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.

25/7/2013: More on Sovereign-Banks Contagion risks in Spain and Italy

Two interesting charts detailing continued rise in risk links between the sovereigns and Italian and Spanish banks:

 Both via Ioan Smith @moved_average.

29/6/2013: Banks-Sovereign Contagion: It's Getting Worse in Europe

Two revealing charts from Ioan Smith @moved_average (h/t to @russian_market ): Government bonds volumes held by Italian and Spanish banks:

Combined:

• Italy EUR404bn (26% of 2013 GDP) up on EUR177bn at the end of 2008
• Spain EUR303bn (29% of 2013 GDP) up on EUR107bn at the end of 2008

Now, recall that over the last few years:

• European authorities and nation states have pushed for banks to 'play a greater role' in 'supporting recovery' - euphemism for forcing or incentivising (or both) banks to buy more Government debt to fund fiscal deficits (gross effect: increase holdings of Government by the banks, making banks even more too-big/important-to-fail); 
• European authorities and nation states have pushed for separating the banks-sovereign contagion links, primarily by loading more contingent liabilities in the case of insolvency on investors, lenders and depositors (gross effect: attempting to decrease potential call on sovereigns from the defaulting banks);
• European authorities and nation states have continued to treat Government bonds as zero risk-weighted 'safe' assets, while pushing for banks to hold more capital (the twin effect is the direct incentive for banks to increase, not decrease, their direct links to the states via bond holdings).

The net result: the contagion risk conduit is now bigger than ever, while the customer/investor security in the banking system is now weaker than ever. If someone wanted to purposefully design a system to destroy the European banking, they couldn't have dreamt up a better one than that...

13/12/2012: Italy & Spain escape bond markets scrutiny... for now

Two bond auctions for the largest peripheral euro area countries showed the sign of markets still believing the ECB promises of OMT 'some time soon' and at significant support levels.

Spain aimed to sell up to €2 billion worth of above-OMT dated paper and in the end managed to sell slightly ahead of target: €2.02 billion in 3-, 5- and 28-year bonds. Recalling that OMT is promising to purchase bonds with maturities up to 3 years, the result was pretty strong.

Average yields were 3.358% for 3-year paper (compared to 3.39% back on December 5th), 4-year yield was 4.2% down on 4.766% back at October 4, and 28-year bond yield was 5.893%.

Bid-cover ratios were 4.81 for 3-year (vs 2 on December 5), 3.13 for 5-year (vs 2.47 on October 4) and 2.09 for the 2040 bonds. This was the first time near-30-year bonds were offered since May 2011.

Spain is now out of the woods in terms of funding for 2012 - it has raised this year's requirement back a month ago - but the country will need to raise some €90.4 billion in 2013.


Italy also went to the well today, placing €4.22 billion worth of bonds - below the maximum target €4.25 billion. The bonds placed were: €3.5 billion of 3-year paper at 2.5% (down on 2.64% in November 14 auction, marking the lowest yield since October 28, 2010 auction) and €729 million of 14-year paper at 4.75% yield. Bid-cover ratios were much weaker than those for Spain: 3-year paper attracted ratio of 1.36 down on 1.5 in last month's auction.

Italy's 2013 funding requirement is expected at over €400 billion.

Thus, both Italy and Spain seemed to have benefited once again from the ECB's OMT promises. The problem is out to 2013 - with both Italy and Spain having to raise just over 1/2 of the LTROs 1&2 worth of bonds, the promise of OMT better translate into actual scaled OMT purchases, and the threat of political mess in Italy better stay out of headlines.

3/8/2012: Did Draghi quietly score a policy coup d'etat?

Let me revisit yesterday's assessment of Mario Draghi's statements. With time passing, it is becoming clear that the key (only) tangible positive is Draghi's comment that he will focus on the shorter end of maturity curve and that this will be consistent with two things:

1. No commitment to sterilization, and
2. Commitment to targeting 'traditional monetary policy' objectives.

Let me explain why I now think these are significant game changers for ECB, and potentially, for euro area.

