Credit Bubble Bulletin

It’s an unusual backdrop where “Risk On” powers a U.S. “Risk Off” is lurking right around the corner. Ten-year Treasury yields declined 10 bps this week (to 2.31%) to the lowest level since November 29th. UK produces sank 14 bps (to at least one 1.08%) to lows since October. 1,257, trading to the high because the election. 18.41, increasing y-t-d gains to 15%. The yen gained 0.6% this week, increasing y-t-d gains versus the dollar to 4.3% (and near a key technical level).

Elsewhere, it appears some preferred investments are performing badly – with popular longs lagging and popular shorts outperforming. The financials continue to lag, while the out-of-favor Utilities surged 4.1% this week. Defensive stocks and shares outperformed this week, while “Trump reflation” wagers underperformed. Low beta outperformed high beta. The tiny caps underperformed again this week. Meanwhile, the Treasury bond bears are running for cover.

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All in every, it would appear Market Dynamics continue steadily to frustrate many hedge fund strategies. At this point, Europe remains at the epicenter from the “Risk On”/”Risk Off” Face-off. Major European equities indices reversed lower into this week’s close. After trading to the best level since 2015, Germany’s DAX index dropped 1.6% during Thursday’s and Friday’s sessions.

Italian equities fell 2.2% this week, and Spanish and French equities posted moderate declines. The European Bank Stock Index (STOXX 600) dropped 3.2% this week, trading to the lowest level since early-December. Through the eye of the global connection market, something just doesn’t look right. And while this week’s Treasury and gilt yield declines were curious developments, the true action is constantly on the unfold in Europe. This week The French versus German two-year sovereign spread exchanged up to 49 bps, the widest because the tumultuous summer season of 2012. This spread widened 11 bps for the week (to 43bps), and has doubled thus far in February.

The Italian to German 10-calendar year spread widened 12 this week, back again to a two-year high 201 bps. The Spanish to German 10-year spread surged 18 bps this week to a seven-month high 151 bps. Markets obviously fret approaching French elections (first round April 23, second May 7). National Front candidate Marine Le Pen is widely likely to win the first round but lose in May’s two candidate runoff.

After Brexit and Trump, marketplaces this time are less ready to take things for granted around. Le Pen is running on the right platform which includes exiting the EU far, time for the French franc and adopting various “France First” measures. Having viewed post-Brexit and post-Trump non-turmoil, perhaps French voters will disregard what has become regular fearmongering. While markets see a Le Pen Presidency as a comparatively low-probability (Citigroup says 20%), there is acknowledgement that such an result would be market disruptive highly.

Many would view a National Front upset as the beginning of the end of the euro monetary experiment. French (to German) relationship spreads narrowed Wednesday on leads for a Macron/Bayrou alliance to counter Le Pen. This development, however, didn’t slow the melt-up in German bund prices or, for example, the rally in Treasuries, gilts and safe haven bonds more generally. And it didn’t stop a sell-off in European bank stocks and shares that appeared behind the late-week underperformance in U.S.

A Friday Reuters headline caught my attention: “Global Stocks Fall, Bond Markets as Trump Optimism Pauses Rally.” I’ve a hard time with the notion of “Trump optimism” fueling international equities. Rather, it’s too much “money” (liquidity) going after highly speculative markets in stocks and shares, bunds, Treasuries, gilts, JGBs, eM and corporates debt. This same fuel has been behind gold and silver’s 9% and 15% y-t-d gains. It’s a Theme 2017 that markets are unprepared for what will be a astonishing change in the global financial backdrop. I expect both the BOJ and ECB to at some point this year begin developing approaches for significantly reducing QE liquidity shots. Clearly, the Germans are contemplating a year-end conclusion to ECB QE operations.

Angela Merkel shows up increasingly vulnerable proceeding into October elections. Responding to criticism from a Trump advisor, Merkel this week commented: “We have at the moment in the euro area of course a problem with the value of the euro. The ECB has a monetary policy that’s not geared to Germany, it is customized from Portugal to Slovenia or Slovakia rather. Will the Merkel federal government and Weidmann Bundesbank art a far more aggressive strategy for reining in Mario Draghi finally? Securities financing markets already are under heightened strain, as ECB purchases ensure an ever-dwindling supply of German debt in the marketplace.