Bond Auctions 'Succeed', But Yields Soar

Yesterday we discussed the 'event risk' facing the euro area due to a plethora of bond auctions taking place this week. On Monday, the auctions of Belgium and Italy went through without a major hitch, this is to say, they did not 'fail' outright – a sufficient number of bids was submitted. We have often remarked on the miraculous ability of the bond auctions of even the worst sovereign debtors in Europe to succeed, which we ascribe mostly to the fact that there is a kind of 'MAD' (mutually assured destruction) situation between banks and governments, combined with what is likely a sub rosa agreement between the ECB and the commercial banks that the former will immediately take bonds acquired in auctions off the hands of the latter in subsequent repos.

Note however that the commercial banks bidding at the auctions are still the legal owners of these bonds even if they pawn them off to the ECB. As a result,  there is a limit as to how much pain they are willing and able to take.

Of course the auctions are not a 'success' from another standpoint, namely the  yields which the governments concerned have to pay. Bidders are extremely reluctant and are demanding ever more compensation for the considerable risks they are taking.  Thus yesterday's auctions (WSJ) once again saw yields reach new highs:

Italy and Belgium fared better in debt sales Monday than had been feared as market sentiment improved after last week's disappointing German bond auction and ratings downgrades for Belgium and Portugal, but still had to pay euro-era high yields to lure buyers. The Italian Treasury sold €567 million of 2023-dated inflation-linked bonds against €500 million to €750 million planned, at a yield of 7.30%. Italian inflation-linked bonds had been seen as very cheap before the auction because they haven't been part of the European Central Bank's bond buying.

Still, this auction was only a warm-up ahead of Tuesday's sale of up to €8 billion in nominal bonds, seen as a more difficult test, not least because of the significant amount on offer.

In another auction, Belgium, the latest country in the euro zone to have its credit rating lowered, sold the maximum targeted €2 billion in four government bonds, but the yields Belgium had to pay at its last scheduled government bond auction this year hit a euro-era high.

The Belgian Debt Agency's €1 billion to €2 billion offer of 2018-, 2021-, 2035- and 2041-dated bonds received total bids of €4.208 billion, implying a comfortable two-fold coverage of the amount sold.  The agency paid an average yield of 5.659% on the September 2021-dated bond, up from 4.372% at the previous auction of this bond on Oct. 31. It paid an average yield of 5.784% on the March 2041 bond, up from 4.280% at the previous sale Sept. 26.“


(emphasis added)

Subsequent to Monday's bond auctions, yields declined a little bit in trading in the secondary markets, no doubt due to relief that the worst expectations were not fulfilled. The results of today's big auction by Italy have become available as we are writing this, and this time the effect on yields was less benign.

According to Reuters:

Italy paid record yields of nearly 8 percent to sell three-year paper on Tuesday, a level seen driving its debt burden out of control if sustained over time.

The yield on a new three-year BTP soared to euro lifetime high of 7.89 percent at the closely watched auction which allowed Rome to raise 7.5 billion euros.

The amount was close to the top of a targeted range of between 5 billion and 8 billion euros. The new Nov. 2014 issue carries a 6 percent coupon, the highest for this maturity from 1997. Only a month ago, Italy had paid a 4.93 yield to sell three-year paper.

The yield on a 10-year BTP bond due in March 2022 rose to 7.56 percent, marking a new euro lifetime high, from 6.06 percent at the end of October.“


(emphasis added)

We're not sure at this stage if the markets will decide to concentrate on the fact that the auction is now out of the way and once again breathe a sigh of relief, or if they will focus on the fact that yields continue to ratchet higher and that Italy simply can not afford to roll over the vast amounts of debt maturing over the next two years at current or even higher yields (note however that it will be possible to do so for a while yet).



Italy's debt rollovers, beginning with August 2011 – click for better resolution.



Apocalyptic Unanimity

Yesterday, we were struck by the increasing convergence of the views of various market observers as to the outcome of the ongoing crisis. It seems now widely accepted as almost a fait accompli that the euro will disintegrate within weeks. Even Jim Cramer (euro bears please take note…) is now on 'Defcon 3', predicting imminent 'financial collapse'. The Economist writes 'Unless Germany and the ECB act quickly, the single currency's collapse is looming'.

