Rolling, Rolling, Rolling...Keep Them Lenders Rolling

By: Michael Ashton | Mon, Jan 16, 2012
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Either the strategy of releasing downgrade announcements for Europe at 4:30 ET paid off, or sovereign ratings have become largely irrelevant. On Monday, albeit a market holiday in the U.S., bond markets ignored the downgrades and equity markets rallied in the U.S. (via futures) and in Europe.

Except for Portugal. Portuguese 5-year note yields rose 193bps to 16.13%; 10-year note yields rose 125bps to 13.17% (see Chart, source Bloomberg).

Portugal seems to be saying 'we got next.'
Portugal seems to be saying 'we got next.'

Why Portugal? Why not Spain, or France? It's understandable why Greece, which everyone already assumes will default, didn't sell off further; Portugal, it seems, is considered next in line. I still would have expected the other countries in the queue to have moved up as well, since they are getting closer to the front of the line (and,as I said on Saturday, there is always a chance that the dominos all fall at once in a big unzipping).

Volumes were lighter, of course, with most U.S. traders out for the day, and we may see more of a reaction on Tuesday, but honestly I don't expect much of one. We did get a tiny bit of additional information on Monday, and that was that the European Financial Stability Facility (EFSF) also, unsurprisingly, had its rating cut from AAA to AA+ as a direct consequence of the downgrading of many of the constituent members. This downgrading happened even though the EFSF is technically ultimately backstopped by only the AAA members...the problem is that those AAA guarantees are only worth €271bln now rather than €451bln. There will be an immediate test of the new rating, although a mild one, as the EFSF goes to market tomorrow to sell 6-month bills (because, you know, 3 months might not be enough to completely solve the crisis I guess).

Speaking of tests of a rating, here's your scary chart of the day. Looking back to the U.S., where Treasury yields are below expected inflation for 10 years, the distribution of US debt looks like this:

Ouch! The employees of the Treasury are certainly earning their pay these days.
Ouch! The employees of the Treasury are certainly earning their pay these days.

Yes, that's $2.7 trillion the Treasury needs to roll this year, not including the new money to cover this year's deficit. About $1.9 trillion of that is in the first half of the year ($1.3 trillion of which are Treasury Bills). I sure hope we can keep rolling a trillion or so T-Bills every quarter! What could go wrong?

Now, the Treasury had a similar, if somewhat smaller, problem last year. But last year, the Federal Reserve was generously vacuuming up hundreds of billions of dollars of the issuance. Right now, investors fleeing Europe are filling in for the Fed. What happens if the crisis in Europe really does recede?

All of these things are hopelessly intertwined. Like two trees which have grown together, the banking and sovereign crises in both Europe and the U.S. may have become inseparable - saving one may imply killing the other. It may be that only way that the U.S. can fund itself is if money continues to flee Europe!

The Treasury will sell $56bln in T-Bills tomorrow, and $15bln in new 10-year TIPS on Thursday. There shouldn't be any problem with these auctions, yet. Empire Manufacturing (Consensus: 11.00 from 9.53) for January is also due out, along with revisions, but shouldn't move markets. We will instead react carefully to news out of Europe, and more particularly our markets will respond on the basis of howtheirmarkets are responding. The reviews from Monday suggest our bonds could lose some flight-to-quality sponsorship, but it's early yet.



Michael Ashton

Author: Michael Ashton

Michael Ashton, CFA

Michael Ashton

Michael Ashton is Managing Principal at Enduring Investments LLC, a specialty consulting and investment management boutique that offers focused inflation-market expertise. He may be contacted through that site. He is on Twitter at @inflation_guy

Prior to founding Enduring Investments, Mr. Ashton worked as a trader, strategist, and salesman during a 20-year Wall Street career that included tours of duty at Deutsche Bank, Bankers Trust, Barclays Capital, and J.P. Morgan.

Since 2003 he has played an integral role in developing the U.S. inflation derivatives markets and is widely viewed as a premier subject matter expert on inflation products and inflation trading. While at Barclays, he traded the first interbank U.S. CPI swaps. He was primarily responsible for the creation of the CPI Futures contract that the Chicago Mercantile Exchange listed in February 2004 and was the lead market maker for that contract. Mr. Ashton has written extensively about the use of inflation-indexed products for hedging real exposures, including papers and book chapters on "Inflation and Commodities," "The Real-Feel Inflation Rate," "Hedging Post-Retirement Medical Liabilities," and "Liability-Driven Investment For Individuals." He frequently speaks in front of professional and retail audiences, both large and small. He runs the Inflation-Indexed Investing Association.

For many years, Mr. Ashton has written frequent market commentary, sometimes for client distribution and more recently for wider public dissemination. Mr. Ashton received a Bachelor of Arts degree in Economics from Trinity University in 1990 and was awarded his CFA charter in 2001.

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