…And that would spell harm for riskies. 10yr Tsy yields are about 10bps less than when we mentioned their relevance to risk assets earlier this week, although one could say they remain in their consolidating triangle. The prospect of an imminent breakdown in yields is looming, however, and a selloff through the 310bps level could be game over for equities and commodities.
Certainly the fundamentals are there for a risk asset decline. Initial claims came in today at 472k vs 450k consensus, as the US employment picture looks bleaker by the minute. Presented below is a chart of jobless claims (inverted, 4wk moving avg) vs the S&P, courtesy of Bespoke Investment Group:
Meanwhile, the Philly Fed diffusion index dropped 13.4 points to 8 vs. 20 consensus, and May CPI declined for the second straight month to -0.2%, the lowest level since December 2008. The leading indicators mentioned in previous posts (ECRI LEI, retail sales, etc.) are warning of a double-dip, while coincident and lagging data are now suggesting the possibility as well. Shrinking tax receipts and swelled budget deficits are starting to take a toll on muni’s, as MCDX components begin their widening. Growth has clearly stalled and the stimulus hangover is now upon us.
One of the symptoms of the spending hangover is the sov debt crisis that has begun in earnest in the European periphery and is making its way to larger Euro economies. As mentioned previously, Spain is in the cross-hairs presently. 10yr ESP Tsy spread to Bunds are in the 335bps region, while the bond auction today resulted in the 30yr going for a 115bps yield premium to last month’s auction. The Kingdom has to roll over about €20B by the end of July and with record (and increasing) ECB deposit facility usage, it looks like a liquidity crisis could hit Spain this summer. It has a property bubble yet to really mean-revert (prices only down 11% from peak), huge unbooked losses on bank balance sheets, and austerity in an already-20%-unemployment environment. With aversion to interbank lending (record ECB deposits + EURIBOR creeping up), Spanish banks are already suspicious of each other’s balance sheets and as more funding is needed, more granular looks at each other’s books will occur, which will expose lots of unrealized losses (similar to fall 08 in USA). Meanwhile, the sov sector is going to have a tough time rolling over its massive redemptions in July, and as Spanish bonds fall, the Spanish banks’ books will come under even more pressure.
But those are fundamentals and macro. Not always the most relevant factors for price action in this market. Equity could continue rallying into the summer, though this bounce off recent lows is suspect in volume (as well as in the fact that market leaders have been selling off and put in major tops). I’m looking for a failure at the 50DMA/1150 resistance level, which would mark the right shoulder of a large h&s (delineated in pink in the SPY chart below) that has been developing since last November. If that is indeed what occurs, the 1040 neckline, when breached, should usher major selling and would be a prime shorting opportunity. Indeed, ICI reported a $3.7B outflow form equity mutual funds last year, bringing the year’s total to $27B. But that’s all speculation; this market has a mind of its own and if we go on to April highs or beyond, it won’t be the biggest surprise. One thing is for sure though: with global growth now stalled, an acute liquidity crunch in Europe, massive debt maturities in the next few months, and a still-rallying USD, whenever we do sell off, it should begin a strong and long wave down.
Speaking of liquidity crunches, BP is tendering a $10B bond issue, with 5yr CDS spreads close to 500bps, as well as selling $10B in assets and seeking a $5B credit line. This is an acute liquidity crunch, as BP has burned through 15% of its cash holdings in just a month. If equity and note declines continue, contagion could result– BLK’s equity value has already dramatically declined since the Deepwater Horizon explosion. Rumor is PetroChina may LBO BP if it drops below $15 PPS, which would have big political ramifications. Expect continued curve inversion.
But back to the possible imminent breakout in Treasuries– as we stated, US sov FI finding a bid will signify (near-term) deflation and risk to risk assets, as there’s a rush to “safety” and liquidity. Billy Gross over at PIMCO, for one, sees a Tsy rally in the works: TRF’s bond holdings jumped by $35B MoM in May, bringing them to 51% of all holdings (from 36% in April).