„Germany’s cautious chancellor, Angela Merkel, can be ruthlessly efficient in politics: witness the way she helped to pull the rug from under Silvio Berlusconi. A credit crunch is harder to manipulate. Along with leaders of other creditor countries, she refuses to acknowledge the extent of the markets’ panic (see article). The European Central Bank (ECB) rejects the idea of acting as a lender of last resort to embattled, but solvent, governments. The fear of creating moral hazard, under which the offer of help eases the pressure on debtor countries to embrace reform, is seemingly enough to stop all rescue plans in their tracks. Yet that only reinforces investors’ nervousness about all euro-zone bonds, even Germany’s, and makes an eventual collapse of the currency more likely.

This cannot go on for much longer. Without a dramatic change of heart by the ECB and by European leaders, the single currency could break up within weeks. Any number of events, from the failure of a big bank to the collapse of a government to more dud bond auctions, could cause its demise. In the last week of January, Italy must refinance more than €30 billion ($40 billion) of bonds. If the markets balk, and the ECB refuses to blink, the world’s third-biggest sovereign borrower could be pushed into default.“


(emphasis added)

We certainly agree that Mrs. Merkel is possibly underestimating the speed and ferocity at which a market panic could crush her ambitious integration plans. We also agree that there are a number of potential events that could become the triggers for such a panic. There is considerable risk that in the case of the failure of a big bank, a wave of cascading cross-defaults could engulf the system. As noted before, Italy and Spain are unlikely to be able to refinance their debts in the markets for very long with bond yields at 7% or higher. To be more precise, they may well be able to roll over their debt at such yields, but sooner or later market access would close down due to the arithmetic of the debt spiral these high yields would inexorably produce.



Spain's debt rollovers from August 2011 onward – click for better resolution.



Meanwhile, the Telegraph reports that the UK Foreign Office is drawing up  plans to help British expatriates as it  'warns of riots in the event of a euro collapse'.

„Diplomats are preparing to help Britons abroad through a banking collapse and even riots arising from the debt crisis.

The Treasury confirmed earlier this month that contingency planning for a collapse is now under way.  A senior minister has now revealed the extent of the Government’s concern, saying that Britain is now planning on the basis that a euro collapse is now just a matter of time.

“It’s in our interests that they keep playing for time because that gives us more time to prepare,” the minister told the Daily Telegraph.

Recent Foreign and Commonwealth Office instructions to embassies and consulates request contingency planning for extreme scenarios including rioting and social unrest.  Greece has seen several outbreaks of civil disorder as its government struggles with its huge debts. British officials think similar scenes cannot be ruled out in other nations if the euro collapses.

Diplomats have also been told to prepare to help tens of thousands of British citizens in eurozone countries with the consequences of a financial collapse that would leave them unable to access bank accounts or even withdraw cash.“

We are actually suspecting that the 'Telegraph' took what is a quite routine contingency planning exercise (after all, the bureaucrats need something to while away their time with) and fabricated a sensationalistic headline out of it. What makes it interesting to us is mainly the fact that the article has been published at all.  Poland's foreign minister Radoslav Sikorski meanwhile delivered an impassioned plea to Germany to 'act to save the euro' in a speech held near the Brandenburg Gate in Berlin.

„Germany is the only country in Europe that can act to save the eurozone and the wider European Union from “a crisis of apocalyptic proportions”, the Polish foreign minister warned on Monday in a passionate call for more drastic action to prevent the collapse of the European monetary union.

The extraordinary appeal by Radoslaw Sikorski, delivered in the shadow of the Brandenburg Gate in the German capital, came as the Organisation for Economic Co-operation and Development called on European leaders to provide “credible and large enough firepower” to halt the sell-off in the eurozone sovereign debt market, or risk a severe recession.“


In a startling comment for a senior Polish minister, Mr Sikorski declared that the biggest threat to his nation’s security was not terrorism, or German tanks, or even Russian missiles, but “the collapse of the eurozone”.

There it is again – apocalypse!

Meanwhile, speculators have certainly joined the bandwagon, increasing their net short position in euro futures to yet another 17 month high, with their exposure rising another 11% last week alone.