For some years, even before the financial crisis hit, the ECB (including Trichet before Draghi) have been focusing or attempting to focus policymakers' attention on the need for structural reforms. In the past this was accompanied with threats of tightening monetary policy. But now, such threats are clearly not credible. Hence, the ECB, to stay on the message that long-term structural reforms must be pursued needed to achieve the following objectives simultaneously:

• Reduce immediate pressure on funding indebted and deficit-laden peripherals (so reduce short-term borrowing rates)
• Increase long-term pressure on the peripherals to incentivise them pursue longer term reforms (so increase slope of the yield curve)
• Potentially support enhanced transmission of lower short-term rates into real economy (so alleviate pressure from sterilization of SMP), and lastly
• Reduce future problem of unwinding SMP-accumulated 'assets' off the ECB balancesheet

Now, what Draghi set out yesterday as a potential plan does appear to do all of the four things above. By focusing SMP on shorter term end of the yield curve, ECB will indeed lower shorter-term borrowing costs for Italy and Spain (3-5 year max maturity), while steepening 10 year instruments costs to discourage, relatively, longer term borrowings. This means Italy and Spain should get an added incentive - growing over time as overall maturity profile of their debt starts to shorten as well - to enact long-term reforms. At the same time, ECB will be buying (assuming it does go through with the threat) shorter-term instruments, implying that unwinding these assets will be a natural process of maturity. ECB will not commit to sacrificing long-term flexibility of its policy tools by expanding SMP on the longer end of the yield curve, thus reducing overall risks to the monetary policy in the future.

Some thoughts for the weekend, folks...

2/8/2012: A hell of a non-event

After all the hype and the pomp of recent weeks, today's ECB council and Mario Draghi's subsequent pressie were anti-climatic. Nay, they were outright bizarre, given the 'priming' achieved over the last week. The timeline of the whole fiasco is below - for the fun of it taken off twitter (please note: no tweets affiliations provided due to the way the data was extracted, so apologies to all).

The headline conclusion is as follows:

Sig Draghi's 'Big Bang':

1. ECB 'may' address the seniority issue of ECB over private holders of PSI bonds - an issue that should've addressed more than 3 months ago, 
2. ECB 'might' buy some Spanish/Italian bonds but ECB won't tell how much or when, 
3. It is up to 'Governments' to do something about all of this and apply to EFSF, but
4. ECB will now 'plan modalities' like the rest of the EU has been planning over the last 3 years.

Outcomes:

1. Draghi has managed to bid down Italian and Spanish bonds
2. Draghi manages to further undermine his & ECB's credibility
3. The idiots who bought into peripherals on foot of expectation Draghi was about to start buying them based on his July 26th speech should have seen it coming: Draghi: In the speech on July 26th in London, I made no reference to a bond-buying programme

