Venezuela: A Bondholder Nightmare, A Market Failure. Where Was Macro?

This post was written in collaboration with and cross-posted on Caracas Chronicles. Check them out! 
“The time between the “outrageous” and “yeah, you didn’t know that?” can be incredibly short.”

This tweet was about the Hollywood harassment scandal, but it applies to markets on a regular basis and it certainly did in Venezuela last week.  

Intrigue surrounded the amortization and maturity of two PDVSA bonds, which required roughly $2 billion for bondholders. Sanctions preventing US dollar transactions and new US dollar funding for the regime complicated the already difficult task of cobbling together payments with an absolutely broke government.

And yet... it paid.

PDVSA somehow bundled the October 28th amortization payment across the line, and promised, with some credibility, that the check would be in the mail for the maturity of the PDVSA bond of November 2nd.

Then, one of the more surreal events in the history of sovereign defaults happened: after market hours on Thursday evening, Maduro announced that the government will stop paying principal and interest on the current debt load, the same day they pledged to pay back a bond at par. And what had been a tumultuous but profitable week for Venezuela bondholders, turned into a total nightmare.

The 7% December 2018 bond saw its value cut in half from the high 60s Thursday afternoon, to the mid 30s on Friday, just above what many people use as assumption of what defaulted sovereign debt is worth in a restructuring.

venny chart.JPG

With the wave of Maduro's magic wand, “Venezuelan default” went from “outrageous” to “yeah, you didn't know that?”

Here's where “macro” comes in. Those who’ve been following me for the last few months know that I have a healthy skepticism of macro trading strategies. There are traders out there who are constantly ahead of the curve, who see opportunities more quickly and accurately than the rest of the crowd, even in markets they don't trade in every day. But for the vast majority of the universe, there has to be a definable edge when you are doing something the rest isn't, whether it's a different type of analysis, or taking advantage of some market breakdown or regulatory change.

The different pools of capital in financial markets should produce enough diversity to keep markets “honest” in the same way Leo Messi keeps defenders “honest” because they have to protect against him charging to the goal or threading a brilliant pass to a teammate. You can’t “cheat” towards one or the other because you'll pay for it.

How did markets miss that Venezuela could default any day? Did they miss out on this chart, which shows nearly $4bn in payments going out the door in Q4 2017, for a country with stated foreign reserves of $10bn?
 
Capture.JPG
A few months ago, I talked to some EM managers on the subject. One suspects that (debt holders) are going to start bailing when it's too late, ourselves included. Anyone that has anything to do with an index gets burned by being underweight, so they inevitably come back. To step out of the position, you would have to compensate, and there isn't enough risk-adjusted yield to do so elsewhere.”

That's the “cheat”; for bondholders, Venny debt was a case study of game theory in Emerging Markets. The market structure is set up in such a way that the biggest foreign investors were afraid to sell and afraid to buy. Macro investors should have stepped in and said “Look, the market thinks there is a better than 50% probability that 2018 maturity bonds will be paid at par next year.  There's nearly $4bn in bond payments this year, another $10bn next year, versus $10bn in foreign reserves at best, for a country under sanctions that prevent access to new dollar funding.”

Why didn’t they? There's a few reasons:

  • The capacity of repo markets to lend bonds has been greatly curtailed. After the post- Global Financial Crisis reforms, banks don't want the risk of lending bonds in a credit on the edge of default. This situation leads to a lot of difficulty in trying to establish a sizable short position in the bonds, and when you can, it can be prohibitively expensive;  


  • The size and risk appetite of global macro has been overwhelmed by the size of real money investors. The days of George Soros pushing around markets and central banks are over; enter the era of the multi-trillion-dollar passive asset managers such as Blackrock, Vanguard, Fidelity, etc.


  • The liquidity provided by Wall Street banks seized up further when the US imposed sanctions on USD transactions with the regime. A couple key players in the interdealer “wholesale” market stepped out after the August round of sanctions, worsening market liquidity and amplifying the wild swings Venny bonds are known for.


  • Call it what you will, self-preservation, or the Bachaquero on Wall Street trade, but guessing the date of the Venezuelan default has been a trader parlor game for over three years now more than one hedge fund trader got carried out on the short Venny theme. Traders were lulled into complacency that Maduro would simply find a way. He didn’t.


With macro traders sidelined and real money investors petrified, liquidity dried up and the market became hostage of local brokers and regime insiders, rather than economics and risk. A break that macro traders were unable to exploit… and Venezuelans couldn't prepare against. It is yet another testament to the power of market efficiency, and the consequences when it breaks down.

The losers in this game? Not the regime, the fixed income investors or even the hedge fund guys that shorted Venny too early: the real losers were the Venezuelans who died because there weren’t enough dollars to service the debt and import food and medicine.  
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24 comments

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Leftback
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November 6, 2017 at 8:11 PM ×

Dead money unless you want to be paid in Bolivars or rotting bananas. Let's see how long it takes to find out who is on the hook for this pile of Venny dung. It's a shame this is happening, it is such a beautiful country. Waste, corruption, foreign interference.

