29/12/15: There Are Two Ways 2016 Can Play Out for Euro Area Bonds

With the pause in ECB QE over the holidays season, bond markets have been largely looking forward to 2016 and counting the blessings of the year past. The blessings are pretty impressive: ECB’s purchases of government bonds have driven prices up and yields down so much so that at the end of this month, yields on some USD1.68 trillion worth of Government bonds across 10 euro area countries have been pushed below zero.

Per Bloomberg chart:

Value of bonds with yields below ECB’s -0.3% deposit rate, which makes them ineligible for purchases by the ECB, is $616 billion, just shy of 10 percent of the $6.35 trillion of bonds covered by the Bloomberg Eurozone Sovereign Bond Index. As the share of the total pool of marketable European bonds, negative yield bonds amounted to more than 40% of the total across Europe at the start of December (see here: http://www.marketwatch.com/story/40-of-european-government-bonds-sport-negative-yields-and-more-may-follow-2015-12-02).

Two questions weigh on the bond markets right now:
1) Will the ECB expand the current programme? Market consensus is that it will and that the programme will run well beyond 1Q 2016 and spread to a broader range of securities; and
2) Will low inflation environment remain supportive of monetary easing? Market consensus is that it will and that inflation is unlikely to rise much above 1% in 2016.

In my view, both consensus positions are highly risky. On ECB expectations. Setting aside inflationary dynamics, ECB has continuously failed to ‘surprise’ the markets on the dovish side. Nonetheless, the markets continued to price in such a surprise throughout 2015. In other words, current pricing is probably already reflecting high probability of the QE extension/amplification. There is not much room between priced-in expectations and what ECB might/can do forward.

Beyond that, my sense is that ECB is growing weary of the QE. The hope - at the end of 2014 - was that QE will give sovereigns a chance to reform their finances and that the economies will boom on foot of cheaper funding costs. Neither has happened and, if anything, public finances are remaining weak across the Euro area. The ECB has been getting a signal: QE ≠ support for reforms. And this is bound to weigh heavily on Frankfurt.

On inflationary side, when we strip out energy prices, inflation was running at around 1.0% in November and 1.2% in October. On Services side, inflation is at 1.2% and on Food, alcohol & tobacco it is at 1.5%. This is hardly consistent with expectations for further aggressive QE deployment and were ECB to engage in more stimulus, any reversion of energy prices toward the mean will trigger much sharper tightening cycle on monetary side.

The dangers of such tightening are material. Per Bloomberg estimate, a 1% rise in the U.S. Fed rates spells estimated USD3 trillion wipe-out from the about USD45 trillion valuation in investment-grade bonds issued in major currencies, including government, corporate, mortgage and other asset-backed securities tracked by BAML index:

Source here.

European bonds are more sensitive to the ECB rate hikes than the global bonds are to the Fed hike, primarily because they are already trading at much lower yields.

Overall, thus, there is a serious risk build up in the Euro area bond markets. And this risk can go only two ways in 2016: up (and toward a much worse blowout in the future) or down (and into a serious pain in 2016). There, really, is no third way…

12/5/15: European Bonds are Set to Continue their Decline

Things are getting ugly in the bond markets. Bund 10 year is already up ca 7bps, while Italy is up 9bps.

Here's yesterday close for the 'peripherals':

Source:  @tradeweb

And Italy, Spain, Portugal on a longer view:

Source: @Schuldensuehner 

Meanwhile, Germany...

Source: @Schuldensuehner 

Meanwhile, the theme of investment flows (ETFs) rotation is may be starting, although European ETFs are seeing record inflows, breaking USD500 billion mark in April:

25/4/2014: A stretch of numbers here... a bond sale there... Greek Deficit in 2013

This week we had the data release by Eurostat showing the fiscal position of the euro area sovereigns for 2013, followed by the statement by the Troika (EU Commission, the ECB and the IMF) on Greece's fiscal position.

Based on data-driven Eurostat conclusions (see details here: http://trueeconomics.blogspot.ie/2014/04/2342014-some-scary-reading-from-eurostat.html) Greek fiscal deficit was 12.7% of GDP in 2013. Based on the Troika conclusions, Greece has managed to generate a budget surplus of 0.8% of GDP in 2013. The two numbers are so widely apart that the case of 'thou shalt not spin too much' comes to mind.

In reality, to arrive at 0.8% surplus, the Troika had to do some pretty extreme dancing around the real figures: they took out non-recurring spending out of the Greek deficits (all banks measures and all interest paid on gargantuan 175.1% of GDP Government debt). Just how on earth can debt interest payments be non-recurring is anyone's guess. But even removing that (to arrive at normal definition of primary deficits), the official primary deficit for Greece at the end of 2013 stands at 8.7% of GDP. The swing of 9.5% of GDP bringing this to a surplus of 0.8% is 'banks measures'.