*DJ Draghi: Govt Council May Consider Undertaking Further Non Standard Measures #wsjeuro
*DRAGHI SAYS INVESTOR CONCERNS ON SENIORITY WILL BE ADDRESSED
*DJ Draghi: Will Design Appropriate Modalities for Such Measures Over Coming Weeks #wsjeuro
*DRAGHI SAYS ECB MAY TAKE MEASURES TO ENSURE POLICY TRANSMISSION
*DRAGHI SAYS TENSIONS IN FINANCIAL MARKETS AMONG RISKS
*Markets rally Mario Draghi on comments about eurozone. IBEX and MIB up by around 2%
*Draghi: Governing council may undertake outright open market operations of a size adequate to reach its objective. But no firm commitments
*DJ Stoxx 600 Index Up 1% As Draghi Speaks #wsjeuro
*DJ Draghi: Inflation Likely to Decline Further in 2012, be Below 2% in 2013 #wsjeuro
*So is Draghi strategy to bid down IT+ESP bonds to buy them cheaper?
*Oh, the Italian 10-year yield just tightened several bps
*Draghi talked markets by 5%. Delivered a delay. Huge blow to credibility
*IBEX and MIB rally losing steam as ECB chief Mario Draghi statement continues
*FTSE goes from up 50 to Negative on Draghi NON comments
*DJ Draghi: Sees Significant Progress on Fiscal Consolidation in Recent Yrs #wsjeuro
*DRAGHI SAYS IMPORTANT FOR BANKS TO BOOST THEIR RESILIENCE. Yes. with all those epic earnings
*RT @EKourtali: aaand : Italian, Spanish 10-year yield spreads over German bunds reverse earlier tightening (tradeweb)
*WAAAAAAR RT @djfxtrader: #Germany's Bundesbank to DJ-WSJ: No comment on #ECB Council Decision
*DJ Stoxx 600 Index Slides Into The Red on Draghi Comments; Down 0.2% #wsjeuro
*The Market Rally Has Now Completely Vanished Amid Mario Draghi's Press Conference read.bi/N0Vn3x
*FTSE, DAX, CAC, MIB, IBEX now in negative territory as ECB boss Mario Draghi fails to deliver on eurozone action pledge
*Draghi: we have discussed possible reductions in interest rates, unanimous decision this wasn't the time #wsjeuro
*Press conference Mario Draghi: Introductory statement to the press conference via ECB PR bit.ly/Qzrdon
*Draghi: first thing is that govts have to go to the EFSF. As I've said several times the ECB cannot replace govts #wsjeuro
*LIVE: Draghi implies that seniority and EFSF/ESM measures have to happen before the ECB takes action. read.bi/Ncwtuj
*Draghi: ECB may undertake outright open market intervention of a size adequate to reach its objectives #wsjeuro
*"Many of the details [of seniority and EFSF use] will be worked out by the [ECB]" in the coming weeks. read.bi/NLo06l
*ITA +20bps SPA +10bps since Draghi started
*Draghi: the effort will be focused on the shorter part of the yield curve #wsjeuro
*"This effort is going to be focused on the shorter part of the yield curve...which will introduce discipline on the longer part." -Draghi
*DJ Draghi: This Effort is Very Different from Previous Bond-Buying Program #wsjeuro
*Markets not happy. CAC-40 turned negative having been up 1.2% earlier in #Draghi's press conference. #wsjeuro
*"I'm a little surprised by the amount of attention this received in recent press." -Draghi on saying no to ESM bank license. "Not up to us."
*The current design of the ESM does not allow to be recognized as a suitable counterparty. (for ECB repo) -Draghi
*Oh man the Spanish 10-year did not like that ESM remark. Nor Italy.
*Euro sinking like a stone. Down 200 pips since peak at start of press conference.
*SPANISH TWO-YEAR NOTE YIELD 14 BPS LOWER AT 4.80%
*Euro /Dollar breaks 1.2200
*Meanwhile... Italy Govt Bonds 10 Year Gross Yield 5.934%
*EURO EXTENDS DECLINE AGAINST YEN; WEAKENS 0.5% TO 95.42
*Markit iTraxx Europe already widened 5bps since start of Draghi speech - now at 159.5bps
*Draghi: You shouldn't assume we will or will not sterilize SMP purchases. The committees will have to tell us what is right.
*Draghi: Endorsement to do whatever it takes to preserve euro has been unanimous, but clear Mr Weidmann, BuBa have reservations #wsjeuro
*Spain CDS already 22bps wider at 560bps
*Spain's IBEX35 share index now down by almost 5% after ECB chief Mario Draghi failed to deliver on his eurozone action pledge.
*Italy Govt Bonds 10 Year Gross Yield 6.00%
*FTSE MIB -2.44%
*FTSE MIB -3.00% -- Italy Govt Bonds 10 Year Gross Yield 6.055% -- ITALY 10 - GERMANY 10 SPREAD 473bps
*IT GETS WORSE: US Futures sliding harder after Mario Draghi flop read.bi/NLpsFS
*Draghi: Even if we were ready to act now, there are not grounds to do so bit.ly/QzAPzq
*Italy Govt Bonds 10 Year Gross Yield 6.129%
*Spanish stock market has plunged 600 points in last few minutes, now down 5% pic.twitter.com/JHQZDAtl
*Draghi on whether ECB willing 2 buy private sector assets - "no reason to be specific on what other options are" - eh, left it open?
*DJ Draghi: Statement on Bond Buys Wasn't a Decision, it was Guidance #wsjeuro
*Draghi stresses bond-buying language: "MAY DECIDE" if conditions are met #wsjeuro
*Italy 10-Yr Erases Gains, Yield Rises 23bps to 6.16%
*EMU epitaph: "I want to stress the ECB remains the guardian of price stability and that remains its mandate." - Draghi.
*Bond market to Draghi: If you'd like to buy bonds, we'll make them cheaper for you... bit.ly/QzLfPG
*RT @edwardnh: Draghi has lost all credibility now. The ECB is going to do nothing. Watch yields rise.
*Draghi: it is pointless to go short the Euro. Well, if you went short the euro when Draghi started speaking you are up 200 pips
*Draghi: "It's pointless to go short on the euro because the euro will stay." The first point hardly implies the second.
*Trichet: "Speculating on Greece defaulting is a certain way of losing out" July 27, 2011. And then... bit.ly/NVWP6b
*FTSE MIB -3.17%
... and some more
*Spanish 10s hit 7% bit.ly/QA24Ks
*Priceless! RT @FGoria: S&P: Portugal 'BB/B' Ratings Affirmed; Outlook Remains Negative On Exposure To Spain

