A disturbance in the farce?

*Cyprus will be covered next...

I try to pull together event of multiple posts in the daily wrap from throughout the day, however I can't pull the detail of each individual post, I can't get you to the specifics of the horrible decline in breadth throughout the market that is specifically addressed in the Market Breadth posts and follow up posts showing breadth getting worse in to a rising market, volume falling off and of course 3C charts that are almost beyond the realm of possibility.

I will ask you to try to remember the multiple events, posts and charts of the last two days (Thursday and Friday), specifically the very odd huge plunge in High Yield credit (when something is breaking in the market it generally shows up in credit and market breadth first, the 2-dy plunge in the credit of choice in a risk on / rally is High Yield where the flight to safety is in to investment grade. The fact that HY credit not only broke with the SPX which it has been following all year, but broke in such a way over 2-days that it erased ALL of 2013's gains and then some is a huge red flag screaming that there's a massive disturbance in the farce.

Do you recall in the wrap the note regarding the 10-year Treasury falling to lows of the week?

I'm not a specialist in treasuries, but I understand the basics, when yields fall (as we saw in our leading indicator "Yields vs the SPX" it means there's more demand for the Treasuries, when there's more demand, it's typically a flight to safety away from risk asset like High Yield Credit and stocks and in to the safe haven assets such as treasuries so the fall of the 10-year to the week's lows with the fall in HY credit to the year's lows are all part of the same event, a move away from risk and in market time, this was a move that was not gradual, but a sudden disturbance.

March 13th Bloomberg reported that 10-year Treasury yields fell from an 11 month high as a $21bn issuance from the Treasury saw the largest demand since last October (remember this was during the time of the market fears over the Fiscal Cliff). Internals of the offering were also strong, the Bid to Cover (a measurement of demand by comparing the number of bids received vs the amount allocated for offered) was strong at 3.19 vs 2.68 at the previous auction in February. The March13th auction saw  Indirect bidders (includes foreign central banks) jump from the 28% at the last February auction to 47.7% (the average over the last 10 actions has been 36%). Non-Primary Dealers or Direct bidders came in at 30% vs the last 10 auction average of 21.8%. Primary Dealers were only left with a 22.3% takedown vs the average of 42.3 (these are also the group of bidders that are known for flipping treasuries to the F_E_D during Permanent Open Market Operations (POMO) as the F_E_D cannot directly bid treasuries in auctions, the Primary Dealers are the F_E_D's proxy (such as large investment banks-MFGlobal was a PD before their demise) which are required to bid at auctions and typically make a nice chunk of change flipping the Treasuries in which some cases they only hold 1 week before the F_E_D monetizes them under POMO, that's a nice profit for VERY little risk.

In other words, as covered in "Daily Wrap-Rare Rant" on Thursday March 14th when I showed this chart of Yields covering the day's auction with an excerpt of the commentary below...

Remember the drop in yields (red) vs the SPX took place right around 1 p.m. at the time of the 10-year auction...

"Yields fell as the 10-year auction of $21 billion at 1 p.m. saw yields fall to 2.029% (vs Feb. 2.046%). The "When Issued" at 1 p.m. was at 2.053%, this seems to indicate there was a flight to the safety of bonds as we have seen in the 3C charts of TLT recently. Other internals of the auction such as the high bid to cover, huge indirect of 47.7% and the second lowest Primary Dealer takedown in history at 22.3%-in other words, the internals were stellar and the idea of front-running the F_E_D was not at all apparent in the auction."

The 10-year is a benchmark note and as such, is the instrument used in the repo-market where firms borrow and lend securities. Interestingly this securities repo-rate closed at a negative 2.95%, meaning traders were willing to PAY to borrow the security in exchange so they can lend cash. Since there's such heavy demand for the 10-year, those who want to short it or sell it are finding it exceedingly difficult to borrow the security. The strong demand has not only materialized in the internals of the auction, but in the repo-markets where those who own the 10-year are not willing to borrow it out, they are much more concerned with holding it.

Additionally the 10-year term premium (a little more difficult to explain, but a model created by the F_e_d that includes expectations for interest rates, growth and inflation) was negative 0.58 percent after reaching 0.56 percent on March 11, the least-costly level since April 5. A negative reading indicates investors are willing to accept yields below what’s considered fair value-a measure of the Flight to safety bid.

Now I can't say I entirely understand all the dynamics here and implications, but I now it's a rare event. On Friday, 3/15, the Treasury/F_E_D issued a "Large Position Report" for the 10-year 2013 security, this is essentially a notice in which anyone holding $2 billion or more of the security must report their position to the Feral Reserve BanC of New-York by no later than 12 pm EDT March 21st.

Why? There has been a surge in "Fails to deliver" on the security last week.

What is "Fails to Deliver"? From Investopedia the most basic definition is as follows:

"An outcome in a transaction where one of the counterparties in the transaction fails to meet their respective obligations. When failure to deliver occurs, either the party with the long position does not have enough money to pay for the transaction, or the party in the short position does not own the underlying assets that are to be delivered. Failure to deliver can occur in both equity and derivatives markets.

Whenever a trade is made, both parties in the transaction will have to transfer the cash and assets before the settlement date. Subsequently, if the transaction is not settled, one side of the transaction has failed to deliver. Failure to deliver also can occur if there is a technical problem in the settlement process carried out by the respective clearing house.

For forward contracts, a party with the short position's failure to deliver can cause significant problems for the party with the long position, because these contracts often involve significant volumes of commodities that are pertinent to long position's business operations.

Failure to deliver is also important when discussing naked short selling. When naked short selling occurs an individual agrees to sell a stock that they neither own nor have borrowed. Subsequently, the failure to deliver creates what are called "phantom shares" in the market which may dilute the price of the underlying stock."

In essence, they're trying to figure out who is holding what since the paper trail of borrowed, shorted, borrowed and sold securities would be very difficult to follow, this is an accounting of who is holding what in a basic form.

Without going in to P_O_M_O specifics, Friday's P_O_M_O operations internals showed there's a lot of reluctance from Primary Dealers to hand over their safe haven paper to the F_E_D.

Also from what was published from Tuesday to Thursday of last week, the repo-rate were exceptionally low, all you need to take away from this is that, there's a sudden shortage in the 10-year collateral - apparently  leading to the F_E_D's notice for $2 bn + holdings report.

Friday's HORRIBLE print in US Consumer Sentiment would certainly give rise to a flight to safety trade, however these unusual events in the Treasury space have been going on long before the Sentiment printed Friday and the call for Large Position Reports hasn't happened since February of 2012.

The point of this post, without going to far in to the realm of speculation has to do with 1) the very odd and unusual movements in different securities, most obvious was the 2-day decline of High Yield Credit that had been following the SPX nearly tick for tick in profits this year to a sudden loss of all profits for 2008, odd rumblings in the Treasury ETFs and accumulation there, the break down of market breadth, leading indicators, volume and other factors.

As I said, I don't want to get too far in to speculation yet with regard to a shadow banking system that is so complex, regulators can't even understand it (this is where regulated financial institutions were able to keep sub-prime off their balance sheets (through transactions in the shadow banking system). However should events continue to unfold, we may be at a point in which things are becoming visible (which means they have long been troubled as shadow banking is akin to under the table deals), in simpler terms, we may be coming up on a Lehman moment.