The problem is that with 12.7% of GDOP deficit and 8.7% primary deficit in 2013 and with debt of 175.1% of GDP, Greece is plain simply and undeniably an insolvent state. This is precisely why exactly at the time of the above data publication and at the time when the Troika was extolling the virtues of the fiscal surplus in Greece, the very same European authorities praising Greek Government were announcing that they have engaged in a new round of debt relief negotiations with Greece (http://www.ft.com/intl/cms/s/0/9ec817d8-cadf-11e3-9c6a-00144feabdc0.html#axzz301XTTXyT).

Meanwhile, bust, bankrupted and in new default talks, Greek Government is hell-bent on buying votes into the upcoming European elections. Per FT account linked above:

"About 70 per cent of the [bogus Greek] primary surplus has already been allocated for current expenses rather than for writing down existing debt, according to the finance ministry. The government has set aside €524m as a one-off payment to low-income families and pensioners ahead of next month’s European elections. Another €320m will cover a projected deficit this year at IKA, the main social security organisation, following a decision agreed with international lenders to cut employers’ contributions."

This is truly epic: European authorities praising national Government for bogus surpluses that are explicitly being used to fund giveaways to vulnerable voters groups at the time of elections. This is 'reformed Europe'?

This is precisely the circus that is driving up valuations of peripheral bonds (http://mobile.bloomberg.com/news/2014-04-23/samaras-met-dimon-for-greek-bonds-on-way-to-a-400-return.html?alcmpid=markets) and that has an exactly negative correlation with the underlying strength / structural health of some of the peripheral economies (see my comment on this here: http://trueeconomics.blogspot.ie/2014/04/2542014-ecb-denmark-negative-rates.html).

10/2/2014: Six Years to Admit the Obvious? Call in Europe...

There are two things to be said about the latest comments from Euro area's chief banking regulator, Danièle Nouy issued recently (see FT's piece from yesterday: "Let weak banks die, says eurozone super-regulator" for more):

• They are so trivially obvious, that given it took EU 'leaders' 6 years to come up with them, one has to wonder if the EU mandarins have any capacity to supervise banks in the first place, and
• Danièle Nouy deserves praise for speaking to the reality.

Here are the main points of what she said:

1. “One of the biggest lessons of the current crisis is that there is no risk-free asset, so sovereigns are not risk-free assets. That has been demonstrated, so now we have to react.” Correct. But don't expect any change soon. 
2. On the upcoming ECB tests: some banks need to fail for tests to be credible. 
3. “We have to accept that some banks have no future,” she said, parrying speculation that a wave of consolidation could save the currency bloc’s weakest lenders. “We have to let some disappear in an orderly fashion, and not necessarily try to merge them with other institutions.”

You'd think all of the above should be trivial. And you would be right. Which makes the fact that these statements are front-page news in Europe ever so more amazing.

28/1/2014: Decline in Debt and Regaining of Trust?

The following out this morning:

So is Herr Schaeuble correct? Did reductions of debt help 'regain trust during the crisis'? Were there actual reduction in debt?

Table summarises 2007-2013 maximum debt levels (for General Government Debt as % of GDP) attained by the euro area economies and the year when this maximum was attained:

Three observations:

1. With exception of two countries: Germany and Portugal, 2013 debt to GDP ratios are maximal for the entire period 2007-2013.
2. In the case of Germany, peak debt level attained in 2010 was 82.44% of GDP, while in 2013 estimated level of debt/GDP is expected to be 80.393% of GDP. The reduction is small. Meanwhile, German bund yields are not reflective of any specific reduction - they were low in 2009 and 2010 and they are low now.
3. Portugal's peak debt/GDP ratio is notionally at 2012 at 123.8% of GDP. Country 2013 expected debt/GDP ratio is 123.56%, which is statistically indifferent from 2012 levels, so we cannot call this material by any measure.

Here's evolution of debts over the period in two charts, confirming that there has been no reduction in debt levels relative to the earlier stages of the Global Financial Crisis:

And here is the chart showing how dramatic were the increases in debt levels over the course of the crisis:

But, of course, virtually the entire euro area bond yields have shown improvements in 2012-2013, which is really totally and completely divorced from the debt dynamics:

The IMF is not even projecting decline in debt until 2015...

11/1/2014: Trueeconomics cited in Expresso

Trueeconomics cited in today's Expresso article on euro area peripheral bonds:
http://expresso.sapo.pt/grecia-e-portugal-lideram-descida-dos-juros-da-divida=f850116.

