Overnight Tensions Eased As Italy Sells 5, 10 Year Bonds
With little on the event calendar in the overnight session, the main news many were looking forward to was Italy's auction of €2.5 billion in 5 and €4 billion in 10 year paper, to see just how big the fallout from the Hung Parliament election was in the primary market. As SocGen explained ahead of the auction: "The target of Italy's 2017 and 2023 BTP auction today is a maximum EUR6.5bn, but in order to get to that tidy amount the Tesoro may be forced to offer a hefty mark-up in yield to compensate investors for the extra risk. Note that Italian 6-month bills were marked up at yesterday's sale from 0.731% to 1.237%. Who knows what premium investors will be asking for today for paper with the kind of duration that is not covered by the ECB OMT (should that be activated)? Will Italian institutions, already long BTPs relative to overall asset size, be forced to hoover up most of the supply?" The outcome was a successful auction which, however, as expected saw yields spike with the 4 year paper pricing at 3.59% compared to 2.95% before, while the 10 Year paper priced some 60 bps wider to the 4.17% in January, yielding 4.83%.
The result was a brief dip in Italian OTR BTP yield, which have since retraced all gains and are once again trading in the 4.90% range on their way to 5%+ as JPM forecast yesterday. And as expected, talk promptly emerged that the auction was carried by "two large domestic buyers" in other words, the two big local banks merely levered up on Italian paper hoping furiously that they are not the next MF Global.
Continuing with SocGen's recap of the situation on the ground in Italy: "In the meantime, the political situation on the ground is far from being resolved and new elections cannot be ruled out. Before it gets to that, efforts will concentrate on forming a centre left government but that will be easier said than done especially in the upper House. Monti stays in charge until the new government is appointed, but given the conditionality attached to the OMT, it is unclear whether the ECB is still in a position to backstop should the crisis linger on. President Draghi may choose not to comment on the situation in a speech in Bayern today."
In other news, Italy business confidence rose before the Italian election from a revised 88.3 to 88.5, even as the brilliant visionairies at Moody’s said Italy's election is credit negative.
Elsewhere, ECB’s Praet said that accommodative policy could lose effectiveness:
“I am referring to what used to be known as ‘instrument instability’ in policy-making,” Praet said in a speech in Frankfurt today, according to a copy provided by the ECB. “The need to apply larger and larger doses of the same policy interventions only to see their macroeconomic influence becoming more and more tenuous.”U.K. Q4 GDP shrank 0.3%, or as much as expected, on trade, weak domestic demand, as the BOE is inches away from joining the mega print global reflation attempt.
Finally, Commerzbank said it has repaid in full its €6.2 billion from the second LTRO, in the process stigmatizing all other banks who haven't done so.
And the comprehensive recap from DB's Jim Reid:
One can't help wondering whether the Italy election represents a triumph for the notion of democracies or alternatively whether it shows that in an era of incredibly tough choices, such a system is doomed to deliver highly unhelpful outcomes. Maybe in this circumstance much depends on whether you think austerity is a necessary evil or whether you think it’s been an unmitigated disaster. Mr Monti was put in place as a democratic outcome was seen as unlikely to yield the policies designed to keep Italy within the Euro but many believe his policies have helped cause one of the worst recessions in living memory in Italy and it’s not
surprise to see the voter rebellion.
Europe needs to take this rebellion very seriously and maybe think about its policies going forward. If it wants to keep the Euro as a going concern over the years ahead it may need to find a way of easing off on austerity whilst simultaneously finding a way for the ECB to be distributing more non-conditional liquidity. A difficult balance.
Our European economists write that with no workable majority in the Senate, the most likely outcome now is a “caretaker government” which – at best – will come up with a new electoral system. As it currently stands though, the centre-left’s Bersani has indicated that he will at least try to form a government, but without mention as to which political groups he will reach out to. Yesterday Bersani called on all his opponents, including Berlusconi, to back a five-point programme of political reform, easing of austerity and job promotion. Angelino Alfano, of Berlusconi's centre-right People of Liberty party, indicated that weeks of tough negotiations lie ahead before a new government takes office, possibly in late March.
