Archive - Jul 12, 2011 - Story

Risk-aversion remained the dominant theme during the early European session on the back of fears of contagion to core Eurozone countries from the peripherals. The mood of Eurozone finance ministers tilting towards more flexibility in restructuring of Greek debt, and with the Dutch finance minister not negating a selective default for Greece exacerbated the risk-averse tone. Moreover, an article in the ABC newspaper, citing unnamed sources, that as many as six Spanish banks have failed the European stress tests, including five savings banks and one medium-sized bank, also weighed on sentiment. European equities, led by financials, traded lower in early trade, which supported Bunds as the Italian 10-year bond yield crossed the 6% mark for the first time since 1997. However, a reversal of sentiment was observed as the session progressed, supported by market talk of the ECB and China buying in the European bonds, together with successful T-Bill auctions from Italy and Greece, which observed narrowing of the Eurozone peripheral 10-year government bond yield spreads. Elsewhere, GBP/USD plummeted around 70 pips following lower than expected CPI figures from the UK, which also provided strength to Gilts. Moving into the North American open, markets look ahead to key economic data from the US in the form of trade balance, and IBD/TIPP economic optimism, as well as the FOMC minutes later in the session. In fixed income, USD 32bln 3-year Note auction is also scheduled for later.

• Markets rocked as debt crisis deepens (FT)
• EU Revives Buyback Idea as Crisis Hits Italy (Bloomberg)
• Italy Fears Jolt Markets (WSJ)
• U.K. Inflation Slows in June on Spending (Bloomberg)
• China Money Supply Growth, New Lending Rebound Even After Cooling Measures (Bloomberg)
• Foreign-Exchange Reserves Jump in China (WSJ)
• Corn Slides for Second Day as USDA May Raise Global Inventories Forecast (Bloomberg)

Busy economic calendar with two notable bond auctions out of the US Treasury.

Equities internationally and bonds in Greece, Ireland, Spain and Italy have fallen this morning while gold rose to new record nominal highs in euros and pounds (over EUR1,118/oz GBP980/oz respectively). The Italian 10 year rose above 6% for the first time and the Spanish 10 year yield rose to 6.12%. US stock futures are pointing to losses on the U.S. opening. Irish government bonds have reached a new euro era record high with the 10 year rising to 13.57% - up from 11.6% only 5 days ago. Ireland’s “bail out” is clearly not working as contagion deepens in the eurozone.

As of this morning China has migrated from a purely symbolic European White Knight to an actual one. While overnight trading action was set to recreate the panic from September 15, 2008, suddenly something changed. That something? China. Per Dow Jones: "Bunds give up nearly all of Tuesday's early gains with the September contract just 12 ticks higher on the day at 129.26 after making a spike at 130.91, a gain of 177 ticks from the open. The latest, unconfirmed, rumor pushing bunds lower is that China is behind the supposed ECB enquiries for peripheral debt prices. As yet no official confirmation from market sources of any central bank buying. In the cash space, the 2-year yields 1.235% and the 10-year 2.65%." As China has been actively buying up EURs over the past two months and is now massively underwater on a cost position that may be in the hundreds, but is certainly in the tens of billions of dollars, the ongoing collapse in the EUR currency will now force the PBOC to resort to increasingly more drastic measures to protect its strategic investment. The irony of this is that the Swiss National Bank, which this morning had to watch in horror as the EURCHF plummeted to 1.15 and for the longest time has been fighting the Fed (which loves a strong EUR) has been joined by the PBOC, which is now also trading on its behalf. The First Central Bank War is now officially on.

One of the main catalysts for today's European market action was the Italian 1 year Bill issuance which was supposed to set the tone for Italian bond demand, especially since thanks to ISDA's stupidity (which had made it clear CDS will not trigger in any event as the organization is completely spineless), there is no reason to any longer hedge a negative basis at issuance. Well, Italy did pull it off, although at terms that a month ago would have inspired shock within the market. "The 6.75 billion euro sale was the first test of appetite for Italian paper since a surge in nerves that it will be next to fall in the euro zone's debt crisis due to domestic political tensions and a combination of high public debt and low growth. The gross yield on the 12-month BOT bills rose to 3.67 percent from 2.147 percent at a previous auction in June. This was the highest level since September 2008, according to Reuters calculations on Italian Treasury data. The bid-to-cover ratio fell to 1.55 times from 1.71 in June, when the treasury sold a slightly lower 6 billion euros in total." However, even this data was very suspect after 10 Year Italian-Bund spreads hit a new record wide of 355 bps earlier as the Italian contagion is now fully on. In response, both the ECB and China are now rumored to be scooping up all peripheral bonds in the secondary after a long hiatus as the ECB is on the verge of panicking, side by side with European bond investors, following remarks by Dutch Finance Minister De Jager who said, as predicted yesterday, that a Greek selective default "Is not excluded anymore."

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