bonds

Ralph Atkins

A debt restructuring in Europe “is not in the plan,” Jean-Claude Trichet, European Central Bank president, has just told Bloomberg Television. The ECB would certainly hope that was not the case – it would worry about contagion effects.

But Mr Trichet’s choice of words did not appear to rule out the possibility in every eventuality. Perhaps that was wise: the consensus among financial market economists is that the level of Greece’s public indebtedness makes some kind of Greek rescheduling inevitable in coming months or years.

The ECB’s thinking towards Greece etc has not necessarily changed, however. Read more

Strong demand for today’s eurozone bond issue, priced at a yield equivalent to 2.89 per cent. Hardly surprising. For exactly the same risk profile as German bonds, you get half a percentage point extra payment per annum for your money. (48 basis points, to be precise.)

The news is being greeted as a vote of confidence in the eurozone. Likewise, Japan’s pledge to buy at least 20 per cent of the bonds was treated as an offer of support. Klaus Regling, EFSF chief, said: “The huge investor interest confirms confidence in the strategy adopted to restore financial stability in the euro area.” But does it? Really?

Surely hard-headed profit-seeking is a more plausible explanation? After all, a vote of confidence would be investors buying Portuguese, Greek or Irish bonds; whereas here they are buying bonds backed in full by Germany. The legal framework of the EFSF makes clear that member states are each independently liable for debt issued, up to their maximum commitment. The only exceptions are countries currently “stepping out” (Greece; Ireland) and those that have not yet signed up in full (recent euro-joiner Estonia). See the table below. Read more

And down they go again. A mere €146m ECB-bought bonds settled last week, following a bumper, €2.3bn, week the week before. As serious discussions began about enlarging the funds or the mandate of the EFSF, markets calmed and government bond yields fell, requiring less intervention from the ECB. Relatively speaking, however, bond yields remain high.

One idea floated at the discussions is that the EFSF will be allowed to lend money to sovereigns to buy back their own debt.

In June last year, the Bank of New Zealand issued the country’s first covered bond – securities backed, for example, by mortgage payments. (So the bank, receiving loan payments, in turn issues debt, receiving cash for that and allowing them to lend more.) Seven months later, the central bank has already seen fit to limit issuance of these bonds to 10 per cent of a bank’s total assets.

The practice allows a bank to increase leverage. The popularity of this and similar leveraging techniques in the US and Europe has been blamed for difficulties faced during the credit crisis. Complex interdependencies are created by reselling debt, repackaging it or simply issuing new debt on the basis of cashflow from other debt. Read more

China and Russia sold off substantial amounts of US debt during December – a month that saw the biggest treasuries sell-off since the collapse of Lehman’s. Market commentators entered denial mode: this was “not necessarily the start of any particular trend,” said one. “It’s too early to infer that China is shifting its diversification stance,” said another.

All this denial suggests the market is waiting for bad news – a theory backed up by volatility futures, which suggest a great deal of volatility is constantly expected roughly two months away. Whatever the date, Bad News is due in roughly two months’ time (these are VIX futures, and yes, you can buy a future on just about anything). Are these connected? Here’s one theory.

US borrowing costs have been kept artificially low for years, thanks to demand for US treasuries by world investors. The fact that the dollar is a reserve currency, and is considered safe, has kept demand for the debt high even when it is not a profitable investment. The normal laws of supply and demand are distorted. The people buying and the people selling are doing so for different reasons.

This asymmetry should be a cause for concern. Read more

Belgium looks set to raise less debt than initially thought despite the fact the auction was shifted from the open market to a syndicated deal through the banks. Reuters reports €3bn is due to be raised, against earlier discussions of €4-5bn:

Market participants are starting to express disappointment with the progress of Belgium’s 10-year syndicated deal, where final terms have been set at Eur3bn to price at +93 bps over mid-swaps. For reference this contrasts earlier talk of shooting to raise EUR4bn or more likely Eur5 bln, from original (and still cheap) guidance of +90/93 bps. More worrying is how the deal reportedly neared Eur7 bln of orders, and now is talked for a book of only Eur6 bln.

Spain also shifted from auction to syndicated deal this week, which renders the chance of auction failure very low by shifting – at a cut – the fund-raising responsibility onto a group of banks, who then in turn lend to the sovereign. It’s a relatively safe option that can lead to larger deals, as lenders feel more confident lending to several institutions than just to one.

Back to Belgium, is the ECB planning to combat the country’s rising yields? Read more

Research from the Bank of Japan argues that we are seeing a multiplier effect in capital flows between emerging markets and the US, and its reversal could cause a very sudden upward correction in US government bond prices.