23/9/2013: Everyone is doing more of the same, alongside German voters

And here we have it, folks: Germany votes for status quo, markets seem to be voting for the same...

Meanwhile, ECB is promising to do nothing new in larger quantities, should markets decide to follow Merkel in repeating more of the past...

2/9/2013: Sunday Times August 25: Construction Sector Revival?

This is an unedited version of my Sunday Times article from August 25, 2013.


Not a week goes by without a new report on the property market and construction sector digging up disparate shreds of evidence to suggest yet another turnaround in the property sector fortunes. Some of these are based on the real data, albeit often selectively interpreted; others, on desperate hodgepodge of hearsay and industry anecdotes.

Spin and marketing talk aside, the data itself can be highly unpredictable and hard to interpret. Between Q1 2010 and Q4 2011, Irish Construction sector Purchasing Manager Indices (PMIs) published by Markit and the Ulster Bank were signalling what looked like a stabilisation. CSO’s building and construction sector activity index also posted a quarter-on-quarter rise in Q3 2011. The sector promptly reverted into the red from there.

Faced with past false starts in the data and promotional advertorials in the media, we may be tempted to write off the building and construction sector altogether. This would be a mistake for at least three reasons.

Firstly, traditionally, the building and construction sector acts as one of the leading indicators of real, sustained economic recovery. In particular, in normal recessions, the recovery is led by the early return of firms to capital investment, including in buildings and structures, usually closely followed by an increase in residential investment by the households. Both the US and the UK are showing this pattern over the last two years. While Ireland's recession is driven by deeply structural factors, one can expect any sustained growth momentum to occur only on foot of renewed domestic investment.

Secondly, based on real factor costs calculations, Irish building and construction sector contributes directly 1.6 percent of Irish GDP today. This is a significant contribution, although it is just a half of the average contribution recorded over Q1 1997 - Q1 2013 period. Furthermore, building and construction contribution to GDP rose by 7.3 percent in Q1 2013, while the overall GDP at factor costs declined 1.3 percent. Bringing Ireland's building industry to the long-term sustainable levels in volume and value implies increasing its direct contribution to the GDP by over EUR1.5 billion on current levels to EUR3.8-3.9 billion.  Reaching this level of activity will put Irish building and construction sector output ahead of that by the agriculture, forestry and fishing.

Thirdly, some of the recent data on building and construction sector does warrant extremely cautious optimism.

Let's take a look at the main sources of information on the state of our construction industry. These include, CSO's quarterly reports on volume and value of output in the building and construction sector, as well as more forward-looking planning permissions through Q1 2013. We also have more current Purchasing Managers Indices (PMI) covering data through July 2013. Monthly CSO data on property markets indicates, albeit imperfectly, the trends in the demand for residential investment. Last, but not least, we have international forecasts and data from the Eurostat, ECB and Euroconstruct.

On the surface, the data concerning the building and construction output points to some improvements in the sector activity and dynamics. Per CSO, year-on-year, the volume of output in building and construction increased by 10.7 percent in Q1 2013.  There was an increase of 9.5 percent in the value of production in the same period. The annual rise in the volume of output reflects year-on-year increases of 26.8 percent and 2.4 percent respectively in civil engineering and non-residential building work. Alas, output in residential building decreased by 2.5 percent. Not exactly the growth breakdown one would expect from a building investment recovery.

The above weak positives, however, are further undermined by the fact that the levels of activity in the sector remain extremely low by historical and international comparatives.

Building activity in residential construction sub-sector back in Q1 2006 stood at 107.9 as measured by value index. In Q1 2013 the same stood at 7.8. The latter number represents an increase of just 0.5 points above the all-time low. Non-residential building sub-sector posted shallower peak-to-trough declines, although these still are well in excess of anything seen in normal recessions and in other euro area countries. Despite the shallower contraction, the non-residential construction also showed poor pick-up dynamics: the sub-sector output is now up just 2.6 points relative to the absolute low in Q2 2012.

Truth is, most of the recent gains in CSO’s building and construction indices to-date have been driven not by the organic private sector investment, but by civil engineering activities. Forth quarter running, this trend suggests that although, the construction sector might have stabilised, this stabilisation appears to be driven simply by the unprecedented fall in sector activity to-date, rather than by any sizeable pick up in demand for traditional building and construction investment.

The rosy projections from Euroconstruct, envisioning Irish construction sector expanding some 16% out through 2015 is case in point. As robust as this forecast growth number might appear, if it were to materialise, Irish construction sector will only return to 2011 levels of activity by the end of 2015.

Instead of a U-shaped recovery, we are currently witnessing a continued L-shaped disaster.

