The Great Unwind has begun

[A_Random_Walk]

Marketwatch

SAN FRANCISCO (MarketWatch) – The Great Unwind has begun, Citigroup Inc. strategists warned on Wednesday.
As markets and economies de-leverage across the globe, investors should avoid companies and countries that have grown to rely too much on borrowed money, they said.

“Steady growth, low inflation and rock-bottom interest rates encouraged economic and financial participants across the world economy to gear up over the past few years,” Robert Buckland and his colleagues on Citi’s global strategy team wrote in a note to clients. “Easy money encouraged many to buy a bigger house, a bigger car or a bigger speculative position.”
“But now, any behavior that relied upon continued access to easy money is being dramatically reassessed,” they added. “Leveraged banks must lend less, leveraged consumers must consume less, leveraged companies must acquire or invest less, and leveraged speculators must speculate less.”

During the last credit crisis in 1998, European banks were leveraged 26 to 1. In the early part of this decade, leverage grew to 32 to 1. Now the sector is geared 40 to 1 on average, according to Citi’s European bank research team.
“The banks have a long way to go,” the strategists said. “We would continue to avoid the sector while they are de-leveraging.”

[yoganmahew]

I read somewhere that this Citi note was as close as anyone has ever come to shorting their own bank!

[whizzbang]

Just as well; we don’t know any countries that got dependent on cheap credit!

[2Pack]

A bit late I thinks and nothing new around here neither !

[yoganmahew]

Something from Across the Curve - written by a US bonds trader:
acrossthecurve.com/?p=524

The massive unwind of risk positions continues in the Treasury market. The yield on the 2 year note has jumped 10 basis points today to 1.56 percent from 1.46 percent. The 5year note yield has increased 8 basis points to 2.39 percent while the yield on the benchmark 10 year note is up 3 basis points to 3.36 percent.The bond is the only positive performer as its yield has actually declined 2 basis points to 4.19 percent. The 2year /10 year spread has narrowed to 177 basis points and is about 7 basis points tighter today.

There are several theories floating around for this curve flattening trade as well as for the price action in commodities and currencies. For the conspiracy theorists there is a Bear Stearns connection. The view expressed here is that Jamie Dimon’s troops have marched across the street to Bear Stearns and are in the building unwinding risk positions as we speak. They have very little reason to hold the risk positions which Bear had in place as JPM already takes substantial risk via its own trading enterprise as well as in the activities of its own portfolio. Why strap another layer of unfamiliar risk on top of what is already in place? There will come a time when the benefits which accrue to JPM from this shotgun marriage will allow for greater risk taking but at the outset the prudent risk taking course is to purge the Bear positions and start fresh.

This thought process is certainly plausible and believable but fails to acknowledge that there is a significant financial universe apart from the players at Madison Avenue and 47th Street in midtown Manhattan. Indeed there is and many of them are in pain ,too. The trials and tribulations of these other players has resulted in this massive deleveraging as quarter end(and Japanese year end) approaches. Senior mangement at a disparate collection of organizations is in survival mode and risk reduction mode. They are looking to unwind winners and losers and when the calendar arbitrarily reads April (Eliot’s cruelest month) they will think about rebuilding positions. In the meantime, present a minimalist position to shareholders and investors so that the barrage of unwanted questions is limited.

One final thought on liquidity and that is that it is severely impaired. Liquidity for the uninitiated is the ability to move blocks of securities quickly and unobtrusively at a level very close to some transparent price. As an example, if one steps back to last August and views the market for plain vanilla swaps (the cleanest and simplest form of derivative) it was regularly possible to transact $2billion to $3billion trades in the 5 year and 10 year part of the curve on a 1 basis point spread.

Here is how it worked. A large hedge fund calls its salesperson and says that it desires to receive on a 5 year swap. The salesman calls the swap trader ( market maker ) and tells him that XYZ hedge fund looks to receive on $2 billion 5year swaps. The trader would reply that his mid is (hypothetically) 3.995. This meant that the trader would be willing to pay the client at 3.99 percent or receive from the client at 4.00 percent . In most daily trading markets stability ruled and billions could trade on this tight 1basis point market.

That is no longer possible as liquidity and traders appetites for risks have been reduced. One salesman at a very large derivative shop with whom I conversed this morning reports that the norm is now 1 basis point from mid and the most that will trade is $250mm rather than the billion which would have in a quieter time. So using the previous example with a mid of 3.995 the market maker would pay the client at 3.985 and receive from the client at 4.005. That does not sound like much but on a block of $1billion it is a lot of wood and if I can still do the calculation each one of those basis points is worth about $400,000 per billion .

A similar phenomenon has transpired in other liquid markets and it increasingly difficult to trade for size in agencies ,corporates and off the run government bonds. I think that many senior risk mangers witnessing the reduction of liquidity have decided that the only prudent course is to reduce their own positions and hunker down in the deep weeds for a more advantageous trading environment.

That fear drives the unwinding of positions which results in the significant market moves of the last several days.

That was much longer than my usual composition and I hope it is coherent!