30/7/2012: Grazie, Sig Draghi?

So Mr Draghi made some serious sounding pronouncements last week. The markets rallied. Over the weekend, more serious sounding soundbites came out of Mr Juncker. The markets... oh... still rallying? And thanks to both, Italy had a 'Successories'-worthy auction today am:

• Italy 5 year CDS fell 20bps to 478 (lowest since early July) prior to the auction
• 5 year bond sold at yild 5.29 (against 5.84 in previous) with bid/cover of 1.34 (down on 1.54 achieved in previous auction) and maximum allotment of 2.224bn out of 2.250bn aimed
• 10 year 2022 5.5% bond sold at 5.96% yield (previous auction 6.19%) and bid/cover ratio of 1.286 (against previous 1.28) with allotment of 2.484bn out of 2.5bn planned.

Grazie Sig Draghi?

Now, wait a sec. Yes, there's an improvement. But on less than €4.7bn of issuance... and Italy needs are:

(Source: Pictet)

And hold on for a second longer:

• Italy's net debt financing cost was at 4.721% of GDP in 2011 with debt/GDP ratio of 120.11% which implies effective financing rate of 3.931%
• Of course, a single auction does not lift this up in a linear fashion, but... if Italy had troubles with 3.9%, should we not be concerned with 5.29%?
• Let's put it differently: Italy's GDP grew in 2010-2011 by 1.804% and 0.431% respectively. Over the same period of time, Italy's government debt net financing costs went from 4.236% of GDP to 4.721% of GDP. This year they are set to rise to over 5.36% of GDP as economy is likely to contract ca 1.9-2.0%.

So maybe (I know, cheeky) cheering the current yields is a bit premature? Eh?

27/11/2011: Even with IMF's €600bn - Italy is too big to bail

There are some interesting reports in the media over the weekend, speculating that the IMF is preparing a super package for Italy, rumored to reach €600 billion. Here's a link from zerohedge that outlines the details of these rumors (here). There are several reasons to be skeptical as the feasibility of such a package and the potential effectiveness of it.

Here are these reasons.

Firstly, the IMF is a rules-based organization that normally can lend only 4-5 times (400-500%) of the country quota. Italy's country quota is SDR7.8823 billion or €10.7bn which can allow IMF to lend under normal arrangements up to €53.5 billion (at a severe stretch, I must add as the fund prefers not to lend to the full leverage of 500%).