More forward-looking indicators, such as the construction sector PMIs strangely contradict the data on the actual sector activity reported both by the CSO and by the Eurostat. Since around mid-2009, civil engineering PMI persistently signaled sharper contraction than overall construction sector PMI and its housing and commercial sub-sectors. More ominously, PMIs across all sub-sectors of construction industry remain in a contractionary territory every month from January 2012 through July this year. One exception is a weak expansion signaled by the housing sub-index in July this year. No matter how one spins the PMI data, however, the indicator continues to show the sector shrinking, not expanding across all quarters since the onset of the crisis, including Q1 and Q2 2013.

This points to the deeper, structural problems in the sector.

Demand for new construction remains exceptionally low, outside the small sub-pockets of activity, such as premium segment of Dublin City apartments and houses, and the highly tailored top quality office space suitable for the booming services-exporting MNCs. The former trend is clearly evident in this week's residential property prices figures published by the CSO. It is further confirmed by the data showing continued weakness in demand for residential properties based on the volume of transactions in the markets. The latter is evident in industry reports and in aggregate shift in exports growth away from manufacturing and professional services toward ICT services.

All-in, investment in buildings and construction remains effectively nil across the economy and without a significant pick up in this investment, the sector performance is going to be highly volatile and concentrated in specialist areas, such as agricultural facilities and wind farms, to be accurately reflected in the high-level data.

This month, ECB Monthly confirmed that the malaise affecting the building trade in Ireland is similar in drivers to the demand-induced recession in the euro area. The ECB linked construction industry slump in Europe to weak macroeconomic conditions, debt-stricken households and dysfunctional banking system. All factors present in the euro area case for the building sector continued decline are also at play in Ireland.

Which brings us to the last piece of evidence necessary to complete the puzzle: the planning permissions. CSO data showed that the number of planning permissions for houses actually fell 9.3 percent year-on-year, reaching the second lowest level in history of the data series. Number of permissions for apartments also fell, by 18.4 percent on Q1 2012. More ominously, aggregate activity in the construction sector, as measured by the new permissions granted, shrunk across the board and hit an absolute lowest point for any quarter since Q1 1975.

In summary, there is little evidence to-date of a sustainable and robust uptick in Irish construction sector activity, while there is plenty of evidence that the sector output is close to stabilising at the extremely low levels. After six and a half years of ongoing declines, we now have a construction industry showing ‘bouncing at the bottom’ pattern of output. Alongside the rest of the economy, Irish building firms are desperately searching some catalyst for the restart of the investment cycle.

This realisation, coupled with the recognition of the overall importance of the sector to the Irish economy in the long run and as a potential driver for the recovery should lead to a significant re-think in the policy stance toward the sector.

Targeted tax incentives for construction sector have not worked and will not work in the current environment of subdued demand. Instead, we need to push for a more aggressive deleveraging of the households and development-related property sector firms. The former means re-thinking our approach to mortgages arrears to include mandatory and enforceable restructuring and rebalancing of the household debt to deliver sustainable and quick resolution of the debt crisis. The latter implies a re-drawing of the property tax to cover land holdings.

While we might like to stimulate the demand side of the investment equation in building and construction sector, such stimulus is simply not on the cards for the Exchequer struggling with excessive fiscal deficits and debt and for the economy suffering from severe private sector debt overhang. Focusing on dealing with the household debt problems, and holding the course on fiscal targets while trying to avoid tax increases and capital spending cuts is all we’ve got as the potential tools for spurring some recovery in the construction sector.

BOX-OUT:

This week, the IMF published a research paper co-authored by the fund own researchers with participation from the University of Geneva that looked at multi-annual fiscal consolidations planned across the 17 OECD economies in the period between 1980 through 2011, including those covering the current crisis period. The researchers asked a simple, but highly contentious question: are sovereign debt markets pressures responsible for forcing the governments into adopting austerity programmes.

The study has found the only in a third of all cases of past and current austerity programmes, the plans for fiscal consolidations were driven by market pressure. In the nutshell, markets are important, but by far not the main sources of pressure on the highly indebted and/or deficit-stricken governments. The authors further found that markets exerted pressure on the governments in the cases where fiscal and macroeconomic fundamentals have deteriorated more severely than in an average crisis. In other words, the markets are not the culprits behind the severe austerity, but rather a reflection of the underlying crises present in the first place.  Per authors: “If history is a guide, the absence of market pressure will not inhibit fiscal consolidation in advanced economies with currently weak fundamentals, such as high debt ratios, adverse debt dynamics or below trend growth.”

