The T Report: GDP Better Be Good and Redefining “Successful” Auctions

The market has continued its overnight rebound, at least in part on expectations that GDP will hit 3%. I could see that happening quite easily. There was enough good data at the start of the year that the consensus estimate of 2.5% seems slow. The same group that complains about how Case-Shiller is backwards looking, ignore the fact that Q1 GDP is old news. I am also not sure that 3% is good for the markets, because we are at least partly living in a world where expectations of QE3 are as important to stock prices as the data itself.

Data in Europe was awful. Spanish unemployment hit 24.4%. About the only remotely positive thing I can say about that is that they seem to have decent benefits and if the U.S. had comparable benefits we might have a much higher labor participation rate and in turn a much higher unemployment rate than the currently stated 8.2%. And it wasn’t just Spain, as French unemployment is now nearing 10%, which might explain why consumer spending dropped a whopping 2.9% last month.

The market is doing a great job shrugging off the two notch Spanish debt downgrade inflicted by S&P, though the question is why is it doing such a good job? Spanish 5 year and 10 year bonds are both yielding 10 bps more on the day, and the 10 year is at 5.93% right now, and has flirted with a run at 6%. Even in Italy, where a semi-reasonable bond auction helped spark the rebound from the overnight lows, we see little evidence of the success, as 5 year bonds are at 4.9% (15 bps higher on the day, and curiously back to 12 bps higher than 5 year Spanish debt). In CDS, Spain still trades about 25 bps higher than Italy (485 vs 460). Let me be the first, and likely only person to thank the $20 billion of CDS shorts in Italian CDS for their part in the auction. Yes, CDS shorts do like to buy bonds in auctions. We should also thank Italian banks for stepping up and doing their LTRO duty. With Italian 10 year bonds briefly breaking 5.75%, they hit yields not seen since January, so maybe the auction wasn’t successful after all? I think we will see further evidence that Italian debt is being concentrated in the hands of Italian banks, making a conversion to Lire that much less painful.

The last paragraph was confusing. I thought about trying to fix it up, but the situation is confusing. The allegedly successful Italian auction is accompanied by rising rates, which is contradictory, and while stocks are ignoring the problems in Spain, the bond market isn’t.

We have seen the bond market diverge from the equity market before. As recently as two weeks ago we saw stocks remain strong while credit showed signs of weakness. I don’t see any obvious reason why this time would be different. European credit problems are real and expanding, the economic data here has been mixed, and real QE is likely off the table, and the best the market can hope for is Twist, which really had limited impact on stocks (LTRO had far more impact on stocks, until that magic wore off).

Fixed income ETF’s did well across the board, with treasuries and spreads improving. I struggle to find any reason to own the HY ETF’s here, as the premium seems too big again, and the portfolio isn’t what I would want to own at these yields.