Bond Yields Keep Rising, Industrial Output Weakens Sharply

The latest news from Italy, Spain and Greece are hardly comforting. The brief boost in confidence occasioned by the appointment of 'technocrats' in Italy and Greece has given way to a more sober assessment.

First, Italy had another five year bond auction that saw yields at a level far surpassing that of the previous auction of similar debt.

According to Marketwatch:

„Italy's government sold 3 billion euros ($4.1 billion) of five-year government bonds Monday in a test of market sentiment after the appointment of economist Mario Monti to head a new technocratic government. The yield on five-year bonds rose to 6.29% from a yield of 5.32% in a previous sale last month, news reports said, reflecting a sharp jump in yields in recent weeks. But the yield remained below the level seen in the secondary market around 6.35% ahead of the sale.“


Yields on existing Italian debt also rose once again yesterday, partially reversing the pullback seen late last week when the ECB is said to have intervened heavily. One factor in this may have been the disastrous results reported by Italy's largest bank,  Unicredito :

„Italian bank UniCredit is to ask shareholders for 7.5 billion euros ($10.3 billion) in new capital, cut 6,150 jobs and retreat from key business areas in a bid to repair its ravaged balance sheet and return to profit.

Revealing a 10.6 billion euro third-quarter loss along with plans for Europe's largest rights issue in the banking sector for over a year, it scrapped its dividend payment for 2011 and joined other banks in aiming to cut back on its lending.

UniCredit, the only Italian name in a list this month of the most important global banks, is the country's most internationally exposed lender, operating in 22 countries.

But it is bearing the brunt as the euro zone's third-largest economy is sucked ever deeper into the region's debt crisis. UniCredit holds 40 billion euros of Italian government bonds and its shares have lost half of their value this year, leaving its fundraising representing half of its value and making it painfully dilutive for investors.

Its shares closed down 6.2 percent at 0.77 euros, valuing it at just under 15 billion euros. Some 5,200 of the jobs will go in its home base of Italy, now in the eye of the euro zone's crisis storm. Another 2,000 will go in western Europe, including 800 in Austria, partly offset by new jobs in eastern Europe. About 62,000 of the bank's 160,000 staff are in Italy, with 51,000 in central and eastern Europe.

The third-quarter loss included 9.8 billion euros of writedowns, of which 8.7 billion were linked to ill-timed takeovers in eastern Europe in the past few years. Goodwill from deals in Ukraine and Kazakhstan was entirely written off. It also announced writedowns on its Greek bond holdings and on a number of brands, including Germany's HVB and Bank Austria.

"It looks like a kitchen sink job … a massive hatchet job across the business," said one analyst who did not want to be named.“

This is also bad news for CEE nations, in several of which the eerie calm that has pertained over the past year or so has lately given way to crisis conditions as well (Hungary is currently at the forefront of these developments).

However, amid the Italian gloom, there was also a small piece of good news, namely a report that several hedge funds that have been betting against euro area debt have begun to take long positions in Italian government bonds.

“Some of the hedge funds that made the biggest and most sophisticated bets against European sovereign debt began reversing those trades last week.

People familiar with the trading at three large hedge funds that specialize in trading bonds and credit default swaps said that those funds began to cover short trades and actually go long European sovereign bonds last week.

"The idea is that it has gone too far, especially with Italy's debt," a trader at one credit fund said.

Italian bonds briefly traded above the 7 percent yield that many consider the "unsustainable" level. An auction of 3 billion euros ($4.1 billion) of five-year Italian bonds reach a yield of 6.3 percent. That's the highest level since June 1997, according to reports. It's nearly a full point higher than just one month ago

These high yields are attracting some buying from hedge funds that see it as a "win-win scenario."

"If yields keep climbing, the ECB will have to take action to bring them down. If they fall, then I have discounted bonds to sell into the market," said one hedge fund manager.”


