Spanish Bond Yields Fall On LTRO Deus Ex Hopes

Tomorrow's LTRO is now the latest deus ex out of Europe soon to become a bust ex machina. With consensus for Europe's TLGP operation, which the wildly optimistic ones equate with a Risk On facilitating carry trade expansion facility, at roughly €250, some banks have indicated just how desperate they are and outlier estimates such as those from Citi and RBS see allottment hitting as much as €550 billion. As explained previously so many times, a carry on trade presumes incremental leverage and loading up on even more sovereign debt, something even bank CEOs have said they can no longer afford to do, and furthermore as Exane explained "analysts question whether banks will heed Sarkozy’s suggestion they use the LTRO to finance euro-area governments; it is no substitute for QE." Ironically, by letting the ECB off the hook, for the time being, the LTRO being misperceived as a QE equivalent is making Europe's reality even more difficult as it has greatly weakened the case for Draghi printing. And that is the only thing that can help Europe, if only in the short- to medium-term. But for now, with one day left until the latest Christmas illusion is shattered, we had some great news out of Spain which managed to place 3 and 6 month bill at plunging rates.

Here is Reuters explaining yet again the short-term dynamics of European debt markets:

Demand from banks at the three-year tender is expected to be around 250 billion euros, according to a Reuters poll, although forecasts ranged from 50 to 450 billion, indicating a high degree of uncertainty.

Italian 10-year government bond yields were last 13 basis points lower at 6.74 percent, narrowing the spread over Bunds to 481 bps. Equivalent Spanish paper fell 8 bps to 5.18 percent.

About 330 billion euros worth of ECB loans mature this week, while the ECB is expected to lend banks 250 billion euros in one-week cash on Tuesday and 50 billion in three-month loans on Wednesday in addition to the three-year tender.

Tuesday's tender was also seen as key for sentiment towards peripheral debt.

"If the allotment is significantly lower, then the market will probably conclude that the borrowing is being rolled into the three-year, thus this would offer more support to the front end," Credit Agricole strategist Peter Chatwell said in a note.

"However we would add a point of caution: reduced usage may also mean that banks are choosing to use the dollar facility, along with an FX swap, to fund euro positions."

"The expectations are massive," one trader said. "A higher take-up is going to give the periphery some support, but we're possibly setting ourselves up for a fall. It's not guaranteed that they're going to buy (peripheral bonds)."

The notable item from above is that as we have been suggesting for two weeks now, Europe is suffering from not only a USD shortage but also a dollar one.

As for today's Spanish auction, it came out well, as was expected with the market bleary eyed on the latest set of insurmountable LTRO expectations.

On Tuesday, the Spanish Treasury sold 3.7 billion euros of 3-month paper for 1.735 percent, after an average yield of 5.11 percent in November, at a bid-to-cover ratio of 2.9, up from 2.8.

The 6-month bill sold for an average yield of 2.435 percent, down from 5.227 percent, with 1.92 billion euros sold and demand outstripping supply by a factor of 4.1, after 4.9 a month earlier.

While average yields were down from a month earlier, and around 30 basis points lower than levels seen in the secondary markets before the auction, the Treasury was still paying more than 150 basis points above pre-crisis levels on both bills.

Demand for the 3- and 6-month Spanish Treasury bills was high, with more than 18 billion euros offered for 5.6 billion euros sold, above the targeted amount of 3.5 billion to 4.5 billion euros.

"This is another impressive auction from Spain and an early Christmas present for the Treasury," said Nicholas Spiro, managing director of Spiro Sovereign Strategy in London

"Spain is by no means out of the woods. The Spanish economy is still flat on its back and Spain is threatened with yet more credit rating downgrades."

Economists believe Spain is already in its second recession in three years and the sluggish economy and high deficit have put it at centre of the euro zone debt crisis. The main concern is that if it needs a bailout it would stretch available funds and political will.

Alas, just like everything else to come out of Europe, this latest and greatest hope will soon be crushed. But with 4 days before Christmas, perhaps even Europe deserves a brief window of opportunity in which hope is the only strategy.