The researchers also concluded that the current crisis is different from the previous ones, primarily because the current crisis involves “…increased policy uncertainty, monetary union in the euro area, and unprecedented monetary accommodation.”

So the fabled ‘bad wolves’ of the bond vigilantes so frequently evoked by the austerity-planning Governments in the popular media and on election trails are nothing more than the ordinary messengers conveying the reality of fiscal and monetary mismanagement.

26/5/2013: FTT v Sovereigns' Addiction to Debt

FT.com reports (http://www.ft.com/intl/cms/s/0/c3121802-c480-11e2-9ac0-00144feab7de.html?ftcamp=published_links%2Frss%2Fhome_us%2Ffeed%2F%2Fproduct#axzz2UQE68h14) that 

"The European Central Bank has offered to help the EU redesign its financial transactions tax to avoid any ‘negative impact’ on market stability, highlighting official fears about the implementation of the levy."

So far so good, as FTT indeed is likely to cut liquidity in the markets, reducing markets efficiency, and potentially increasing volatility, rather thane educing it.

Of course, the original idea the EU came up involved levying tax on trading in bonds, equities and derivatives. So one would expect the following prioritisation from the ECB concerned with markets impacts:
1) Not to distinguish between bonds and equities in tax application and rates, as the two instruments are de facto long-only instruments in either corporate (real) economy, banks (financial economy) and sovereigns (for bonds - which somewhat qualifies as a real economy as well).
2) Levy tax primarily on derivative instruments (although here, tax can be avoided much easier)
3) Recognise that in the restricted competition environment and with legacy subsidies from the crisis period still in place for incumbent financial institutions, any FTT will be at least in part passed onto retail investors and savers, and in more extreme cases - e.g. duopoly model of banking in Ireland - onto all retail users of banking services)
4) Real economy - incomes, investment, entrepreneurship, unemployment, etc - will be most impacted by the FTT levied on real assets - equities and some (not all) bonds and this effect will be stronger the stronger is the banking and investment banking sector concentration in the economy.

Alas, as is clear from the FT.com article, the ECB is not concerned with (3) and (4) whatsoever, and it is unconcerned with (1) either. It also seems to be aware of (2) pitfalls. Aside from that, ECB is concerned with the perennial task faced by all European Government - the obsession of raising as much tax revenue as possible while incentivising more debt pumped into sovereign bond markets.


Per FT.com: "The ECB believes markets should efficiently “transmit” changes in interest rates to the real economy." You might think that this means transmitting higher (lower) ECB rates into higher (lower) (a) Government bond yields and (b) higher/lower cost of private credit. Err… you would be wrong.

Per FT.com there are rumours that "…the ECB would prefer to have a limited UK-style stamp duty on equities". What can possibly go wrong, then?

ECB concern is clearly to grease the wheels of sovereign bond markets. The fact that FTT will reduce markets liquidity in real instruments & will cost retail investors in the end - well, that is hardly ECB's concern at all. ECB like the EU Governments is only worried about own coffers & give no attention to the economy.  

Equity markets volatility (FTT original raison d'être is to reduce volatility) had NOTHING to do with the current crises. The ECB focus on 'UK-styled stamp duty on equities', if confirmed, thus exposes FTT as a pure scam to raise more tax revenues, not a measure to deal with 'markets instability'. 

As FT.com quotes one of the market participants: "bond markets were a “phenomenally attractive” way of channelling savings into investment." Alas, it is not - corporate bonds are debt. Shoving more debt while disincentivising equity investment is not a great idea for long term sustainable funding.

In Europe, lending money to Governments, including to fund dodgy unfunded pensions and white elephant projects, is tax-wise deemed to be more laudable than to invest in equity of real enterprises. By corollary, lending to companies is also deemed to be more preferential than funding them via equity. One of the outcomes of this decades-long preferential treatment of debt is the current crisis: over-bloated and under-funded public spending coupled with too much private debt (including banking debt) against too little equity (the latter imbalance drove the bailouts of banks in euro area periphery).

With this in mind, talking about 'Robin Hood' taxes on Financial Services in EU is equivalent to believing in Santa's Magic raindeer as a viable alternative for public transport.

22/4/2013: Who funds growth in Europe?..

There are charts and then there are Charts. One example of the latter is via IMF CR1371

The above shows a number of really interesting differences between the euro area and the US, as well as within euro area:

• Look at the share of overall funding accruing to the traditional (deposits) banks in the US (tiny) and the euro area (massive) - debt is the preferred form of funding for Europe
• Look at the share of equity in the US funding and in euro area, ex-Luxembourg - equity is not a preferred way for funding growth in Europe.
• Why the above matter? Simply put, debt - especially banks debt - is not challenging existent ownership of the firm raising funding. Which means that patriarchal structures of family-owned firms, with their inefficient and paternalistic hiring and promotions and management systems can be sustained more easily in the case of debt-funded firms than in the case of equity funded ones.
• Look at the role played in the US by the credit supplied by 'other financial institutions' - non-banks. Again, these would be more 'activist'-styled funding streams exerting more pressure on management and ownership structures.

