Tuesday, October 5, 2010

Economics 5/10/10: Irish bonds - ECB propping Leni up, for now

Irish bonds have been performing quite strongly in the last few days, following last Thursday desperate news on banks recapitalizations. What gives, one might ask? Was the certainty of Ireland posting a historical record-breaking 32% budget deficit this year better than the uncertainty of previous estimates? Or was it something else.

Given the opacity of the sovereign bond markets - especially for countries like Ireland (note the farce here - Government own securities exist in a world of much more restricted newsflows than ordinary equities, and yet everyone today expects Governments to lead in a charge for greater transparency and regulation) - one finds it difficult to explain what has been happening here.

Two possible contributing factors emerged in recent days to at leats partially account for strong performance:
  1. ECB buying Irish bonds; and
  2. Short positions being rolled up in profit taking
Now, we have some confirmation to (1). FT Deutschland reports today that last week ECB has dramatically increased purchases of Greek, Spanish and Irish bonds, having bough ca €1.384 billion worth of stuff in one week, and bringing its total holdings to €63.5bn. The weekly ramp up was some ten-fold on €134 million of same bonds purchased in the last week of September. ECB now holds some 14% of the entire sovereign debt market in Greek, Spanish and Irish bonds. This implies that market valuations in these bonds are entirely bogus.

FT Alphaville has a few charts on both Irish & Portuguese markets (here).

Which brings us to the shorts closures. Holding an open and backdated short position in the paper artificially propped up by the ECB is like taking a proverbial p**ss into the gale force wind storm. Given that most shorts against Irish debt were written around mid- to late-August, this was clearly the time to book some profits. Which, of course, further pushed up demand for these bonds and thus prices. Yields compressed down.

But the question next is: where does the freed up cash flow now? Most likely, the markets will pause to see whether the ECB latest purchasing is going to continue. If so, expect another rise in prices and a waiting game, as markets participants would rationally expect the ECB to start unwinding new purchases in a couple of weeks time. Once that move is seen on the horizon, new shorts will be taken, once again.


Furrylugs said...

I really hope you're making a fortune on this quality of analysis since the Irish Government didn't pay you a rouble for the free advice over the last two years.

TrueEconomics said...

- as you mentioned, the Irish Government has no interest in paying for any real analysis whatsoever, preferring to burn the little remaining equity of the 'Yes, Minister' men surrounding them; and
- in addition, Irish corporate sector has no interest whatsoever to either understand or speak out truth.

This is not really new - Irish corporate leaders steadfastly refused to contribute to any real analysis since as far as I can remember (2000). Just look at the army of the economics analysts/drones employed in the financial services companies in this country.

Which means that I can still enjoy the title of being 'independent' - aka 'unpaid'... :-)