Considering all these panicked invocations of imminent collapse one is left to wonder though, why did the DJIA rise by nearly 300 points yesterday? If we are not completely mistaken about the meaning of positioning data, then we would argue that with virtually everyone already sitting on the same side of the boat, the markets will begin to do the unexpected – which in this case means the euro should at least see some short term strength, which in turn would have affect many other markets due to the well-known and well-worn inter-market correlations that the systematic black boxes and robots trade off.


Rumors Denied, More Credit Ratings Gloom

One of the alleged triggers of yesterday's 'risk assets party' was a rumor launched by Italian newspaper 'La Stampa' that the IMF was preparing a € 600 billion bailout for Italy. It apparently didn't occur to the journalists writing the report to first ascertain what the IMF's total lending capacity actually is (it is at present only $400 billion in toto).

Of course it would be possible for the ECB to provide financing to the IMF, which in turn could then lend the money to Italy. We do believe such a plan is at the very least among the options under consideration and it may well be implemented if the situation worsens. Alas, for now the rumor has been officially denied, which has been the fate of every single  'bazooka rumor' over the past two years or so.  There aren't even any talks with Italy, never mind huge loan packages being readied.


„The International Monetary Fund said it isn’t discussing a rescue package with Italy and Japan said no such talks have occurred within the Group of Seven, amid concern that Italy will struggle to bring down borrowing costs.

The Washington-based lender isn’t in discussions with Italian authorities on a program for IMF financing, a spokesperson for the fund said today in an e-mailed statement. Italy’s La Stampa newspaper reported that the IMF may be preparing a loan of as much as 600 billion euros ($798 billion) to support Italian efforts to restore investor confidence.

“The IMF simply does not have the resources” on its own for such aid, Marc Chandler at Brown Brothers Harriman & Co., chief currency strategist at the bank in New York, wrote in a note to clients. It’s also unclear whether the fund would be able to get agreement on leveraging its lending capacity to such a degree, he wrote.“


The IMF, which extended one-third of the rescue packages for Greece, Ireland and Portugal, had about $390 billion available for lending as of Nov. 17, according to data posted on its website. The Italian daily reported that the IMF had several options to increase its firepower, including coordination with the European Central Bank.  Italy would pay an interest rate of 4 percent to 5 percent on the loan, La Stampa reported, without saying where it got the information.

“Schemes to leverage the IMF, which the proposal seems to assume, quickly run into political and technical difficulties,” Chandler said. “It is not clear who bears the cost of the risk. It is not clear that leveraging the IMF would be acceptable to a sufficient number of members.”


(emphasis added)

So much for that one. And yet, stocks and the euro rose anyway.

Italy now plans to add a balanced budget amendment to its constitution, but the cumbersome political process in Italy ensures that this will take a while to take effect:

„In one sign of progress, Italy's lower house of parliament was preparing Tuesday to introduce an EU-backed measure to amend the constitution to require a balanced budget. The move is a first step in a long process. The amendment must be approved twice in both houses, the second time after a six-month interval.“

Concurrently, the credit rating agencies continue to add to the sense of foreboding by warning that they may soon issue additional downgrades. Standard & Poors was rumored to be muttering darkly about the dangers to France's AAA status:

Standard & Poor's could downgrade the outlook on France's AAA credit rating to negative within a week to 10 days, according to a report Tuesday in French newspaper La Tribune. Citing several unnamed sources, the newspaper said in its online edition that the move by S&P could come "shortly" – the step before the rating itself is actually lowered.“


(emphasis added)

Moody's meanwhile reiterated its warnings on euro area sovereigns, noting that 'defautls by several countries can no longer be ruled out' and indicating that further ratings downgrades are highly likely:

„While Moody's central scenario remains that the euro area will be preserved without further widespread defaults, even this 'positive' scenario carries very negative rating implications in the interim period. The rating agency notes that the political impetus to implement an effective resolution plan may only emerge after a series of shocks, which may lead to more countries losing access to market funding for a sustained period and requiring a support programme. This would very likely cause those countries' ratings to be moved into speculative grade in view of the solvency tests that would likely be required and the burden-sharing that might be imposed if (as is likely) support were to be needed for a sustained period.