What about Ireland? Look at the composition of funding sources in the country:

1. Strong reliance on corporate bonds markets is probably reflective of three factors: (a) concentrated loans issued during the building boom and related to construction, development & investment in land remain the legacy of the boom and rely on collateralized bonds issuance, (b) banks funding via collateralization, (c) concentrated nature of Irish listed plcs, (d) massive M&A spree undertaken by Irish plcs and larger private companies on foot of cheap leverage available in the 2000-2007 period, etc. The volume of bonds might be large, but their quality is most likely lower due to the above points.
2. Strong - actually second strongest in the sample after Cyprus - reliance on bank lending to fund economy.
3. Weak, extremely thin equity cushion. 

Now, keep in mind: equity is the best, most stable and most suitable for absorbing crisis impact form of funding.

30/3/2013: Euro area sovereign risk rises in March 2013

Here's an interesting bit of data (pertaining to analysts' survey): per Euromoney Country Risk survey:

"As of late March 2013, the survey indicates that 13 of the 17 single currency nations have succumbed to increased transfer risk [risk of government non-payment or non-repatriation of funds] since... two-and-a-half years ago." And the worst offenders are?.. Take a look at two charts (lower scores, higher risk):

Per definition of the transfer risk: "The risk of government non-payment/non-repatriation – a measure of the risk government policies and actions pose to financial transfers – is one of 15 indicators economists and other country risk experts are asked to evaluate each quarter. It is used to compile the country’s overall sovereign risk score, in combination with data concerning access to capital, credit ratings and debt indicators."

28/2/2013: Risk-free assets getting thin on the ground

Neat summary of the problem with the 'risk-free' asset class via ECR:

Excluding Germany and the US - both with Negative or Stable/Negative outlook, there isn't much of liquid AAA-rated bonds out there... And Canada and Australia are the only somewhat liquid issuers with Stable AAA ratings (for now). Which, of course, means we are in a zero-beta CAPM territory, implying indeterminate market equilibrium and strong propensity to shift market portfolio on foot of behavioural triggers... ouchy...

10/11/2012: Euro Area bonds supply - November 2012

Five weeks forward bonds supply calendar from Morgan Stanley:

And aggregates:

29/10/2012: Euro Area and GIIPS: banks & bonds

An interesting set of two charts from BIS (through Q2 2012) documenting Euro area banks' exit from GIIPS (click to enlarge):

28/10/2012: BNP note on Spanish Bonds risks

A neat summery from BNP on (1) current bond ratings, and (2) links between ratings and eligibility for inclusion in bond indices:

And a few words on the importance of Spanish ratings risks to ESM/OMT etc:

"As has been demonstrated throughout the EU debt crisis, credit ratings can have a material impact on sovereign bond markets. ...However, not all downgrades have the same effect on bond yields. More specifically, the loss of an AAA rating (S&P on France and Austria, for example) and, more importantly, the loss of investment-grade status (Greece, Portugal) matter more than other downgrades and may have dire consequences for sovereign bonds, because of the significance of those two ratings levels as critical thresholds for investors."

"The downgrade to sub-investment grade, in particular, is linked to the eligibility criteria for various global bond indices, i.e. the minimum rating required for a sovereign bond to be included in an index. Fund managers tend to track the performance of major bond indices and, as a result, when a country’s sovereign bonds drop out of an index due to ratings ineligibility, investors have to adjust their portfolios and offload the country’s bonds. So, any downgrades to sub-investment grade could lead to massive selling flows and have a huge impact on the bond yields of the country in question. More than that, quite often, markets tend to front-run the ratings agencies and start to offload the bonds of the country they suspect may be downgraded to sub-investment grade in the near-term future."


"... Currently, Spanish ratings are getting extremely close to those same [as Portugal in 2011 downgrade case] eligibility thresholds. In general, BBB- is the critical limit for bond index eligibility, but different indices have different rules on calculating a single rating for each country (they can use, say, the average, middle, best of all, or specific ratings). For Spain, currently rated BBB-/Baa3/BBB, any trio of one-notch downgrades is going to push the average rating below the eligibility threshold."