Comments

[Ghordius]

"Alas, just like everything else to come out of Europe, this latest and greatest hope will soon be crushed"

soon = days? months? or years? soon is such a flexible word... I'd suggest soonish

[GeneMarchbanks]

The laser-like focus on Eurozone financing will dwindle by March or April. UK austerity, China crash, Japan bond fiasco... those will start driving markets

[Ghordius]

China crash? so soon? I'd given another year...

Re Japan, yes, the "bug in search of a windshield", but most hedge funds have not found the "handle" to short them directly.

Can't have a proper bear party without the proper instruments, eh? We'll see.

[slaughterer]

Shorting Japan directly is the dream of many a Hugh Hendry / Kyle Bass wannabe.   Not only is "timing everything" when shorting China and Japan, but also the selection of the shorting WOMD is the "other half of everything." 

[GeneMarchbanks]

Hendry is playing a dangerous game IMO. I f I understood correctly he is shorting steel companies like Nipon. Few can afford to do what he's doing.

You can always play by proxy though. The big four banks in Australia are loaded with toxic housing paper. It has to be close the end... little down side risk and the reward could be subprime-esque... almost.

[slaughterer]

I would not expect bank CEOs to make public their enthusiasm in this LTRO carry trade while making full strategic use of it for their own secret aims.    Draghi has been telegraphing the potential power of this LTRO in lieu of a full all-out print fest, and the effect on the Spanish bond yields should illustrate that power quite clearly.   Clearly, MS and others are broadcasting it as the deus ex machina which it is not, but in combination with all the other measures deployed, might be the temporary relief Santa needs for his rally before of course the unprecedented and horrifying Q1 2012 of massive rollovers, and bond auctions which will be the next and most severe wave of the crisis.   

[misterc]

I don't get it. Why shouldn't banks do this LTRO-PIIGS-carry trade? Because their shareholders don't want them to? Since when do they have a say? Please explain to me..

[slaughterer]

No explanation necessary.  You already fully understand.

[LookingWithAmazement]

Yields fall - bye bye crisis.

[youLilQuantFuker]

Anything for participation. This, banned as racist, is what the EU needs. Hollywood marketing:

http://www.youtube.com/watch?v=wsTXumUC3jg

[oh, for the smarties, that was sarc mixed with tragedy and nostalgia ]

[disabledvet]

This is the first right thing the euro people have done since this crisis began...and I think calls that it will fail are premature. There has been a fundamental lack of expressing the total idiocy of bailing out the banks but not the countries and is absolutely the primary cause of this catastrophe. Germany squawked at their superiority as everyone fled to the PERCEIVED safety of German bunds... But now those bunds must rise in yield and fall in price dramatically to meet the risk engendered by a general euro collapse since private interest has en toto trumped the absolute necessity of getting economic growth and tax receipts flowing into government coffers. As we now see once the government fails the bank bailouts are by definition "all for naught."

[slaughterer]

Exactly.  +1

[Josephine29]

Todays Spanish auction results seem to give proof that there is a lot of hope for this version of the carry trade. Frankly from the numbers it looks as though it is already happening. For those who do not understand it then it works like this.

What created this sudden enthusiasm for Spanish government bonds?

The examples I gave on the second of December have something else to support them now and it is due to a new initiative at the European Central Bank. It announced at its last policy meeting that it will hold two separate three-year long-term refinancing operations and the first of these is on Tuesday.

So as long as you have collateral (Spanish government bonds are collateral) you can have as much money/liquidity at an interest-rate of 1% as you want for three years. So the 2016 bonds which were issued yesterday at a yield of 4.02% suddenly look attractive do they not. You can finance them for 1% for the first three years of their life and make just under 3% a year (there will be a “haircut” applied by the ECB).

Also existing bonds look attractive and if we look at the yield on existing 3 year maturity Spanish bonds they have fallen from 5.1% on the day of the ECB announcement to 3.57% as I type this. Suddenly the improvement in the price of these bonds does not look as good as it did before did it? Yet again risk is being moved around but the underlying issue is unchanged and taxpayers find themselves potentially on the hook yet again should this pack of cards fall down.

http://www.mindfulmoney.co.uk/wp/shaun-richards/why-spanishitalian-and-belgian-govenrment-bond-markets-have-recovered-and-worrying-uk-liabilities/

[disabledvet]

The important part is that the Spanish Government is forcing Spanish Banks to buy the euro denominated debt. This has been to me the root of the crisis all along: the banks themselves have no faith in the euro--with the French being the worst of all. Simply put this debt must be bought if there is to be any hope for the euro at all. This is absolutely the...necessary thing to do. I guarantee the French will not follow suit...but that does not mean that Germany and Italy won't...and if they do they might just finally "pull that rabbit out of a hat."