What worries us is that the weeks and possibly months of uncertainty that lay ahead may stifle any confidence within the Italian economy and hold back the recovery. This would be very unwelcome news but it’s a realistic concern if no solid Government can be formed.
On that note, S&P and Moody’s released statements overnight commenting that while there is no change in Italy’s BBB+/Baa2 credit ratings just yet, the elections have underscored that risks to carrying out structural and fiscal reforms are substantial.
In terms of the markets, we had a significant risk-off session in Europe which saw Italian assets underperform while gilts and bunds rallied. 10yr Italian bond yields added another 41bp to close at 4.896% in its weakest one day performance since December 2011. As it stands now, 10yr yields are about 77bp off the January lows but still about 170bp lower than the peaks of summer 2012. Italian equities had a similarly weak day, testing the -5% level early in the session before closing just off the lows (-4.89%). European credit indices were also under pressure with Main (+9bp), Crossover (+34bp) and Financials (+17bp) all gapping wider on solid volumes. Perhaps the outperformer on the day was EURUSD which managed to hold at around 1.306 and finished broadly unchanged.
With this context it was impressive to see the US rally yesterday, especially after Europe closed. US markets hit a bottom just as European markets closed yesterday.
Indeed, the S&P500 was a nursing a loss of -0.2% at the time of the London close, and from there the index added 0.8% to close with a pretty respectable 0.6% gain. Bernanke offered a robust defence of the Fed’s asset purchases before the Senate Banking Committee, reiterating that inflation risks were subdued and that monetary policy was contributing to the economic recovery. Indeed, his defence was so robust that Reuters described it as coming from someone who “doesn’t plan to seek Senate support for a third term” (Reuters). As DB’s Joe LaVorgna characterises it, the bottom line is that Bernanke remains dovish. While Bernanke did not specifically address the question of where he stands on the possible need to taper the rate of monthly QE purchases, there was nothing in his remarks to suggest he is ready to change at this point.
All ten S&P500 industry sectors finished the day higher led by cyclicals and retailers – the latter helped by a 11pt rise in consumer confidence (69.6 vs 58.4 prior and 62.0 expected). Outside of the consumer confidence print, it was a solid day for US data overall with the Case-Shiller index (+0.88% vs +0.65% expected) and new home sales (+15.6%mom vs +3% expected) surprising to the upside while FHFA house prices were in line (+0.6%). Equities were also given a boost by index heavy-weight Apple, which bounced 2.7% off the session lows on reports that the tech-giant could announce a stock split at its upcoming shareholder meeting.
With the positive lead from the US, Asian markets are trading with a positive tone overnight. All major bourses are trading higher this morning with the notable exception of the Nikkei (-0.9%) which is lagging ahead of the official nomination of the BoJ governor and deputies expected by the end of the week. USDJPY is marginally lower at 91.98 and the region’s credit markets are trading around 1-2bp tighter on the day.
While Europe frets over the Italian stalemate, we should also note that we are a couple of days away from the point where the US budget sequester comes into effect (March 1st). We may get an update on where things stand today with reports suggesting both the Democrats and Republicans are preparing rival bills to replace or delay the sequester, to be voted on by the Senate on Thursday. According to the Hill, the Republican plan would maintain the level of spending reductions but give the President more flexibility to minimize their impact on government services. The Democratic package, meanwhile, would delay the sequester through to the end of the calendar year and offset the $110 billion cost with a mix of spending cuts and tax increases.
Turning to the day ahead, Italy will be testing investor appetite with a EUR2.5bn 5-year and EUR4bn 10-year auction this morning. In terms of data, euro area economic sentiment and consumer confidence in France and Germany are the main prints. Across the Atlantic, US durable goods and pending homes sales are scheduled. Bernanke speaks again at the House Financial Services Committee at 3pm London time, but we would expect that Fed Chairman will add little to his Senate testimony yesterday.