"Credit ratings are important not only with respect to eligibility for the major bond indices, but also in calculating the haircut the ECB applies to collateral posted by European banks. According to the ECB’s graduated haircut schedule, an extra 5% haircut is applied to ratings in the BBB+/BBB/BBB- range (the ECB uses the best rating of S&P, Moody’s, Fitch and DBRS). This extra 5% haircut applies only to category 1 assets, which include government bonds. For other assets, like bank, corporate and agency debt, this extra haircut can reach up to 23.5%, creating severe additional collateral requirements for banks."

"This is particularly important for Spanish banks, which tend to absorb around EUR 400bn of liquidity from ECB’s open market operations. The ECB recently announced that it is suspending the application of the minimum credit-rating threshold to its collateral eligibility requirements for the purposes of the Eurosystem’s credit operations for marketable debt securities issued or guaranteed by the central government of countries that are eligible for OMTs or are under an EU-IMF programme and comply with the associated conditions. However, this does not affect the application of the previously mentioned graduated haircut approach."

"So, focusing on Spain, a one-notch downgrade by DBRS would mean that marketable securities issued by Spain would fall into the higher haircut range and Spanish banks would have to post additional collateral with the ECB. A trio of one-notch downgrades by S&P, Moody’s and Fitch would push the Spanish average rating below BBB- and Spanish bonds out of those bond indices that use the average rating as the threshold for eligibility. For those bond indices that use the middle rating of S&P/Moody’s/Fitch (or the better of the first two), a one notch downgrade by each of Moody’s and S&P would be enough to push the single rating below the eligibility threshold, too. Because of this, any upcoming developments in relation to (1) direct bank recapitalisation by the ESM, (2) a Spanish request for a precautionary programme, (3) economic and social developments in Spain and (4) funding rates are going to be critical, as they could prompt further downgrades, with severe implications for the Spanish bond market."

"If any of these downgrade combinations takes place before Spain has made an official request for a programme, we believe a request would, in effect, become inevitable. At the same time, if Spain asked for a programme tomorrow, this would not necessarily mean that any further downgrades would be off the cards. Almost all of the ratings agencies have said that they will have to assess whether ESM intervention is likely to become a complement to or a substitute for market access. If it turns out to be the latter, this would be in line with a downgrade to the sub-investment-grade category."

"At this point, we should mention that if Spanish bonds are removed from the global bond indices, this could have an impact on Italian bonds as well. The reason is that some investors may have replaced their Spanish bond holdings with an Italian bond proxy in order to benefit from better liquidity and protect themselves from panic selling, should Spain be downgraded further. As a result, if Spanish bonds’ drop out of various indices, these investors could suddenly find themselves overweight Italy versus the index, so they would have to sell some of their Italian bonds to re-adjust their weightings and track the index."

"We saw this kind of move when Portugal was downgraded to junk by Moody’s in July 2011 (taking into account that this was not completely expected by the markets and PGB liquidity had already dried up). In the five days after Portugal’s downgrade, 5y Italian and Spanish yields jumped by 95bp and 65bp, respectively."

Nasty prospect, albeit the risks are diminishing, in the short run, imo.

6/10/2012: Euro area bonds supply calendar for October 2012

Morgan Stanley October bonds supply calendar for euro zone sovereign bonds:

 

And summary of volumes for redemptions, coupons and new issuance:

Ireland's volumes above refer to coupon payments only.

23/9/2012: Euro area bonds supply Sept-October 2012

5 weeks from September 14th - cumulated gross supply of sovereign bonds of €70.5bn and €57.3bn of redemptions and coupons:

And supply calendar

All courtesy of Morgan Stanley

27/7/2012: Some thoughts on Draghi's thoughts

Just two reactions - reflective of the markets sentiment - to yesterday's statements by Mario Draghi:

Markets are thin, as Europe slides into its annual 'Beach lounge & sun screen' mode, but nonetheless yesterday's statement by the ECB chief is significant. Not a game changer overall, yet, but a sign that the team captain is starting to see the problem more clearly.

So what did he really say?

