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Goldman Expects Another 10% Margin Hike For Italian Bonds
Goldman's Francesco Garzarelli has just released a follow up to the "next steps" piece from yesterday (which so far has been woefully wrong in predicting a ceiling to Italian spread). So perhaps this time Goldman will be a little more accurate, which for those who may be buying Italian bunds on the dead cat bounce, will not be a good thing. Here's why: " Should Italian BTPs trade above 450bp relative to AAA-rated EMU sovereigns over a period of time, the initial margin would increase by a further 10%. Currently, the initial margin for repo on Italian securities on LCH ranges between around 4% and 20%, increasing along the maturity structure." The take away from the above - another 10% margin hike is coming. As for those who bought Italian bonds from Goldman yesterday on hope that the bottom is in, better luck next time - as Goldman says "In the meantime, the higher priced Italian government bonds will continue to be sold, as commercial banks raise liquidity buffers as higher margin requirements are applied. On our central case, intermediate to long-end bonds should continue to be supported relative to AAA-rated securities by the ECB." Considering the 5s10s is most inverted since 1994, this is not a very controversial call.
Full Goldman Note:
1. Overview
Markets initially took relief from the news of a change of government in Italy, alongside tighter scrutiny by the EC/IMF of the country’s fiscal policy. As we comment below, it may take up to the end of this month to have clarity on what political solution will emerge from the current crisis. In spite of calls for early elections, we continue to assign a low probability to this outcome. Still, pressures on the front-end of the Italian curve will likely persist until political uncertainty clears, with the ECB continuing its secondary market purchases in what we have previously described as ‘passive containment’ mode.
This morning, London Clearing House (LCH) announced a 5% increase in the initial margin applied on Italian collateral. Should Italian BTPs trade above 450bp relative to AAA-rated EMU sovereigns over a period of time, the initial margin would increase by a further 10%. Currently, the initial margin for repo on Italian securities on LCH ranges between around 4% and 20%, increasing along the maturity structure.
A credible commitment to structural reforms in Italy could result in a speedier (and less controversial) financial support from the ECB and the EFSF. IMF backstop credit lines, reportedly turned down by the Italian delegation at the Cannes G-20, could be reconsidered.
Separate from the European sovereign turmoil, and on a more encouraging note for risky assets, Chinese inflation figures for October were market friendly. Specifically, October CPI inflation fell to 5.5%yoy - in line with market expectations - from 6.1%yoy in September. Further high-frequency data reported by the Ministry of Agriculture suggests food prices have continued to moderate, and we continue to expect November CPI inflation to be below 5%. PPI inflation fell to 5%yoy, significantly below market consensus of 5.8%, from 6.5% in September. This moderation in inflationary pressures creates room for a shift to a more accommodative stance by Chinese policymakers. The China Securities Journal reported overnight that credit policy will remain loose in the fourth quarter and suggested that a cut in the reserve requirement ratio could not be ruled out. The prospect of such policy-driven relief for equity markets was a rationale for our long recommendation in Chinese equities, and the HSCEI index is outperforming the region today (+2.2%).
More broadly, the market appears to be increasingly trying to separate developments in Italy, and sovereign Europe more generally, from underlying macro developments, as Kamakshya Trivedi commented in Monday’s Global Markets Daily. In addition to the above mentioned HSCEI vs. SPX position, we are recommending two further macro-informed tactical trades on the back of these dynamics: (i) Long US cyclical sectors vs. defensives through our Wavefront Growth basket; and (ii) short the iTraxx Europe Crossover index. Separate notes by Noah Weisberger, Charlie Himmelberg and their respective teams expand on the rationale behind these views. Our tactical FX recommendation to position long in SGD and MYR, funded out of EUR and USD, also follows this logic.
2. Italy – What Next?
After seeing his parliamentary majority slide further in a routine vote ratifying the 2010 state accounts, last night Italian PM Berlusconi said he would step down as soon as Parliament approves a new set of austerity measures. These should be unveiled in the coming days and passed by the end of next week at the earliest. The measures, which are expected to include the sale of public real estate and the reform of local services, fall short of tackling more politically charged areas such as pensions and labour market reforms.