In addition, IMF has announced two new programmes last week (discussed here). The Flexible Credit Line programme - whereby IMF does not specify lending leverage to be achieved, applies only to "members with very strong track records... based on pre-set qualification criteria to deal with all types of balance of payments problems." So IMF would have to qualify Italy as a country with "strong track record" and its solvency problems as "balance of payments problem". This, of couse, is possible, though not probable, as Italy's "strong track record" is hardly that "strong". In addition, the new lending will have to take place outside the normal arrangements mentioned above, as the deployment of such arrangements would not be consistent with "strong track record" even in theory. So to raise €600 billion, IMF will have to leverage Italy's SDR allocation 6,000%.

Let's put this number into perspective. Lehman Bros TCE leverage ratio was 4,400% at the time of collapse and its average TCE leverage ratio prior to collapse was 3,100%.

At any rate, IMF is most likely to assign Italy a precautionary borrower status under Precautionary Credit Line (see link above) which allows for 24 months leveraging up to 1,000%. This, of course means Italy will be able to raise just €107 billion through IMF loans or about 1/3rd of its roll-over requirements (not to mention new borrowings demand) through 2012.

Secondly, suppose IMF does indeed lend Italy €600 billion - enough to barely cover the country refinancing needs for 2012-2013. Then, two things happen:

1. 1/3rd of Italy's total Gross Government Debt becomes overnight senior to the rest of its debt - as IMF always assumes seniority in lending. This will push existent Italian bonds yields to 15% or 18% or more. We do not know, of course, exactly where the debt will be traded, but what we do know with almost certainty is that there is not a snowball's chance in hell Italy will be able to refinance maturing debt after 2013 on its own. So IMF lending Italy today commits IMF to lend to Italy in 2014 and on.
2. €600 billion is unlikely to cover all Italian needs for 2012-2013, especially if Italian banks are to take a hit on other sovereign bonds. let me run through the EBA banks stress tests model under the following assumptions: Greece haircut 80%, Italy haircut 10%, Portugal haircut 25%, Spain haircut 10% (notice - all very benign) and CT1 ratio of 9%. Italian banks shortfall on capital is €34 billion. Now, recall that Italy also has insurance companies (e.g. A.Gen) and pensions funds - which will see some fall-outs from the haircuts as well. Say €10 billion. Italian bonds downgrade due to IMF lending (see item 1 above) is likely to cost banks and other financial sector companies another  €11 billion and €4 billion. So we are into total bill of ca €60 billion right there. Italian deficits in 2012-2014 are expected to gross €76 billion per IMF latests forecasts. As shown in the chart above, debt maturity, plus new deficits financing will consume some €453.4 billion in 2012-2014 and €630.5 billion in 2012-2016. 

So the total funding that Italy might require is in the neighborhood of €510-690 billion, depending on which period we assume the package will cover (2012 through either 2014 or 2016 respectively).

And this assumes no deterioration in GDP growth (tax revenues) or deficit spending etc. It also assumes that market funding costs IMF built into its deficit forecasts (4% 10-year average pre-November 2010) remain under the IMF lending deal. In fact, of course, that is open to speculation if IMF can lend Italy €600 billion at anything below 5.3-5.8%.

So overall, folks, I am skeptical as to the IMF's ability to conjure €600 billion for Italy. And furthermore, I am skeptical as to Italy's ability to manage cover for its deficits, banks and roll-over needs under such a package. This doesn't even begin to address my concerns as to Spain waiting in the shadows.

Now, lastly, you might suggest that the IMF loans can come in conjunction with EFSF loans. Alas, the EFSF has some serious troubles itself - the following two posts from the zerohedge amply illustrate: here and here.

You see, Italy is too big to bail. Even if it is also too big to fail.