1. Raised a possibility of direct bonds purchases for distressed sovereigns (read: Italy and Spain) - in my opinion a minor issue. Take Spain - from now through mid-2015 it will need €542 billion to roll over existent bonds and fund itself, plus €20 billion potentially in regional financing. ECB's hands are currently relatively tied when it comes to rescuing Spain by the fact that two out of three tools ECB can use to do so are ineffective if not damaging to Spain. Usual policy tool of lowering interest rates will have little-to-no impact on Spain which is suffering from the same breakdown in the monetary policy transmission mechanism as the rest of the euro zone. Draghi hinted at as much within the overall euro area context. ECB can use the LTRO3 tool. Alas, (1) this would mean that LTRO3 will be explicitly focused on financing sovereign (as opposed to banking sector) needs; (2) financing Spanish Government via LTRO3 would only increase contagion from the sovereign to the banks and back to the sovereigns; (3) Unable to issue LTRO to a specific country, the ECB is likely to risk even more carry trade and contagion across the euro zone as the result of such a move. So the only tool left is SMP. ECB has built up some back pressure here with no SMP purchases in 19 weeks, hence the trigger reaction yesterday to Draghi's statement, but I have severe doubts this will work, even if restarted as the scope for SMP purchases for Spain would be well under €75-80 billion - a drop in the funding requirement.
2. Noted that elevated sovereign yields can restrict the monetary policy transmission mechanism (presumably via the heightened liquidity trap effects and carry-trade incentives), which would bring them within the ECB mandate. This is consistent with his statement to the EU Parliament earlier this month where he stressed that both inflation and deflation are part of the ECB mandate. More specifically, Draghi said that "The short-term challenges in our view relate mostly to the financial fragmentation that has taken place in the euro area... Investors retreated within their national boundaries. The interbank market is not functioning... the key strategy point here is that if we want to get out of this crisis, we have to repair this financial fragmentation... So [first] regulation has to be recalibrated completely." In other words, Draghi sees regulatory, not balancesheet barriers to interbank lending (and thus regulatory causes of a liquidity trap). Fine, but that does not mean a short-term response on the cards. And it does not mean a major departure from the previous position of the ECB that regulatory fix must be applied ahead of monetary fix.
3. Spoke about the fact that the ECB mandate is too restrictive to deliver effective monetary policy - again re-iteration on his statement to the EU Parliament and potentially a clear signal the ECB would not mind if its mandate was expanded. Yesterday, Draghi went further to link the ECB unbalanced mandate to the ECB's ability / willingness to act in the sovereign bond markets. This is what referenced in the quote that the ECB is 'ready to do whatever it takes' to preserve the euro. But the quote contains much more than that: "...another dimension to this that has to do with the premia that are being charged on sovereign states borrowings. These premia [relate to] default, with liquidity, but they also have to do more and more with convertibility, with the risk of convertibility. Now to the extent that these premia do not have to do with factors inherent to my counterparty – they come into our mandate. They come within our remit." FTAlphaville has a good note on the convirtibility bit (here).

In short, I don't read Draghi's statement as a major and definitive turnaround in the ECB policy, but rather a continued sign of ECB drift toward pressuring both: 

• the markets sentiment, and 
• the euro area policymakers to act to increase ECB powers and/or carry out significant policy framework changes (ESM, banking union etc).

Continued is the key word here, because, in my view, yesterday's statement is not as divorced from the earlier Draghi comments as some analysts might suggest (or wish for).

These pressures, however, is an important component of policy drift across the euro zone. Leaderless Europe needs a jolt from the ECB to force it out of policy stalemate. That such an approach might be working is reflected in this latest report from the 'front'.

8/2/2012: A more pleasant Sovereign arithmetic

And for a rather more pleasant sovereign arithmetic, here's an interesting table from the Global Macro Monitor (link here) summarizing yoy movements in 5 year CDS:

Frankly speaking, all of this suggest some severe overshooting in CDS and bonds markets on upward yield adjustments over time followed by repricing toward longer term equilibrium. What this doesn't tell us whether we have overshot equilibrium or not... Time will tell.

7/2/2012: An unpleasant risk arithmetic

Here's the guys Irish authorities trust so much on risk assessment, they contracted them to do banks stress tests - PCARs - back in 2010-2011. Note: this is a statement of fact, not an endorsement by me. The Blackrock folks produce quarterly report on sovereign risks and this the summary chart from the latest one - Q1 2012. Negative numbers refer to higher risks:

So Greece leads, Portugal follows, Egypt and Venezuela are in 3rd and 4th place worldwide of the riskiest nations league and then, in the fifth place is Ireland, followed by Italy. And here's the summary of the euro area ratings:

Yes, bond yields have been improving significantly, including due to both fundamentals and banks liquidity steroids, which is a good news. The bad news, yields have been declining for other countries as well and investors' relative sentiment is not improving as much as the absolute levels of yields declines suggest.

Today, one of the Irish Stuffbrokerages claimed in a note that: "The country’s success in meeting its targets under an EU/IMF bailout without social or political unrest and its export-focused economy has enabled it to dodge the recent Eurozone downgrades by S&P and Fitch and distance itself from fellow bailout recipients Greece and Portugal. " Distancing we might be, but the neighborhood we are lumped into is not changing as the result of this distancing. At least not for now.

Please note, the assessments above are consistent with CMA analysis based on CDS spreads, covered here.