(emphasis added)

In part these trades seem to be based on the idea that ECB intervention will save the bacon of investors if the trade somehow does not work out after all – this is of course a dangerous rationale for a trade, as it amounts to a variation of the 'potent directors fallacy'. Still, as we have noted before, Italy's overall government debt situation is far less dire than the data would suggest on the surface. It is therefore not out of the question that the market will reassess the merit of Italy's government bonds.

Unfortunately, economic data emanating from the euro area continue to signal deterioration, with Italy's economy especially hard hit –  so Italy's government will find it difficult to reach its deficit goals. As the WSJ reports:

“Output from euro-zone factories fell in September at its fastest rate in two and a half years, underscoring the threat of recession in the 17-nation currency bloc.

Industrial output fell 2% in September from August, more than reversing the prior month's gain of 1.4% and marking the biggest drop since February 2009, the European Union's statistics agency Eurostat said Monday.

Production was notably weak in the region's big three economies. Output in Germany, the driving force for European manufacturing, dropped 2.9%, and in France it fell 1.9%. Italy, now in the process of forming a new government to try to solve its huge debt problems, saw industrial output plunge 4.8% in September.

The weak state of manufacturing in September is the latest in a string of data to suggest the euro zone is heading for an economic downturn, possibly as early as the fourth quarter.

"September's plunge in euro-zone industrial production provides the strongest signs yet that the recovery in the sector has come to an end," said Ben May, economist at Capital Economics, a consultancy. "These data appear to support our view that the euro zone will soon fall back into another fairly deep recession."


(emphasis added)

Meanwhile, Spain's government bond market has recently been the subject of benign neglect by the ECB, with the result that Spanish yields have suddenly risen sharply, once again closing the gap with Italian yields.

Spain is in deep economic trouble, with the economy suffering almost Great Depression-like conditions.

As reported by SFGate:

“Spain risks seeing its borrowing costs rise closer to those of Italy as European Central Bank buying fails to cap yields and slowing growth threatens to make its deficit-reduction targets unachievable.

The gap between 10-year Spanish and Italian yields rose to more than 150 basis points early last week as Spain's borrowing costs held below 6 percent, while investors drove Italy's to a euro-era record of more than 7.48 percent. Since Nov. 9, the spread has narrowed to about 60 basis points, with Italian securities rallying to yield 6.5 percent and Spain paying 5.9 percent, up from as low as 5 percent five weeks ago.

"There's a high probability of Spain following Italy," said Phyllis Reed, head of fixed-income research at Kleinwort Benson Bank in London. "In the very short term, the trigger is just the fact that we're getting close to the edge of the abyss with the euro."

Europe is battling a debt crisis that so far has cost five leaders their jobs, including Italian Prime Minister Silvio Berlusconi. Spanish voters will elect a government this week that will have to slash the deficit by about a third and finance bond redemptions of about 50 billion euros ($68.7 billion) next year, with the European Commission forecasting that the nation will miss its growth and deficit goals.

"The markets' attitude towards Spain is quite sanguine compared to Italy at the moment, but we think that this could potentially change in the coming months, if not weeks," Stephane Deo, chief European economist at UBS AG in London, said in a research note. The prospect of a "deep recession," plus the potential cost of bank bailouts, are reasons to be "increasingly concerned about the Spanish situation," he wrote.


Spain will post a budget deficit equal to 6.6 percent of gross domestic product this year, above its 6 percent target, the European Commission said Nov. 10, as it forecast the economy would expand 0.7 percent this year and next, below government goals of 1.3 percent in 2011 and 2.3 percent in 2012. Unless the new government takes additional measures, the deficit will be 5.9 percent next year, breaching the 4.4 percent target, the commission said.”


(emphasis added)

In Greece the latest developments include the observation that minimum wage laws no longer keep wages from sinking – this is bad news for wage earners in the short term, but it is ultimately good news for the economy in the long run. As we have noted previously, both prices and wages in Greece need to fall to allow the economy to regain its competitiveness. Lower nominal wages are not a problem if prices fall commensurately and no income losses occur in real terms. Of course the process isn't as smooth as one would like, but it is necessary to go though this if any progress is to be made. The situation is discussed in this article at Reuters.