Trump's much-hyped tax reform bill is dead in the water in its present form, and nothing at all is going to pass in the Senate until after Thanksgiving, if indeed this calendar year or ever, btw.... small cap permabulls and Treasury bears, please take note.

Classic stealth rally in the long bond right now, what equity types like to refer to as climbing the wall of worry. But wait, everyone including the shoeshine boy, Uber driver, man on the Clapham omnibus and Paris Hilton knows: "rates are going higher". Right?

The yen is having a decent day and the Euro got off the canvas too. USD longs beware - in the short term, growth projections will be revised downwards once the truth sinks in on the tax reform stalemate.

Squeeze susceptibility absolutely abundant here - long bond, JPY, EUR, vol and possibly gold.

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johno
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November 6, 2017 at 11:58 PM ×

Last week buying downside on GBPUSD and today buying upside. If the Times article is correct (and would seem the logical thing), EU will get a satisfactory statement on the exit bill to commence transition and trade talks before Xmas. Not sure why everything I read is a recommendation to receive GBP rates. Economy is at capacity, productivity growth is nil, BoE has started hiking, and the transition pushes consequences (which still look severe to me) some years out. Companies won't be cutting/offshoring, but probably still holding off on investment/capacity additions (until they know what the trade deal looks like), which just adds to inflationary pressures. We could have a whole cycle unfold before any new trade agreement comes into effect ... no?

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Shawn
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November 7, 2017 at 2:38 AM ×

@leftback...come on man, know your stereotypes. The bananas are from Ecuador. :) not even sure what Venny would pay in. Furious socialist discourse, maybe.

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November 7, 2017 at 3:22 AM ×

@LB how do you plan on using gold in a risk off situation? Are you assuming it’s a long VOL play? Are you taking advantage of low vol environment and buying options on gold? There is supply and demand issue in the options market, no doubt.

The dollar is viewed differently all over the world. Its rule of law, values, financial architecture are all attributes that are investors are happy to put their capital with the US.USD is a safety play just like gold(right or wrong). The two are becoming correlated lately (which is just fascinating) I see JPY catching a bid...but I feel it’s days as a go to safe haven are over. Im not suggesting the JPY itself is dying of course. Just that it’s former status as safety play is over.


@johnno do you think BOE can raise aggressively? I’m not sure, but your point with trade talks delayed causing inflationary pressures is a good one. My concern is GBP will get large waves of inflation until trade talks are finalized...

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November 7, 2017 at 3:25 AM ×

“Furious socialist discourse.”Haha True knockin Shawn. I’d say that Famine is what Venny specializes in...

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November 7, 2017 at 8:15 AM ×

Not good in Venezuela. But in Melbourne today, the Melbourne Cup was won again by Dr.No's brother when is comes to the Melbourne Cup, Goldfinger.

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IPA
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November 7, 2017 at 5:49 PM ×

@Shane, relentless bid in nat gas. Wooly caterpillars and other mother f*cking insect creatures are crawling into a hole near me. I got them coming into my house too like it's the end of the world. 5 day forecast now shows freeze coming. I was talking to neighboring farmer and he said current conditions remind him of 2013-14 winter, snuck up and surprised everyone in Nov. Go back and look at nat gas chart, oh my! I am not prophet, just his servant. Anyway, I am sure you got the daily on your radar, $3.20 - $3.35 congestion and a lot of memory in between. If that clears we go to $3.45 - $3.70 in a straight shot.

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November 7, 2017 at 7:38 PM ×

@IPA True knockin bro...god this could be a big trade man. I just looked 10 years back like a few days ago (price/temp) and I spotted 2014 my man. So the willies were actually a thing huh? I thought you were clowning. I even thought you might have been referencing a candle chart formation, in some cryptic story....haha attack of the worms! For real tho I love those little guys so that’s sweet they’re out not sweet about your pad...damn I am daffy, because I was sure you were speaking code hahah, fuck kind of embarrassing actually...

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Leftback
admin
November 7, 2017 at 9:55 PM ×

Another decent day in the silent stealth rally for the long bond. JPY was knocked down, but got up again. We added some upside exposure first thing this morning. About gold, we were just thinking lower dollar, higher precious metals. Nothing clever.

Small caps bleeding and under-performing, a lot of tax reform anxiety there. Boo-hoo, no new all time highs for the Russell, in fact lowest close in a month for IWM small caps.

Short IWM, long TLT, some JPY exposure. We still have the synthetic long vol play on.

You guys keep watching Natty and the worms. :-)

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November 7, 2017 at 11:41 PM ×

@LB, coming to a research note soon, daily. "The Trumpy Contrarian Indicator". Where do you start for composition instruments. Yeah, the Russell IWM will be a big one. How about the gambling sector, that's sure to put its hand up for selection. Also, I think advertising stocks might make a grab for beta capture exposure to the gambling sector through nothing but historical correlation. Lastly, news media stocks is an contrarian asset in itself, no need to bother there. God, I "Fucking love the punt"

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November 7, 2017 at 11:55 PM ×

@LB, best 12 years in this market I will ever spend. I didn't get carved out of any of thee above.

