere 20-30 b.p.

Likewise, credit default swaps (CDS) for Greek sovereign debt have now soared to 275-285 points (late Fri. updt.), up from 10-15 (see chart below, click to enlarge). This means that the mathematically calculated Cumulative Probability of Default (CPD) comes in at 21.5%, the 8th highest amongst sovereign risks (for comparison, Dubai is 6th on the list with 26.2%). To give you an idea of other eurozone members' CPDs, France is at 2.6% and Spain at 9.1%.

Greek CDS: Nosebleed on Mt. Olympus

All this trouble brewing in eurozone's weakest link is causing reasonable questions for the euro's viability as a global reserve currency. After all, claim the euro-naysayers, what is the EU if not a mere free trade zone with a common currency attached? In other words, Greece may be the euro's Trojan Horse... or at least, a damn good excuse for selling euros (see chart below, click to enlarge).

US Dollars Per Euro

Just one month ago I sounded the bell of euro's overvaluation vs. the dollar, having just seen the movie 2012. To use another Trojan allusion, there were simply too many Dollar Cassandras around, and they had even made guest appearances in popular movies. A sure omen of reversal, if ever there was one...

Monday, December 14, 2009

Throwing Good Oil After Bad Debts

Abu Dhabi decided to bail out Dubai (once again) by providing $10 billion in order to prevent a bond coming due today from defaulting. As the post's title says, that's precisely like throwing (more of) Abu Dhabi's perfectly good oil after Dubai's stinking bad debt. At today's prices, $10 billion is equivalent to nearly two months of Abu Dhabi's full-out oil production. And there's more bad debt where that came from, of course.

Ahhh, you will quickly say: it's only fiat money - book entries upon book entries. And Abu Dhabi still gets to physically keep its oil and can always hike the price it charges and get its money back from all the rest of us - including Dubai's lenders who are currently being bailed out (again).

Oh yeah? Not so fast..

In today's push-button interconnected global economy a bailed-out lender can immediately convert Abu Dhabi's pennies from heaven into a tangible commodity (say, crude oil), hire a VLCC and anchor the whole thing off the coast of Singapore. By bailing out Dubai and its lenders, Abu Dhabians are making a fool's bargain. They would have been much better off had they told everyone to take a hike, including those who kept building castles in the sand.

Ahhh, but what about the oil producers' ability to raise prices almost at will? Hah! And why do you think the US is sitting on Iraq, to mention just one geo-political petroleum pressure-point? Please note that Iraq has just announced plans to raise production to 12 mbpd in the future (it currently produces about 2.5 mbpd). If it succeeds (admittedly a huge if), it will surpass Russia and become the world's second largest producer of crude after Saudi Arabia. Kiss pricing power good-bye..

Friday, December 11, 2009

Revenge Of The Bond Nerds

Well, what do you know? The participants of the Roman orgies that took place during the Debt Dump and Bail Saturnalia (feel free to add punctuation marks as you see fit) are finally being presented with the bill. It's still in the process of being added up in toto, but it looks to be a doozy.

The irony is that - for the moment - the bill is being thrown at the face of those far less responsible for the mess than the big-time orgiastes. And to add insult to injury, the bill is summarily and contemptuously presented by that troupe of orgy-organizers who arguably made the mess much worse.

But, let's explain things in plain Latin.

Recent days have seen a raft of sovereign-credit downgrades and warnings by Moody's, S&P and Fitch, causing sharp rises in government bond yields and credit default swaps (CDS) for those affected. No doubt goosed by the (near-sovereign) collapse of Dubai, rating agencies are belatedly falling all over themselves to kick weakest-link borrowers in the groin, i.e. countries like Greece and Spain. Other countries like Italy, Portugal and Ireland are seeing their bonds come under pressure, too.

For example, look at the chart below tracking 5-year CDS for Greek government bonds.

Greek Government Debt CDS

After settling down from the late 2008 - early 2009 global panic, credit concerns rose again following some domestic issues (elections, dodgy statistics); but the catalyst that really spooked the market was unquestionably Dubai's loud insolvency, which made everyone stand up and face facts.

The rating agencies are also dropping hints about the UK and US, but they are still far from daring (or foolish) enough to really step on such big toes, preferring instead the time-tested method of beating on black sheep (or scapegoats, if you are more classically educated in things Greek and Roman) in order to send veiled messages to the King.

So, what of the "bond nerds" in today's title? (Apologies to my erstwhile colleagues - I use the term affectionately, of course). They are those ladies and gentlemen on trading desks and investment committees who have the decidedly unglamorous job of making markets and selecting straight, boring government paper to invest in: Treasurys, gilts, etc. They are very, very far removed from the hustle, bustle and juicy bonus pools common to more "meaty" structured debt securities. That is, they were - until the spectre of sovereign default raised its ugly head; suddenly, the nerds are running the show.

A 50 basis point swing in, say, the spread between Greek and German bond yields is enough to send global bond, stock and FX markets gyrating, causing massive stress to mandarins from prime ministers and central bankers, to Brussels-based bureaucrats.

What are the bond nerds saying, every time they hit a bid on the 10-year GGB or buy a Spanish CDS?

Simply this: Enough already with being so free with the taxpayers' and our investors' money... You guys can't run massive budget deficits as far as the eye can see and raise debt levels to the sky, without paying the price. You can't bail out the global financial system and keep unemployment down and consumption up, without us questioning your 1+1=3 arithmetic. You can't have your cake and eat it, there's no such thing as a free lunch - and funny money is no money at all.

Yeah, we may be nerds, alright, but you better take good care of us because you need us big time. Unless you want to walk the Minsky Way, that is...

Have a pleasant weekend (pondering government finances, perhaps?).

Saturday, December 5, 2009

Dollar Survey

Today, a Sudden Debt "special" survey.

Where do you think the dollar foreign exchange rate will go over the next 6-12 months? Please heed the obvious proviso: this is NOT a scientific survey, its results are NOT predictive and thus NOT to be considered investment/speculation advice.

I have re-done the poll, using a different provider that does not limit the size of the answers.