Here is just a brief snip we wanted to comment on:

Before it resigned to make way for a unity government this month, the government of former prime minister George Papandreou pushed new pension cuts and wage rules through parliament, allowing firms to ignore sectoral agreements that normally set minimum wages for specific industries.

Greeks erupted in protest. More than 100,000 people took to the streets in the biggest 48-hour strike in years, leaving central Athens strewn with broken paving stones and smouldering rubbish containers after hours of riots.

Hostile unions said the moves would push Greece into a "death spiral" of economic contraction if the government continued to slash salaries, hike taxes and allow lay offs.

"If we continue this way, it's certain the unemployed will multiply. We'll be talking about the living-dead working to support their families on 500 euros a month," said Nikos Kioutsoukis, general secretary of private sector union GSEE representing about half the country's 4 million workforce.”

The comment by the gentleman from the union displays his economic ignorance.  If wages rates are not allowed to fall, then the unemployed will definitely multiply. If wages are free to adjust to the economic reality, then unemployment can be expected to be held in check. It is precisely because this was not possible heretofore that Greek unemployment has soared so mightily. Naturally, unemployment must be expected to increase during an economic bust in any case, but keeping wages artificially high will tend to worsen the situation considerably.

Also noteworthy were news that the leader of Greece's New Democracy Party, Antonis Samaras, refuses to consider any more tax hikes and won't sign any pledges to the EU. 

I agree with the goals to cut government spending … to reduce debt, to erase the deficit, to make structural changes. I do not agree with whatever stunts growth," he told party MPs ahead of a three-day confidence debate, starting on Monday.

Although Samaras' party are part of the new administration of former ECB vice president Lucas Papademos, its support for the three-day old government has so far been lukewarm and his backing is crucial for passing legislation needed to satisfy international lenders' demands.

Crucially, Samaras said he would not sign any letter pledging support for conditions on a 130bn euro bailout as EU Economic and Monetary Affairs Commissioner Olli Rehn has demanded.

"I don't sign such statements," he said, adding that his word should be sufficient.”


(emphasis added)

Needless to say, we definitely agree with Samaras' stance. There should be enough room to achieve budgetary goals by cutting expenditures. Burdening the citizenry with even more taxes can only make the economic situation worse and may lead to lower rather than higher revenues. We also think that refusing to give in to Rehn's demands is highly appropriate.

More on Euro Hysteria

We have previously discussed the power-drunk EU commissioner for financial markets, Michel Barnier. He has come out in favor of curtailing trading in CDS, as well as supporting the completely ineffectual short selling ban on European financial shares, thus depriving investors of ways to hedge themselves against the profligacy of euro area governments. The man seriously seems to think he can tell the markets what they should do. The latest example of his crazy anti-free market antics is the attempt to ban credit ratings on shaky sovereign debtors. As with the above mentioned initiatives, this will have the exact opposite effect of that intended, as it will only serve to increase uncertainty.

Besides, we doubt that it is even possible, since it amounts to an attempt to ban free speech. Recall here that sovereign credit ratings are unsolicited. They are among the few rating decisions that can be said to be largely free of conflicts of interest.

Barnier seems to fancy himself to be some kind of financial markets dictator. The man is plainly dangerous and should never have been let near a position of power.

According to the Economic Times:

The EU will propose suspending the credit ratings of countries receiving international bailouts or if the ratings cause market instability, markets commissioner Michel Barnier said Monday. 

Ratings agencies are regulated by the European Securities and Markets Authority (ESMA), Barnier said in an interview on French radio station BFM a day before he is due to present proposals to tighten control over the firms that evaluate the credit risk of countries and companies. 

Ratings agencies "won't have the right, if the ESMA decides, to rate certain countries for a certain time that are receiving an international support programme from the IMF or European Union," said Barnier. 