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IPA
admin
November 8, 2017 at 1:15 AM ×

@LB, nice chuckle, you ain't hurting my feelings. In fact, I thrive on being ridiculed. Unless, of course, we are into dick measuring exercises, then I back off and let you run the show. I surely have more vehicles I am riding than just natty. Not all making me money, I should add. Sorry if I was a bit too excited about one I've been stalking for a while, just wanted to celebrate it, that's all. I am not watching it, I am riding it, man. You picked up a few ticks in TLT, I see. Bravo!

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checkmate
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November 8, 2017 at 4:59 AM ×

That was an interesting piece on Ross. Having read it, it makes perfect sense why he would team up with Trump. I have no expertise in US politics ,but it would seem extraordinary to me if people like this will ever succeed in achieving anything of note by way of policy where consensus is required. In that sense I would be very wary of owning risk assets dependent upon that premise

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November 8, 2017 at 5:08 AM ×

Really a vry nice blog i really appreciate all your efforts ,thank you so mch for sharing this valuable information with all of us
Packers And Movers Hyderabad

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IPA
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November 8, 2017 at 7:02 PM ×

Shorties will think twice now before they try to put on a fresh position into this WTI strength. If it clears $58.44 it's a straight shot to $60. I got the exits scattered just below and above it. Holding on to my energy, e&p and svcs equities targets as well. Holding their own under pressure today. This looks like minor flagging before yet another push higher. Chase, baby, chase!

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Leftback
admin
November 8, 2017 at 9:05 PM ×

Yeah, IPA, looking good for a tilt at $60. You did well to stay bullish energy and we did well to listen!!

IWM recovered off the lows today, but HYG looks awful at the moment, that's worth keeping an eye on. For IWM this is the same action in small caps we saw last week, with a low on Wednesday. We took some modest profits there and bailed again, will keep punting small, until we see more vol and start to make a bit more money. Still have long-dated (2018) vol bets in play.

A pause in the TLT train today. Decent auction of 10y today, the 30y is on the block tomorrow. The usual pattern is we see a few days weakness into auctions, and strength thereafter, all other things being equal.

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checkmate
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November 9, 2017 at 8:07 AM ×

This was reassuring;
https://www.bloomberg.com/gadfly/articles/2017-11-09/britain-s-vanishing-housing-market-in-charts

I was beginning to wonder if I was losing my touch. I had been sensing this all year as an incrementally worsening market. Obviously I was watching the associated equities thinking surely at some point investors are going to see what I have seen.
New car sales were hit by approximately a 12%pa slowdown. So we have two significant sectors feeling the pressure at this juncture. Does make me question what adjustments to GDP data are going to be like going forward.

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checkmate
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November 9, 2017 at 8:24 AM ×

I note the Japanese stock run after an extended move looks toppy just as USD/YEN as run into a resistance point. I'll take the profit on my equity holdings as I was relatively late into that move and that combination could see me wrapped up into a correction. Not being nimble enough as cost me in the last quarter so don't want to repeat that mistake.

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JohnL
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November 9, 2017 at 2:33 PM ×

Uranium may be worth a peak today.

https://www.themacrotourist.com/posts/2017/11/09/butt/

Cameco has made a significant product cut.

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JohnL
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November 9, 2017 at 2:36 PM ×

Peek & production.........damn tablet (it's not the proof reading, for sure)

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Leftback
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November 9, 2017 at 7:16 PM ×

checkmate, me old China, agreed on Japan, and thanks for the notes on UK (recession dead ahead?).

Nikkei/EWJ/DXJ has been an absurd momentum juggernaut of late. It was one-way traffic for almost two months into last night's "accident". The candlestick fraternity will be eager to point out the bearish nature of that "abandoned baby" candle in those charts, no doubt. JPYUSD or FXY on the other hand has carved out a decidedly bullish turn*.

[*we're not hearing the applause, and of course we're not expecting it, but we nailed that one this week, along with the weakness in small caps]

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IPA
admin
November 9, 2017 at 8:30 PM ×

@LB, your JPY trade was impeccable! There you go, pal.

I also have been saying here that USD will sell off. DXY had multiple opportunities to get above 95.15 and now it looks like a double top is in place. The price is currently chewing on the neckline at $94.41 and consecutive daily closes below it would probably serve as a confirmation leading to initiation of fresh short positions. Of course, I want no applause as well, especially after my snafu at 94. I guess even a blind squirrel finds a nut once in a while.

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Skr
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November 10, 2017 at 1:21 PM ×

Not sure how a 1% move warrants a standing ovation? But while we are talking about it - any retrace to the mid October swing low, will have any amount of BTFD'ers.

101-resistance becomes support and vice versa.

@Shawn - I didn't have the constitution to trade Venezuela. Easier ways to make money than off the backs of misery and suffering.

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