The MF Global Trade Is Not Coming To (European) Town - Why The ECB's 3 Year LTRO Is The Latest Bailout Flop
On Friday, as the Eurobond market was briefly soaring, we attributed the move to sentiment that was best captured by a note out of Morgan Stanley's govvie desk: "The carry trade is happening, there is no doubt about it. In SPGBs (45bps tighter t0) we estimate 15-20bn (incl 6bn auction) of buying from domestic mid sized banks and cajas THIS WEEK (500mm is usual 2way trading volume per day). We are seeing the same starting with Italian mid tier banks in BTPs today (35bps tighter t0). Also Ireland seems to be very well bid up to 2016 maturities (75bps tighter on day). While Huw and Laurence anticipated this in their research piece on the LTRO from yesterday, we certainly did not expect it to be this intense and front loaded, this is the strongest buying we have seen all year, it feels a lot like QE." In simple summary, what MS was hoping and praying (because if clients are buying, MS is selling) its clients would believe, is that European banks would promptly forget that Europe has trillions of rolling over financial corporate debt, and instead of focusing on generating the cash needed to pay down maturities if no buyer stepped up, banks would somehow re-lever, by buying up even more sovereign debt in hopes of catching a few bps of carry, and completely ignoring the "#1 issue at the heart of the Eurozone crisis"TM - the fundamental supply/demand paper maturity mismatch. Not to mention that any statement which needs the redundant "there is no doubt about it" is a 100% lie. It took the market about 3 hours to wake up from its zombified state and to do a 180, proceeding to rapidly sell off European debt following the realization that the Morgan Stanely thesis is nothing but a purely self-serving lie. The folks at Reuters IFR explain why MS completely botched this one up, and why Eurobanks are finally starting to wake up to the realization that the MF Global trade just may not be coming to town.
But first, some more from Morgan Stanley's attempt to urgently push clients into European paper:
Between now and 2012, the ECB's first 36 month tender allotment on December 21 will be a key event. We believe that the ECB's package of supportive measures significantly reduces the tail risk for euro area banks; and there could be a surprisingly large aggregate take-up at the December and February's tenders combined, which could put a significant dent in Spain's (and to a lesser extent Italy's) 2012 funding needs (see 3 yr LTRO: policy support just for banks or sovereigns too? , December 15).
While we wonder why the sudden urgency by MS to dump European paper before its fiscal year end (after all, like Jefferies, Morgan Stanley has repeatedly told everyone who cares to listen it has zero net European sovereign and bank exposure... As for gross, well that's a different story), we will leave that for another day. What is more relevant to the topic at hand is the refutation of the fundamental logic in the Morgan Stanley meme, which was incorrectly parroted by various C-grade media as a real deus ex, by IFR, as follows.
Banks are unlikely to come to the aid of debt-ridden eurozone countries, with many planning to ignore political pressure to use cheap money from the European Central Bank to fund purchases of sovereign bonds.
With eurozone governments needing to sell almost 80 billion euros of fresh debt in January alone and bond yields rising by the day, the stand-off between policymakers and banks could turn Europe's slow-burning debt crisis into a full-scale conflagration in the New Year. Burned by Greek losses, and under the scrutiny of shareholders, banks have slashed their exposure to weaker European sovereigns over recent months. Senior bankers say they will cut further, despite pressure to use newly available, longer-term ECB loans to buy government debt as part of an officially-sanctioned carry trade.
Here is the quote du jour which will be making the rounds around trading desks on Monday:
"When investors are constantly asking what you have on your books and the board is asking you to reduce your exposure, it doesn't really matter about the economics of the trade," said the treasurer of one of Europe's biggest banks. "Am I going to buy Italian bonds? No."
Bingo. And it gets worse, because when one of the biggest double downers, the head of UniCredit itself, a bank long known for dollar cost averaging in failed BTP bets, says Basta, it's time to get the hell out:
That view echoes comments from UniCredit chief executive Federico Ghizzoni, who this week told reporters at a banking conference that using ECB money to buy government debt "wouldn't be logical". The bank had traditionally been one of the biggest buyers of Italian government bonds, with almost 50 billion euros on its books.
So to all those who say the LTRO has magically been ushered as the European bailout mechanism, we counter with the following which promptly destroys any arguments to the contrary:
[R]ather than use money raised via the ECB to buy government bonds, bankers say that they are more likely to use the funds to pay off their own debts.
"I can't think for a moment why anyone would want to [buy eurozone government debt]," said the head of capital markets at one European bank that is also reducing its exposure to eurozone sovereign bonds. "Everyone is trying to protect capital. It's counter-intuitive. It would be digging a deeper hole for yourself." "Banks need this liquidity to get them through the wall of refinancing they are facing next year. That's where the money is going to go." Such attitudes will come as a major blow to European policymakers, who had been hoping banks would use ECB money to profit from the carry trade, helping governments in the process. "Each state can turn to its banks, which will have liquidity at their disposal," French President Nicolas Sarkozy said after last week's summit of leaders.
And there it is - despite hopes by the central planning authority that they always know what is best, the market has finally awoken to what we have long dubbed the #1 intractable mathematical problem in Europe - one of too much supply and not enough demand. This is, as we dubbed it, the European Death Spiral, although Debt Spiral works just as well - the issue is that there is €2.5 trillion in deleveraging coming due in the next few years, and by using an ECB facility to relever even further goes against the whole premise of said "deleveraging"
Everything else is smoke and mirrors.
And for those in doubt, we will get the answer one way or the other soon enough:
Bond sales in the New Year will be a big test of whether the strategy will work. In the first quarter alone, Italy plans to sell around 50 billion euros in fresh debt and Spain 21 billion euros. If Rome is unable to find buyers for its debt, that could jeopardise the payment of 28 billion euros of maturing debt on February 1 and a further 16 billion euros on March 1. Spain doesn't have any major redemptions in the first quarter.
"It's potentially going to be very very challenging," added one debt banker who is involved in the New Year sovereign debt sales.
"While steps are being taken, the crisis is far from over," added Mark Schofield, an analyst at Citigroup. "There is ample scope for rewidening as the market gets ahead of itself and as each bubble of optimism is pricked by reality. At the risk of sounding like a broken record, things will get worse before they get better."
Perhaps that explains why, now that its latest bluff has been called, Europe has fallen back to the trusty old standby: we have just learned that Euro ministers will hold debt crisis phone talks on Monday. And that, as everyone knows by now, is the cue to sell.