Pandora's box

It's been an exhausting day today, deal flow very much swung between feast and famine. There was relief as the resolution of the debt ceiling wranglings finally came. I found it incredible that even at the eleventh hour, 26 members of the Senate still managed to vote against the legistlation, with the alternative being a US default(!).

Still, the fix is in and we can finally go down to the pub. There I meet one of my friends who was quietly celebrating some serious profit - he had been short Pandora stock (Danish jewellery maker) since May! I never saw the appeal of Pandora and their silly looking charm bracelets which also happen to be enormously overpriced for a mid-market brand. At the time I was telling him while shorting pandora he could go long the luxury high end and the low end in the same industry. I feel that in the follow up to a recession consumers tend to drift away from the middle ground. This guy was so stubborn and so sure of his view that he didn't even bother hedging with a spread position. Pandora share fell more than 65% in one day and much to my disdain he is seriously considering taking the rest of the summer off.

Waiting for Godot?

Market is getting bored of waiting for the US congress to come up with something viable. It's starting to feel a little like Samuel Becket's play (on a separate note I've forced myself to see various production of it over the years and only managed to not leave after the intermission on one occasion).

I'm packing at the moment for a weekend away in a warmer climate! I hope we will have something on the table by Monday.

when will the money run out?

A week later, we are still here - no progress has been made in the U.S. debt ceiling discussions as best we can tell and the house should be voting on their plan tomorrow with the senate later in the week. However a new twist has been brought to the story. Based on the latest numbers, the U.S. treasury managed to find a lot more cash in their back pockets, sufficient to allow them to get by for at least another week. Then the money REALLY runs out.

I doubt this is really something the Treasury wants to shout from the rooftops, as it would take the implied pressure off of the two sides that will ultimately need to do the unpleasant task of compromising. I was secretly hoping that the market would have been uglier yesterday to put a bit more pressure on Congress, but that failed to happen since everyone has been looking for a last minute agreement all along and remained unfazed (or sleeping on a hot summer afternoon?!). I imagine at this stage, both parties, surely aware of the new found leeway, are even more likely to hold out for a deal on their respective terms.

So what happens as the 2nd of August deadline passes? The risk of a downgrade would be raised even further. I've always thought of rating agencies as being completely rubbish but I would still hate for the US to be stripped of their triple As. I fear a big selloff in treasuries as well as equities in this scenario so I have decided to put on some protection, mostly in the shape of put spreads on the US contract with a September expiry. I'm short the higher strike and long twice the lower strike generating a small overall cost. It carries negatively as all outlier trades do but it's a small cost I am happy to bear, for now.

Good luck and have a good week ahead.

the debt ceiling situation

Complete lack of economic data today lead to some super quiet trading hours. I struggled to find liquidity even in the most straightforward treasury market so I had to look for other ways to entertain myself.

All eyes remain on the debt ceiling fiasco. I for one don't believe for a second that there is any real risk of default. However with Moody's and S&P's repeated warnings about a potential downgrade of the U.S. credit rating, the entire issue seems to be taking a decidedly more volatile turn. Now a default would be an event but a downgrade is something based on probability not events. With each passing day, where the two sides are bickering and competing on who can throw more toys out of the pram, the probability of a downgrade increases steadily. So many deadlines have passed that I can hardly remember when the next one is. Nevertheless one would be right in thinking that we need a breakthrough by the end of this week to allow just a little bit of time for legislative procedures.

I've decided to sit relatively light for this week with a small short gamma position. You see I have faith:). In the event of a downgrade I would imagine an initial massive sell off of US treasuries, accompanied by an even more humongous sell off in equities, at which point things become extraordinarily messy. Investor would invariably recalibrate their risk appetite in such an event and very possibly move away from the stock market to return to the treasury market as the latter is perceived as the "lesser of the two evils". It's late and I'm not completely sure if this logic is somewhat flawed. What are your thoughts?

the Fed at a crossroad

Plenty of political drama in Europe today that is only rivaled by the daily verbal barrage coming out of Obama's debt ceiling meetings. I was initially hearing that EU leaders are expected to give their approval before next week to a burden sharing agreement with private holders of Greek debt. Later I heard contradictory reports that Eurogroup plans to give Greece enough money to buy back its own bonds in the secondary market at an average of 50% of its face value. This would constitutes as a voluntary haircut and would render the participation of private sectors unnecessary. In any case I see Greece remaining as fragile as ever.

The other big story was Bernanke's testimony which turned out to more balanced than expected. On the hawkish side he seemed to discount the recent rubbish payroll numbers, attributing the weakness to temporary factors. On the dovish side Bernanke did not dissuade notions of further QE or other stimulus. Upon further questioning, the chairman emphasised the same point.

It's fascinating that he failed to rule out QE3. I would see initiating another round of buybacks as being rather silly and this is a feeling probably echoed by many. This time last year I asked Alan Greenspan in casual conversation whether he thought there should be any monetary stimulus at all and he gave a resounding no. last week I saw him again in Aspen. He laughed when I brought up the stimulus topic and he implied that the QE2 was rather pointless and unfortunately I agree. QE1 and 2 spent over 1.3 trillion USD and apart from inflating asset prices, I'm not sure it managed to achieve a whole lot more. The unemployment rate failed to fall in any meaningful manner so the message is there.

what's happening to the second i in PIIGS?

I was mostly absent from the market last week and coming back today turned out to be a bit of a nightmare. One of our main trading systems failed first thing in the morning and after numerous vain attempts to fix it, our IT decided to restore the entire file system from tape with an estimated completion time of 6 hours.

Everyone was in utter disbelief! I could not see the risk on my book, and had no access to my pricing system. It's practically like a blind person swimming in the dark sea at night alongside a group of sharks. (to be fair, when you are swimming with sharks, whether you are blind makes relatively little difference) I decided that less is more and managed to do as little as possible for the majority of today.

On the PA side, the risk situation is much clearer:) -  I have mostly been keeping a small short EUR position. While the US could be in better shape, the Eurozone continues to do an excellent impression of a deeply wounded organism entering its terminal phase of dysfunctionality. Greece is still in hot water but the hedge funds have moved on - Market seems to have decided that for the next stage of the peripheral punishment, all roads lead to Rome. With the 5y Italian CDS reaching its historical high, the second i is back in PIIGS. Personally I have a lot more faith in Italy - the country is not suffering from a burst property bubble, balance sheet restructuring or massive cuts in public spending. I'm not particularly biased even though I did spend a small but wonderful part of my childhood living in Italy. One thing worth noting is that a large proportion of Greek debt is in foreign hands. This gives rise to an obvious problem as foreign investors tend to pull out of a country a lot more quickly when "sh*t hits the fan". In Italy over half of the government bonds are actually held by the Italians. In any case I aim to take profit when EURUSD is around 1.4000.

Have a good week ahead and good luck.