The argument runs along these lines: investors seeking high returns have caused large capital inflows into emerging markets, causing forex intervention and leaving governments with stockpiles of US dollars. Those dollars are then invested in US treasuries, reducing the yield and making it cheaper for US investors to borrow – and to seek high returns in emerging markets. Repeat.

While no direct mention is made of the Fed’s recent $600bn stimulus, Read more

€2.3bn government bonds bought by the ECB settled last week, taking the emergency assistance back up to levels last seen during the Irish bail-out. Many of the bonds bought are likely to have been Portuguese, in particular during its debt auction on January 12 at which bond yields fell.

The value of bonds settling last week was 20 times that of the week before. Yields have been extremely volatile of late in struggling eurozone economies, including the “periphery” and Belgium. The cost of Greek and Portuguese debt is still falling following the latest interventions and market-calming discussions, but yields in Spain, Italy and Belgium are all rising once again.

An ECB council member has pointed out the possibility of bond-buying duties shifting entirely to Europe’s rescue fund. “That would be one way to have additional flexibility that at times might be found useful,” Cyprus’ central bank governor Athanasios Orphanides told Bloomberg. Senior French officials say they back the plan, though Germany – the fund’s biggest contributor – remains reluctant.

The six AAA-rated euro member states are apparently meeting to discuss the rescue fund in advance of a wider eurozone finance ministers meeting this afternoon. As well as changing the fund’s mandate to allow the purchase of bonds, one change under consideration is simply to increase the reserves at the fund’s disposal. But Austria’s finance minister has called instead for efficiency improvement and sees no “acute” need for an enlargement, while Slovakia’s PM would prefer an increase in the ECB‘s capital, saying such a move would be “more systematic”.

The EFSF can call upon €440bn at present – a sum inspiring “shock and awe” initially, but now considered “too small“. But in practice only about €250bn could be drawn down without risking a downgrade to debt issued by the facility. One way to tackle this, as FT Alphaville pointed out today, would be to accept a downgrade for the fund’s debt. That way, all €440bn could be used. Alternatively, the EFSF could issue tranches – debt with different ratings. Read more

Portuguese and Irish government debt have again been on the ECB’s shopping list – which would appear to exclude Belgian debt, where yields are still rising. Traders report the ECB buying Portuguese and Irish debt, though there might easily be other countries. This suggests the ECB’s bond buys will rise considerably from purchases settled last week – a mere €113m.

Bond yields have been tempering in Portugal, Greece, Ireland and Italy – and also, belatedly, Spain, which bucked the trend yesterday by rising while other yields were falling. This suggests either that markets are less stressed, or that ECB purchases have been large enough and diverse enough to bring bond prices up/yields down through simple supply and demand. Read more

Ireland’s fate should be a cautionary tale to those pushing Portugal towards a bail-out. Ireland’s bail-out – arguably not needed – didn’t work.

Government bond yields – a measure of market stress – rose above 8 per cent, and Dublin found itself inundated with offers of cash. This unlimited funding should have been enough to reassure markets, but it was not, proving a cash shortage was not the problem. Politicians ignored this, and the offers became more insistent. Ireland accepted a loan, but markets were unimpressed and yields stayed above 8 per cent. A month later, yields returned above pre-bail-out levels of about 8.4 per cent. Now they are nearer 9 per cent. The Irish bail-out was misdirected, targeting the symptom and not the cause. Bond markets were worried about bondholder rights, not a cash crunch. Making cash available while remaining vague on bondholder rights was a mistake. Read more

The Swiss National Bank no longer accepts Ireland’s government bonds as eligible collateral in its repo operations. It’s probably not earth-shaking for holders of Irish government bonds, following earlier margin calls on these assets by LCH.Clearnet last year. On the other hand, it’s an interesting window into how at least one European central bank is taking care over its collateral, unlike a few others we could mention.

Modifications to the SNB’s collateral baskets over the last year emerge in this little spreadsheet (Excel file). Several other Irish-domiciled assets also became nicht Repo-fähig in late December 2010, around the time Ireland lost its last AA- credit rating. Anglo Irish medium-term notes, Depfa bonds, etc.

The SNB’s eligible collateral criteria require that securities posted for repo have this AA- rating and that their country of domicile also bears the same rating, which seems open and shut. Until you read that the bank can make exceptions for sovereign securities rated below AA-.

 Read more

The Irish cost of debt is now above the levels that prompted the bail-out. Yields on ten-year bonds closed at 8.4 per cent on Friday and rose higher today. On November 23, yields of about 8 per cent prompted the bail-out (and then rose higher…).