In addition, the ESMA will have "the possibility of suspending temporarily the notation of a country for two months, if it considers the notation would aggravate or accelerate the instability or irrationality of the markets."

Ratings agencies, of which Moody's, Standard and Poor's and Fitch are the best known, have long come under criticism for adding fuel to the fire when they lower their ratings when markets are already tense.”


You really couldn't make this up. If Barnier thinks he can dampen the alleged 'irrationality' of financial markets by issuing edicts of this sort, he must be considered completely delusional. We seem to have spotted another slightly mentally imbalanced victim of euro hysteria here.

In the context of the 'narrowing of choices' we discussed yesterday, here is  FT's Wolgang Münchau, who now thinks there is 'only one way to save to eurozone from collapse', namely by the issuance of eurobonds. So according to Münchau, the menu of choices has shrunk to exactly one. As we remarked yesterday, this paucity of imagination is truly astonishing.

Lastly, the UK's business secretary Vince Cable has joined the chorus calling for unlimited money printing by the ECB:

U.K. Business Secretary Vince Cable said the European Central Bank needs unlimited powers to support the euro and the region’s debt-ridden economies.

“If a monetary deal’s going to work, the central bank has to have unlimited powers to intervene to support economies, and indeed banks, to prevent collapse,” Cable said in an interview on BBC television’s “Politics Show” today. “They need to have that clearly at a European level, and that’s one of the issues that hasn’t yet been adequately clarified.”


“It’s very clear that in addition to the disciplines that the southern Europeans are going to have to adopt, the Germans are going to have to play their role in supporting the euro zone,” Cable said. “That’s either directly or through the central bank, making absolutely sure that the big countries that are subject to speculative attack are properly supported with adequate liquidity.”

Ah yes, the evil speculators are attacking. We can't have that.


Euro Area Credit Market Charts

Below is our usual collection of CDS prices, bond yields, euro basis swaps and several other charts. As always, both charts and price scales are color coded. Prices are as of Monday's close. As can be seen, yields on Spain's government bonds have moved sharply higher – the crisis is still moving from one country to the next.



5 year CDS on Portugal, Italy, Greece and Spain – note the sharp move higher in CDS on Spain – click for higher resolution.



5 year CDS on France, Belgium, Ireland and Japan: CDS on France and Belgium land at new wides as well – click for higher resolution.



5 year CDS on Bulgaria, Croatia, Hungary and Austria – the whole lot keeps jumping higher. As crisis conditions intensify in the CEE nations,. Austria is taken right with them – click for higher resolution.



5 year CDS on Latvia, Lithuania, Slovenia and Slovakia – again, big moves all around, with new highs once again reached by Slovenian CDS – click for higher resolution.


5 year CDS on Romania, Poland,  Slovakia and Estonia  – same story – click for higher resolution.



5 year CDS on Bahrain, Saudi Arabia, Morocco and Turkey – these have decoupled a bit – click for higher resolution.



Three month, one year and five year euro basis swaps – a slight bounce – click for higher resolution.



Our proprietary unweighted index of 5 year CDS on eight major European banks (BBVA, Banca Monte dei Paschi di Siena, Societe Generale, BNP Paribas, Deutsche Bank, UBS, Intesa Sanpaolo and Unicredito) – still moving higher – click for better resolution.



In a slightly positive divergence, Unicredito's share price fails to fall to a new low in spite of the bank reporting a huge loss – click for better resolution.



10 year government bond yields of Italy, Greece, Portugal and Spain – Spanish yields have exploded higher – click for better resolution.



10 year government bond yield of Austria, the 9 year government bond yield of Ireland, UK Gilts and the Greek 2 year note.  The move up in Austria's yields is striking as well – click for higher resolution.



Italy's 10/2 year spread narrows again slightly – click for higher resolution.



Portugal's 2/10 inversion widens a bit again on Monday – click for higher resolution.




5 year CDS on the debt of Australia's 'Big Four' banks are coming in a bit again – click for higher resolution.






Charts by: Bloomberg,



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