However, over the past few weeks, the likelihood of even more negative scenarios has risen. This reflects, among other factors, the political uncertainties in Greece and Italy, uncertainty around the final haircut imposed on holders of Greek debt, the emphasis in the recent Euro Summit statement on the conditional nature of the existing support programmes and the further worsening of the economic outlook across the euro area. Alternative outcomes fall into two broad categories: those involving one or more defaults by euro area countries (in addition to Greece's PSI programme); and those additionally involving exits from the euro area.

The probability of multiple defaults (in addition to Greece's private sector involvement programme) by euro area countries is no longer negligible. In Moody's view, the longer the liquidity crisis continues, the more rapidly the probability of defaults will continue to rise.

A series of defaults would also significantly increase the likelihood of one or more members not simply defaulting, but also leaving the euro area. Moody's believes that any multiple-exit scenario – in other words, a fragmentation of the euro – would have negative repercussions for the credit standing of all euro area and EU sovereigns.“


(emphasis added)

However, if you thought it can not get any more apocalyptic than that, Zerohedge reports that Moody's is now reviewing the ratings of 87 banks in 15 countries with a view toward downgrading their subordinated debt. When it rains, it pours.


„Moody’s Investors Service has today placed on review for downgrade all subordinated, junior subordinated and Tier 3 debt ratings of banks in those European countries where the subordinated debt still incorporates some ratings uplift from Moody’s assumptions of government support, with the potential complete removal of government support in these ratings. The review will affect 87 banks in 15 countries in Europe with average potential downgrades of subordinated debt by two notches and junior subordinated debt and Tier 3 debt by one notch. The greatest number of ratings to be reviewed are in Spain, Italy, Austria and France. For issuers whose ratings were already under review prior to today’s rating action, the completion of the existing review will now incorporate these additional considerations for subordinated, Tier 3 and junior subordinated debt.

Today’s rating announcements follow on from the removal of systemic support from subordinated debt in systems including Denmark, UK, Ireland, Germany and Moody’s report "Moody’s to re-assess government support in bank sub debt ratings globally" published February 2011.

The review has been caused by the rating agency’s view that within Europe systemic support for subordinated debt may no longer be sufficiently predictable or reliable to be a sound basis for incorporating uplift into Moody’s ratings.“


In several cases, the sovereign has faced an increasingly stark trade-off between the need to preserve confidence in their banking systems and the need to protect their own balance sheets.

(emphasis added)

It is no wonder that our bank CDS index keeps rising, along with the yields on outstanding bank debt. Euro area banks now find it practically impossible to get long term financing by issuing bonds. As an aside to this, the decline in the value of outstanding bank debt is a major source of the reported so-called 'profits' of US banks (which have Dick Bove et al. so excited), due to an accounting quirk that allows them to book the decline in their existing debt's value as a 'gain' – since they can in theory buy back their debt below par. Bank accounting seems mainly about erecting Potemkin villages these days.

Alas, even in view of all these negative developments, the fact that we have seen such extreme moves in credit markets recently and the fact that there is such growing unanimity about the eventual outcome of the crisis could in the short term actually lead to a pause in the crisis and allow for a bigger rebound in 'risk assets' to relieve oversold conditions over coming weeks.

As an aside to the 'fiscal integration' plans pursued by Germany: Something we didn't explicitly mention yesterday is that in order to bypass the cumbersome process involved in changing EU treaties, Germany and France are proposing that the nations concerned at first implement a number of bilateral agreement before moving the agenda to the pan-European level.

According to the WSJ:

“Under the proposed plan, national governments would seal bilateral agreements that wouldn't take as long as a cumbersome change to European Union treaties, according to people familiar with the matter. Some German and French officials fear that an EU treaty change could take far too long. That has prompted the search for a faster option.

The plan, which hasn't been finalized, would allow the euro zone to announce a speedy change to its governance. European authorities would gain tough new powers to enforce fiscal discipline in the 17 countries that make up the euro zone, the people said. EU treaty changes could then follow at a later stage.

The precedent that euro-zone governments are considering is the Schengen agreement, under which a subset of EU countries scrapped passport controls at their mutual borders. The EU treaty allows countries to engage in "enhanced cooperation" if at least nine countries agree, circumventing the need for a unanimous treaty change among all 27 EU members.“


(emphasis added)

In other words, this is in a way a test case for getting around the 'unanimity' clauses in EU treaties.


