The T Report: What would be the catalyst?

Over the past few weeks, the market has fully bought into the notion that everything is contained.  That the central banks have done enough to at least delay problems if not fix them.  Much of that was based on moves in bond yields in Europe.  It was circular that moves specifically designed to improve bond yields were attributed with accomplishing far more than just moving bond yields.  Many people were asking “what is the catalyst”.

It seems we have 3 potential catalysts – none particularly surprising, yet all seemed to have been ignored.

1)      Weakness in China.

2)      Weakness in Europe and spread widening for sovereign debt – what started as a slow leak in Spain seems to be accelerating.

3)      Less conviction that US economic data, housing market rebound, and earnings will save the day.

The markets are once again nervous today with European credit weaker, and IG18 noticeably weak today, it is trading at 92.5 now, 48 hours ago, 85.5 bids were getting hit, in spite of the fact that we were at new tights and the index was trading 7 bps rich.  It reminded me of those “5 stages of tequila” shirts, and the market was at the “invincible” stage.  The index is still trading 3 rich, but I would look to take off some of this trade soon as it is a big move in 48 hours, but I think we can see more equity weakness on the open, and the housing numbers could disappoint and accelerate that move.

While not “invincible” the high yield cash market is in the “bulletproof” stage.  High yield cash remains bid this morning, in spite of signs of weakness in investment grade.  If this is a reaction to the move in treasuries and thinking spreads are cheap, then it seems horribly misplaced.  The CDS indices are weak, stocks are weak, and high yield will not follow rates for long.  Sell HYG and JNK.  HY17 vs HYG has reverted back to the spread we recommended it at sadly.  It had been up a point, but HY17 has reacted far more negatively, so far.  We should have taken profits, but this trade was more of a bullish trade, and I do think HYG will struggle to maintain its strength relative to HY17, plus we haven’t had the roll yet, one of the keys to seeing HY17 finally perform.

Earlier this morning we took a look at Who will buy Spanish bonds.  The key takeaway is the LTRO, the increased correlation between banks and their country, and the legal tricks that were played to push Greek PSI through all combine to make potential credit buyers more nervous, and just like in stocks, there are a lot of nervous longs.  Spanish 10 year is above 5.5%, starting to become worrisome.  At 5.75% expect a lot of chatter about 6% and how problematic that is.  CDS is wider in Spain and Italy (440 + 10 on day, and 390 +15 on day, respectively). The 5 year bonds in Spain are underperforming.  All signs of growing nervousness, but at this point it still seems more like an overly complacent market normalizing rather than a move that is overdone.

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