[JOYFUL]

the rain in Spain falls mainly in the mountains, very little reaches the dry Meseta...but what are dry facts before the ef·fer·ves·cent truths of musicals past and present...!?!?!

"Eliza Hurricanes hardly happen.
How kind of you to let me come! Henry
Now once again, where does it rain?"

Reality, it seems, ALWAYS imitates fiction....in this case the Eurozone has a more than nodding acquaintance with that classic

                       CARNIVAL OF SOULS

"Some people will believe anything if you whisper it to them"
Miguel de Unamuno

[disabledvet]

Yeah well "buy the euro debt Spanish Bankers" isn't being done in a whisper by the Spanish PM. This is more like the General Franco of finance...and rightfully so in my view.

[Scalaris]

Are Spanish bonds with AA- credit rating, if I'm not mistaken, being accumulated today in order to be posted as collateral for tomorrow's 3-year LTRO?

If so, does that means that you can post bonds with credit rating as low as A? 

And if this is indeed the case, does that mean that low quality sovereign collateral is being pledged to the ECB, in order for high quality collateral to be acquired, such as bunds - I'm guessing, in order to be subsequently used in the private interbank repo market, which demands higher quality collateral?

So, will the banks sacrifice an increase in their leverage ratios, in order to retain earnings from the difference between the ECB’s lending rate and the yield on the sovereign bond? 

I'd like to know how will this abide with the new Basel capital requirements, and also how are today's debt purchases are being funded?

I'm guessing that I'm confusing much more than I think that I am, since this seems somewhat unsustainable in the long term and I'm not completely sure what they are trying to achieve.

[slaughterer]

You can post bonds for collateral at ECB as long as the country that issued them is not in default.  The thing with Basel III that most are forgetting is that it comes into effect, at the earliest, in 2013.  For now the arb between 1% LTRO lending and EZ sov yields is very attractive.

[Scalaris]

Thanks, I thought Basel III would come into effect within 2012.

Spanish taxpayers will be happy to know they are paying the attractive yield of this trade.

[sudzee]

There must be a limit to the amount of hypothetical and synthetic assets being created to back the status quo. Any type of unencumbered physical asset must be worth multiples of what one would think.

[slaughterer]

There is virtually no limit to "hypothetical and synthetic" but "unencumbered physical asset"s are very rare right now. 

[Börjesson]

"...Europe is suffering from not only a USD shortage but also a dollar one."

Say what?

[Georgesblog]

Europe and reality haven't fit in the same sentence, for months. None of the countries can sell enough bonds to cover the demand for cash, and the answer we're given is that there's one more meeting. Forget January. I see an emergency meeting, before the scheduled meeting. It may not even be announced, just reported. It can't be hidden. The bad dog got loose and the whole EU neighborhood is disrupted. With the Fed talking about moving in with more than $1 Trillion, the debt will have a direct pipeline to the U. S. It is only a matter of time until U. S. banks start having emergency meetings of their own.

http://georgesblogforum.wordpress.com/2011/11/02/the-daily-climb-2/

[Snakeeyes]

There is definitely Obama-type hopium in Europe.

IMF/Hungary Bailout Talks Stall – Hungary Benchmark Rate Rises (But 10yr Sov Yields Fall) – US Treasury Yields Increase – ECB Balance Sheet Is HUGE!

http://confoundedinterest.wordpress.com

[westerman]

Draghi should stop being a pussy and borrow some b52 bombers. Then he should take 20 billion peices of papper, put three zeros on each and bomb the cities of Europe with them. We all know he wants to.

[slaughterer]

Draghi is Goldman's inside man at the ECB.  He has helped their short book quite alot.  

[AldoHux_IV]

But with 4 days before Christmas, perhaps even Europe deserves a brief window of opportunity in which hope is the only strategy.

Are we to feel sorry for these technocrats that continue to make the decisions that harm many people's livelihood? The only hope for so many if these central planners step down-- that would be the ultimate Christmas present.