Meanwhile, the EU Commission has submitted to the Italian Finance Minister a set of questions on fiscal matters, soliciting a reply in writing by 11 November. Although this request may seem intrusive to some, it is completely in the spirit of the greater fiscal coordination and peer review that the EMU countries signed up to earlier this year. In this context, a delegation of the IMF led by David Lipton is expected to arrive in Rome next Tuesday to kick-start a series of quarterly reviews. Such tight oversight by the ‘troika’ on Italy’s economic policy should raise the chances that reforms will eventually go through.
In a note published yesterday, we set out three possible outcomes at this delicate political stage, with different implications for the BTP market and Italian risk premium more broadly. We summarize our views below.
- The most likely scenario is that, in coming weeks, the current centre-right coalition of the Northern League and PdL makes an attempt to rally round another PM candidate who can gain wider acceptance domestically and internationally. In order for this strategy to succeed, the new government will need to win support from smaller centrist parties (and those MPs who have left the PdL in recent weeks). The newly appointed Cabinet would need to prove itself, and reforming the pension system could meet resistance from the Northern League. Still, it would be hard for the ECB and Italy’s EMU peers not to stand by a new Italian government should it genuinely try to pursue reforms. Under this scenario, thanks to the ECB’s interventions, we would expect BTPs to remain capped at around current levels (450bp) over the average of Germany, France and the Netherlands until measures are approved.
- The second most likely scenario is one where the centrist MPs turn down the offer to join a broader coalition. In this case, more MPs from Berlusconi’s PdL party could join forces with formations at the centre of the political spectrum. This could pave the way for a government of national unity of sorts, led by a highly reputable ‘outsider’. From the experience of the early 1990s, the advantage of such ‘technocrat’ solutions lies in the ‘initial contracting’ on the legislative programme (economic reforms agreed with the ‘troika’, better governance through constitutional rules, a smaller public sector, a new electoral law, could all be chapters of such contract), reducing the risks of implementation. We view this as the most market-friendly outcome. The front-end of the sovereign curve would re-price more than intermediate- and long-term maturity bonds, because investors would likely take advantage of the rally to reduce exposure at higher prices. Nevertheless, we would expect 10-yr BTPs to fall to around 350bp over Bunds in fairly short order.
- A third possible scenario involves early elections. These could be held in mid-January at the earliest, although they would most likely be postponed until the Spring amid market turmoil and pressures from EMU peers to strengthen public accounts. This would represent the worst-case scenario for markets, but it is also the least likely in our view. Conscious of the adverse market implications, President Napolitano will probably try to resist dissolving Parliament at this juncture. Also, most centrist parties have openly stated that they want to change the electoral law before a new vote takes place (and a referendum to scrap the existing law is expected to take place next year).
All three scenarios will take some time to play out, a couple of weeks at least. In the meantime, the higher priced Italian government bonds will continue to be sold, as commercial banks raise liquidity buffers as higher margin requirements are applied. On our central case, intermediate to long-end bonds should continue to be supported relative to AAA-rated securities by the ECB. In conclusion, we are most probably approaching the highs in Italian yields (currently over 500bp over German Bunds in the bellwether 10-yr sector, and 640bp in 2-yr maturities), but a volatile and unsettled market remains our base case until Italy’s sovereign creditors can be reassured that long awaited structural reforms to lift the country’s growth rate will be put in place.
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Liquidate bitchez
This is absolutely the wrong move from clearnet. Italian bond shorts need to be punished for de-stabilizing the world economy and banking system. Clearing houses and exchanges need to massively REDUCE margins to relieve the longs and enable a short squeeze that the doomers will never forget. Smart-arse libertarians and doomers need to feel some of the pain that they are inflicting on financial equity investors across the globe.
MDB, I have to admit when I read your posts, I'm picturing an older dude who has stacks of cash and PMs, laughing his ass off as he types these posts.
His employer Dimon wouldn't be pleased if it were true.
;)
How about they compromise?
Increase margins for shorts and decrease margins for longs.
In fact, they could pay a premium to longs!
Money (fiat) is no object.
Makes a s much sense as anything else these tools do.
I think they should rise to eleven. By the way, Happy Nigel Tufnel Day 11/11/11
I got to admit, MDB is a good troll, very professional.
nothing more than I want for goldman to go to $2.
It couldn't possibly have anthing to do with Italy( or any other govenment) living beyond their means and borrowing more than they should be.
LOL. :-)
Will MoMo show up today, or did he imagine seeing this train coming ?????????
I for one, wish that GS would just shut the fuck up altogether.