10/1/2011: Some simple Italian Auction maths

Italy's latest auction of 12mo t-bills came in at:

• Allocation: €5bln 
• Average yield 6.087% vs 3.57%  in last month's auction
• bid to cover ratio 1.989  vs 1.88 last month

The auction proves that

1. Italy is now insolvent (reminder - Italy is heading for 120% debt/GDP ratio with average real growth rate 1990-2010 of under 1% pa, implying that as ECB bound for inflation, Italy's annual expected growth over the next 20 years is unlikely to cover 1/2 of Italy's funding costs for its debt)
2. Italy is now illiquid (see chart below for funding requirements forward, courtesy of the ZeroHedge)
3. EFSF is now blown out of the water, with Italy's funding needs over 2012-2015 alone accounting for more than 1/2 of the entire enlarged EFSF pool of liquidity (good luck raising that, folks)
4. Italy's banking system is now insolvent as well, with Intesa's exposure at €60.2bn, UniCredit exposure of €49.1bn, Banca Monte at €32.5bn
5. Euro area top banks are now also insolvent with BNP Paribas exposure of €28bn, Dexia (aha, that one again) exposure of €15.8bn, Credit Agricole exposure of €10.8bn, Soc Gen exposure of €8.8bn, Deutsche Bank exposure of €7.7bn
6. A 30% haircut on Italy, in addition to 75% haircut on Greece requiring a direct hit on banks capital in Europe of some €315bn (that's on top of EFSF exposure to shore up Italian sovereign alone)

31/10/2011: Bailout-3: The Gremlins Rising premiers

What a day this Monday was, folks. What a day. Just 4 days ago I predicted that the latest 'Bailout-3: The Gremlins Rising' package by the EU won't last past January-February 2012. And the markets once again cabooshed my perfectly laid out arguments squashing my prediction.

As of today we had:

• Italian bonds auctioned last week at 6.06% yield for 10 year paper, the most since 1999. The yield was up from 5.86% at the auction a month ago which marked the previous record high. For Italy, given its growth potential and debt overhang, yields North of 5.25-5.3% would be a long-term disaster. Yields close to 6.1% are a disaster! But things were worse than that last Friday: the Italian Treasury failed to fullfil its borrowing target of €8.5bn to be sold. Instead, the IT sold only €7.9bn worth of new paper. Boom - one big PIIGSy gets it in the 'off-limits' region!
• Also on Friday, Fitch issued a note saying that 'voluntary' haircuts of 50% on Greek debt will constitute... eh... a default / credit event (see report here). Which kinda puts a boot into the softer side of the 'Bailout-3' deal. Boom - Greece gets it in the gut!
• Today, Belgians went to the bond markets and got rude awakening: Belgium placed €2.155bn worth of bonds along 3 maturities: 2014, 2017 and 2021. The country wanted to raise €1.7-2.7bn (with upper side being more desirable), so there was a shortfall on allocation. 10 year bond yields for September 2021 maturity are at 4.372% against 3.751% for those issued in September 2011. Belgium is yet to raise full €39bn planned for 2011 as it has so far covered €37.517bn in issuances to-date. it will be a tough slog for the country with revised deficit of 5.3% of GDP in 2012 (assuming no new austerity measures) and debt/GDP ratio of 94.3% expected in 2012. Boom - a non-PIGSy gets a kick too.
• Also today, Germany marched to the markets with €1.933 billion in new 12-month bubills at a weighted average yield of 0.346% and the highest accepted yield of 0.354%. On September 26th, Germany sold same paper at an average yield of 0.2418%. Today, Germans failed to allocate €67mln of bills despite an increase of 40% in yields in just 5 weeks. Big Boom - the largest Euro area economy gets smacked!
• And for the last one - per reports (HT to @zerohedge : see post here): Europe, hoped to issue €5 billion in 15 year EFSF bonds. Lacking orders, it cut issuance volume by 40% to €3bn and the maturity by 33% to 10 years. As @zerohedge put it: "But so we have this straight, Europe plans to fund a total of €1 trillion in EFSF passthrough securities.... yet it can't raise €5 billion?" Massive Boom, folks - mushroom cloud-like.

So here we have it, a nice start for the first week post-'Bailout-3: The Gremlins Rising'...