All eyes were on Italy early this morning when the country auctioned off €2.99 billion of 4.25% BTPs due July 2014 and €3.75 billion in 5% bonds due 2022, because the ECB, unlike in the secondary market, is not allowed to buy bonds at primary issuance. While it would have been unrealistic to expect a bond failure, the bond levels were watched very closely for signs of deterioration despite over €40 billion of SMP purchases by the ESB in the past 3 weeks. And judging by the reaction (+11 bps in the Italian Bund spread), the market was not very happy with the yields of 3.87% (4.8% previously) and 5.22% (5.77% previously) or the Bids to Cover of 1.32 and 1.27 on the 3 and 10 years, as both slipped following the auction in a market that was very disappointed to see a 5 handle yield on the 10 year. This has set a negative tone to early European trading, with pronounced weakness across markets, and the EURUSD, which has dropped to under 1.44 overnight after trading in the 1.45's late last night. The concern is that even with the ECB buying debt in the secondary market (effectively monetizing), the tail is unable to wag the dog strongly enough, and if the EFSF is not activated soon enough, and expanded significantly, we expect to see the market test the ECB once again, and SMP purchases to soar very soon.
Market reactions to the BTP auctions:
ALESSANDRO GIANSANTI, STRATEGIST, ING, AMSTERDAM
"The auctions were slightly weak, which shows that the ECB must continue to buy bonds on the market to support it. The demand for the 10-year bond was rather weak, with a bid-to-cover ratio of 1.27 from 1.38 at the end of July and 1.33 in June. This (new) bond traded at a discount of around 15 basis points on the market in terms of yield compared with the (current 10-year benchmark) Sept. 2021 BTP, but this was not enough to draw strong demand. The bid-to-cover on the three-year bond was slightly better at 1.32 from 1.31, but the bond was sold for an overall amount which was slightly lower compared with the top of the target range. However it went better for it than for the 10-year bond."
MARC OSTWALD, STRATEGIST, MONUMENT SECURITIES, LONDON
"In size terms they have achieved what they wanted to achieve across the three sales. The yields are basically in line with secondary market levels. The covers are not overwhelming, one has to say. That would tend to suggest the bulk of it has gone into domestic hands.
"There are two ways of rationalising it -- one could say there's some disappointment over the watering down of austerity measures announced overnight. An alternative version would say given the time of year, what do you expect? It's still the holiday season and there's plenty of event risk this week, why would you go charging in?
"Market reaction is probably some disappointment because the cover wasn't brilliant. It wasn't a disaster by any means -- we shouldn't overplay it."
MICHAEL LEISTER, STRATEGIST, WESTLB, LONDON
"The (yield) concession doesn't seem too much out of line. Against the backdrop of the average Italian funding costs over the last five to 10 years this is a level they can feel comfortable with.
"The bid/cover looks a bit weak compared with this year's averages. It will give a reason to those investors who want to sell, but overall we take it as a decent auction.
"The ECB support was clearly crucial. Without the ECB intervention a couple of weeks ago yields would not be trading at this 5 percent level so it might have easily been a full percentage point more.
"The fact that yields remained relatively stable last Friday and more importantly this morning shows indeed that the ECB was successful in stabilising them but the big question is what happens going further."
PETER CHATWELL, RATE STRATEGIST, CREDIT AGRICOLE CIB
"The results look a bit worse than the market was expecting, with the 10-year looking weak with a rather small bid cover ratio. The secondary market action in the existing 10-year BTP is telling of some strain on the market in absorbing the paper, with the current 10-year now yielding 5.12 percent, and Bunds rallying. I think the market is likely to lose a bit of confidence from this auction until 10-year Italy stabilises, which is in the ECB's hands.
DAVID SCHNAUTZ, INTEREST RATE STRATEGIST, COMMERZBANK
"We find it hard to get excited about today's auction being out of the way, as both Italy and Spain have to raise cash twice a month. We find it hard to see genuine investor interest gaining traction as long as the impression is on the front foot that current yield levels are artificially lowered by ECB buying.
"The risk of ECB buying coming to an end at some point, risking a back-up in yields, leaves the risk/reward balance for longs unattractive, if one excludes the ECB stepping in so heavily that 10y SPGB and BTP yields dive towards the 4.50% region."