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...

7/1/2013: A scary chart from Spain

If you want a frightening figure for the start of the week, here's one, courtesy of the WSJ:

Per WSJ: "At least 90% of the €65 billion ($85.7 billion) fund has been invested in increasingly risky Spanish debt, according to official figures, and the government has begun withdrawing cash for emergency payments."

"In November, the government withdrew €4 billion from the reserve fund to pay pensions, the second time in history it had withdrawn cash. The first time was in September, when it took €3 billion to cover unspecified treasury needs." Such withdrawals can lead to sales of bonds, which in turn can lead to higher yields - classic scenario of a ponzi scheme unwinding.

The point is not valuations, but risk.

"Spain will have trouble finding buyers for the estimated €207 billion in debt it plans to issue in 2013, up from €186 billion in 2012, to cover central-government operations, debt maturities of 17 regional administrations, and overdue energy bills," according to WSJ. 

But there is, of course, more. "Spain's commercial banks already have increased their Spanish government-bond portfolio by a factor of six since the start of the crisis in 2008, and now own one-third of government bonds in circulation." In other words, there is a closed loop between Spanish State, State pensions fund and the banks. A liquidity crunch or solvency problems for banks will cascade all across the debt markets, potentially triggering defaults on pensions.

Note: per Eurointelligence report earlier today, "This is old news as already back in June there was a report that Spanish debt holdings by the Reserve Fund had gone from 55% in 2007 to 90%, and it was government policy to reach 100% by replacing maturing foreign debt holdings with new Spanish debt. It is also a bit of a noisy red herring, as a stock of €65bn is about 2/3 of the government's annual pension bill, it is clear that the Social Security Reserve Fund accumulated over the past decade can never be a substantial contributor to future pensions. However, the Euro's prohibition of central bank financing of state budgets may require the creation of such buffer stocks"

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.

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.

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

7/6/2012: Spanish auction

Spanish auction results:
Sold €2.07bn of debt - above target of '€1-2 billion'
10-year bonds at average yield of 6.04%, bid-to-cover ratio of 3.29 up on previous auction cover of 2.56.
New issue close to secondary yields of 6.14%
Crunchy.

16/02/2012: Spanish & French bonds auction

Spain's bond auction results:

• €2.268bn - 3 year bond, 4% coupon, yield 3.332 against previous auction 2.861% with cover of x 2.2 against previous cover of x1.6.
• €0.733bn - 3 year obligacion, 4.4% coupon, yield 2.966 against previous auction 4.984% with cover of x 4.4 against previous cover of x2.4.
• €1.073bn - 7.5 year obligacion, 4.3% coupon, yield 4.832 against previous auction 5.352% with cover of x 3.3 against previous cover of x2.1.

Original target for sales €3-4 billion. Raised €4.074 billion - slightly ahead of target, with improved yields and cover. No allocation map to tell how much of take up was due to banks buying.

Dynamics similar to January 19th auction:

• €1.3bn - 4 year bond, 4.25% coupon, yield 4.021% against previous auction 3.912% with cover of x 3.2 against previous cover of x1.7.
• €2.3bn - 7 year bond, 4.6% coupon, yield 4.541% against previous auction 5.110% with cover of x2 against previous cover of x1.1.
• €3.0bn - 10 year bond, 5.85% coupon, yield 5.403% against previous auction 6.975% with cover of x2.2 against previous cover of x1.7.

And French auction results:

• €5.025bn - 5 year bond, 1.75% coupon, yield 1.93% with cover of x 1.99
• €2.09bn - 2 year bond, 3% coupon, yield 0.89% against previous auction 1.05% with cover of x 2.4 against previous cover of x2.1
• €1.34bn - 3 year bond, 2.5% coupon, yield 1.09% with cover of x 3.0

Via @ForexLive