There are further signs of tension in Ireland, which it seems the bail-out has done little to allay. First, a £10bn swap was set up on Friday between the Bank of England and the ECB in order to provide Irish banks with sterling liquidity that they might otherwise struggle to find.

As the ECB worries about Irish bail-out legislation, and the EU rushes to raise the cash, bond yields in Ireland, Greece and Spain seem to mock these administrative efforts; the latter two again at record highs.

If the legal status of euro area bonds were the major cause of market nerves – rather than Ireland’s fiscal Read more

After reaching a modest Ireland-crisis-high of €2.7bn last week, the ECB’s bond purchases have fallen sharply to €603m. With the cost of debt in Spain and Greece again reaching record highs, is this sort of quantity enough?

Many will say not, especially after bond purchases during the Irish bail-out were revealed last week to be just €2.7bn. What with the bail-out panic and the ECB quadrupling the minimum bond purchase size from €25m to €100m, most had expected a far larger increase in the central bank’s shopping bill. Of course, bearish markets can be subdued with large rumours instead of large purchases – but it’s not a strategy that can work for long.

It jumped last but – not to be outdone – Moody’s has slashed five notches off its Ireland rating, taking it to Baa1 (which is equivalent to Fitch’s BBB+ and about three notches above junk). They’ve also slapped a negative outlook on it, meaning a further downgrade is likely in the next two years if there is no improvement. A multi-notch downgrade was likely – the ratings agency said so itself – though it has come relatively late in the game, after similar cuts by S&P and Fitch.

S&P now offers Ireland the highest rating at A, two notches above Fitch and Moody’s. Under the original ECB collateral requirements of A-, this would mean Ireland’s bonds could still be used – just – as collateral at the central bank. As it is, the “temporary” lowering of collateral requirements to BBB- is still in force, so Ireland need not worry. (As with Greece, the ECB would probably make an exception for Ireland even if its ratings were cut below this level.) Read more

The ECB’s controversial bond buying programme continues to increase, in spite of vocal opposition from high profile figures such as Axel Weber. Last week, €2.7bn eurozone bonds settled – thought to be almost entirely government debt of struggling economies such as Ireland and Portugal.

Perhaps surprisingly, the figure rose following the Ireland bail-out: last week, €2bn settled. The number remains modest compared to the start of the programme, during the Greek crisis, when in one week €16bn bonds were bought. Read more

European officials are considering measures to overhaul the eurozone’s €440bn rescue fund, including using it to buy bonds of distressed governments, say people involved in the deliberations. The changes would make it easier to aid debt-burdened economies without resorting to fully fledged bail-outs.

Buying bonds of distressed countries to lower their borrowing costs is currently only being employed by the European Central Bank, a policy that has proved controversial. Read more

Robin Harding

The NY Fed has announced its tentative schedule for bond purchases through to mid-January. The Desk plans to buy $105bn in Treasury securities. Two observations:

(1) It’s a little less than expected. The $75bn related to QE2 is unchanged, but the schedule includes only $30bn for reinvestment of mortgage prepayments, less than the $35bn a month predicted as of the beginning of November. That suggests the rise in 10-year rates is already affecting the NY Fed’s forecast of mortgage prepayments. I’m trying to find out a bit more about this but with an FOMC meeting next week I doubt the FRBNY will be especially forthcoming. Read more

Both the Federal Reserve and the ECB are now purchasing government debt in large scale. Yet neither of them seem at all eager to admit that they are doing anything unconventional with their monetary policy. In fact, some of the recent statements by both Ben Bernanke and Jean-Claude Trichet are not as straightforward and transparent as they might have been.

In the US, this is probably because of the risk that Congress might actually intervene to stop the Fed from “printing money”. Therefore the Fed has started to make narrow technical arguments which obfuscate what it is really doing. In Europe, the ECB has a strong historical dislike of monetising government deficits, and fears that quantitative easing might be declared contrary to their legal obligations. Therefore they draw very fine distinctions between their actions and US-style QE. In the long run I think that both central banks would be better advised to tell it exactly as it is.

Mr Bernanke has recently claimed that the Fed’s current policy should not be described as “quantitative easing”, a claim I disputed in this earlier post. Over the weekend, he defended the Fed on the grounds that the central bank was not printing money, which has been the accusation levelled at him by many of his Republican critics. Is Mr Bernanke’s claim accurate? Read more

European Central Bank action to calm tensions in eurozone bond markets must remain firmly controlled, otherwise the euro’s monetary guardian risks “losing everything we have”, one of its most ­senior policymakers has warned.

Mario Draghi, Italy’s central bank governor, says in an interview with the Financial Times that large-scale purchases of government bonds could threaten the ECB’s freedom to act without political interference and break European Union rules. Read more