Euro Area Credit Market  Charts

Below is our customary collection of CDS prices, bond yields, euro basis swaps and several other charts. Both charts and price scales are color coded (readers should keep the different scales in mind when assessing 4-in-1 charts). Prices are as of Monday's close. There hasn't been much movement in these charts, but following the Belgian and Italian auctions on Monday, CDS prices and bond yields eased a little bit, almost across the board. An exception were CDS on Greece, which bounced a bit following Friday's sharp pullback.  Likewise, yields on Portuguese and Greek bonds broke to new highs. Portugal's bond market is still subject to  the reverberations in the wake Friday's credit rating downgrade.

What is interesting is that this was enough to cause a pretty strong rally in stocks and commodities. Perhaps it is not really correct to say that the rally was 'caused' by this slight easing in credit stress, but better to say that all these moves are predicated on the same considerations, namely the closeness of the  ECB and FOMC meetings, both of which promise to deliver more monetary easing. Also, markets are quite oversold, so a short term relief rally  should not be too surprising.



5 year CDS on Portugal, Italy, Greece and Spain – click for better resolution.




5 year CDS on France, Belgium, Ireland and Japan – all pulling back a tad – click for better resolution.



5 year CDS on Bulgaria, Croatia, Hungary and Austria – ditto – click for better resolution.



5 year CDS on Latvia, Lithuania, Slovenia and Slovakia – click for better resolution.



5 year CDS on Romania, Poland,  Lithuania and Estonia – click for better resolution.


5 year CDS on Bahrain, Saudi Arabia, Morocco and Turkey – still following their European brethren – click for better 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)  – pulling back from the all time high recorded on Friday – click for better resolution.



5 year CDS on two big Austrian banks (Erstebank and Raiffeisen) – indexed to 100 (to get the prices in basis points, divide the current level by the divisors in the legend). CDS on Raiffeisen have pulled back yesterday after publication of a surprisingly solid earnings report – click for better resolution.



10 year government bond yields of Italy, Greece, Portugal and Spain. Note that Portuguese yields are breaking out. Our long-standing contention that this country would become the next major focus of the crisis is beginning to be borne out – 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. Austrian and Irish yields pull back, but yields on Greek debt continue their inexorable march to ever more absurd levels – click for better resolution.



Belgium's 10 year government bond yield – finally a retreat after yesterday's costly auction – click for better resolution.



Italy's 10 year government bond yield – a small dip after yesterday's auction, but today's bond auction was once again accompanied by rising yields. At the time of writing, Italy's 10 year was just above 7.30% – click for better resolution.



Spain's 10 year government bond yield also dipped on Monday. The next big test will come on Thursday, on occasion of a € 4 billion bond auction – click for better resolution.



5 year CDS on the debt of Australia's 'Big Four' banks – dipping in the wake of the global 'risk-on' rally – click for better resolution.



5 year CDS on China (indexed – divide by the divisor in the legend to calculate the absolute level in basis points) – also a big dip in the wake of the rally in 'risk assets' – click for better resolution.




A few words to yesterday's rally in the SPX back to the vicinity of the declining 50 day movcing average : due to the low volume this wasn't a very convincing rally. However, the possibility that the October rally was only wave 'A' of a developing 'A-B-C' sequence can not be dismissed out of hand. In this case we should expect a rally into year-end. Obviously, much will depend on the to and fro of the backdrop provided by the euro-land crisis and the extent to which central banks decide to adopt further easing measures. We merely want to point out that the case is not clear cut – click for better resolution.



According to press reports, Nomura is the latest financial institution to slash its holdings of European debt.

The AFP reports:

„Japan's top brokerage Nomura said it had slashed its exposure to European sovereign debt amid growing worries about whether the eurozone can resolve its fiscal woes.

The company said it had reduced its Italian debt holdings by 83 percent to about $467 million from $2.81 billion since late September, while also cutting its exposure to other eurozone nations' bonds, including Spain and Greece.

"It's part of our effort to manage our risk profile given the market instability," a Nomura spokesman told AFP on Tuesday.“

Given that so many insitutions are selling euro area bonds, one wonders who (apart from the ECB) is buying? There has to be someone …



Charts by:Bloomberg,



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