Expect them to ease promptly or lower, not hike.
yeah, raising might be the prudent thing to do, but Merkozy probably has some flunkie calling them to lower it
Loving my purchase of FAZ yesterday...
Be careful. BTFD'ers are out and cranked up on coke and Red Bull.
what has been written by gs will become reality
...not until they pocket the market's overreaction to their 'statement.' That's the GS way, n'est-ce pas?
Goldman and other ECN members who create this volatility to profit from it , I wish them to spent there money not on Ferrari's but on Cancer drugs .
Theres no one left to 'profit' from anymore.
The Shithawks are circling...big, greasy, dirty Shit hawks.
When the EU eases the Germans leavses.
OT: On a day like this wouldn't you expect a little riot cam action? Yeah, me too. This from London student protests today.
http://www.bbc.co.uk/news/uk-15659527
The whole world is only on fire and rioting....what could possibly go wrong?
Go wrong? No no no, nothing to see here. Please carry on.
I wonder how many fresh shorts will jump on this down swing just to get squeezed out by the fed in a few days.
I wonder how many longs just got their stops slammed.
Works both ways, just as good either way and its all the same color money.
Longs have stops? News to me.
Well maybe they dont, in which case they take the whole salami bent over.
Special request ZH, Today should qualify for the "deer in the lights" photo. Cracks me up every time. Just when the MO-MO monkeys grew a pair and backed up the hi-beta truck to make up for missing the OCT dead cat bounce, they get their asses handed to them!
Y'all do realize that there may be no shorts involved in this at all?
It's just owners of bonds selling to people who don't really want to buy.
Yea, wel Ive been commenting for a while on the 'Short Squeeze' articles that I doubt it...if anything its the FED short itself.
'Owners of bonds selling to people who dont really want to buy'...yep, you.
Nod.
I smell a Europe that has to decide far sooner than they imagined whether or not they will print or die. The other choices of bullshit gradual austerity or country ejection just left town.
Which is why lowering the margins would have no effect. No one wants this crap, much less to lever up on it.
Leverage is an absolute bitch when markets are in deflation and it doubles down when margin requirements are increased.
Welcome to the party, Italy..
This is a script for an absolutely terrible movie.
A liquidity event is coming because so many participants are nominally bankrupt. Not only are most banks nominally bankrupt, I think a few central banks are also nominally bankrupt.
I say nominally because we have mark to 'make believe' accounting as opposed to mark to market accounting.
Enron has got nothing on these guys or Bernie Madoff.
Next:
1. Europe will impose a well-intentioned ban on raising margin requirements.
2. Anyone's guess.
We have a few days left until total collapse. Proceeds of Bernanke's weekend fund-raising bond and "whatever-else fire sale" to raise cash went to the Big Eurobanks so they can buy Greek & Italian bonds to keep the price up. When Italy and Greece absorb all this excess cash, then we're back to making $$ out of hot air, and this has stopped working for now. I expect the real panzerkrieg to start next week....but check with Elaine Garzarelli first. Need a trillion euros? Just a book-keeping entry, eh ? How about some cat food ?
Yep, just a book keeping entry until it can be tied to any wealth left in the hands of the middle classes. All depends on your perspective.
Got portable property?
The turnip is in the vise, and the screw is being tightened. This story won't go away, anytime, soon.
http://georgesblogforum.wordpress.com/2011/11/02/the-daily-climb-2/
Thanks TD!! I bought puts on BLK yesterday morning after you metioned this on Monday!!
This must be helping French bonds. What metals are used in automatic weapons rounds? I'm thinking about BETTING THE FUCKING FARM ON BULLETS OR THE METALS THEY CONTAIN.
"It is not difficult to rule Italy," Benito Mussolini once said, "it is useless."
The European Central Bank, the only effective bulwark against market attacks, wasted no time intervening to buy Italian bonds in large amounts.
"The ECB is buying aggressively," one trader said.
Italy has replaced Greece at the center of the euro zone debt crisis and is on the cusp of requiring a bailout that Europe cannot afford to give.
Unlike Greece, an Italian default would threaten the entire euro project. EU treaty changes could take a year or more. Rome does not have that much time.
DOW chart reveals very overextended price action and another Wile E Coyote scenario...
http://stockmarket618.files.wordpress.com/2011/11/2011-11-09_dow_4_zb.png
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