In no particular order, I want to touch on some things I’ve seen, heard and thought about on credit and liquidity:
1) The European situation is not a “one size fits all” garden variety credit problem. Fitch has a short summary of the PIIGS countries, and I made comments and highlights on it here:
2) Speaking of sovereign credit, a friend and very sharp guy wrote a couple of posts on the credit default swap market (here and here). One of the key things he noted was the disconnect between inter-dealer volume and client volume. Specifically with respect to sovereigns he wrote:
More than 2.1 million credit default swap contracts were traded. Of greater interest, however, is the fact that almost 1.8 million of these contracts were traded between dealers, 83.7% of the total number of trades. Only 16.3% of the trades, 351 thousand, were bought or sold by non-dealers.
And in the corporate CDS trading space?
130 of the 202 corporate reference names have an average of 5 or less trades per day by non-dealers. 149 reference names have 10 or less trades per day by non-dealers. Only two corporates have more than 40 trades per day by non-dealers.
First, I have to say the volume differences between inter-dealer trading and non-dealer trading is staggering. But it leads me to some questions. Questions that need answers…
- What are the dealers doing? Is this how they are trying to make the market appear “liquid?”
- Is there another explanation? I’ve been toying around with this idea that there may be another reason completely unrelated to trading and market-making. The volumes are such to support the headcount in those departments – so this could be bureaucracy and bloat. It may be totally wrong, and a sign my medication needs to be upped dramatically, but I’m just saying there may be an alternative explanation.
Another thing: I’m much less beholden to the view of CDS as “insurance.” It’s a derivative, plain and simple. While it may have been intended to be an insurance-type product, like any other derivative it takes on a life all its own. I have always held the belief CDS were just a way to gain a long/short exposure to credit risk – migration risk in particular. Baudrillard discusses the idea of the simulacra – a synthetic that replaces the organic – and with the focus on CDS performance, the case could be made that CDS are watched more closely than the cash instruments they derive their characteristics from.
The question is “does it make sense for this to be happening?” Personally I don’t think so. I think you need to understand the workings of both the cash and the synthetic. And given the nature of the CDS market, I think we all need to keep in mind that CDS are an imperfect proxy for assessing default risk.
3) Treasury auctions were pretty strong, but truth be told I thought they’d be a bit stronger. I’m including the results from both auctions here:
One thing that stands out to me is the presence of the direct bidders at the 10yr. The direct bidders are banks buying Treasuries for their own account. Since banks had been buying MBS right alongside the Fed…
it would make sense for them to step up participation in Treasury auctions of 10yr notes since the correlation between 10yr notes and 30yr fixed rate mortgages is quite high. This also means mortgage rates will stay lower as well, and to be honest I probably underestimated the strength in 10yr bidding’s effect on mortgages.
4) While everyone has been talking about LIBOR-OIS and my long, lost friend TED, effective Fed funds are still not showing volatility. There’s an anomalous data point from the summer of last year but other than that daily Fed funds have been extremely quiet:
In fact, possibly a little too quiet…