Some Perspective On Italian Bonds

From Peter Tchir of TF Market Advisors

Italian Bonds

It seems like the market is enjoying the "success" of the Italian bond auctions.  Given the extreme intraday volatility we have had this week, it is hard to argue that we won't see a spike higher in stocks on this news, but the reality is that: 

  • 5 year Italy is still 100 bps wider in 1 month
  • the Italian curve is flattening 
  • 10 year Italian and Spanish bond yields are about back to where they were before the alleged ECB/China buying rumor  Greece had a very successful auction last March.  It was over subscribed, a 6.375% yield seemed good at the time, and it traded up on the break. Less than 2 months later it was at 70 

Italy may not be Greece, but its important to remember that Greece wasn't Greece just 15 months ago.  It seems like we have been talking about the problems in Greece for ages, but the reality is the market let them price a big "successful" bond deal in March of last year.  While it is important to remember that the Troika has shown great support for sovereign debt, its also important to remember the market got it horribly wrong last year.

I'm sure no one will complain about sovereign CDS today, but given the amount of outstanding CDS on Italy, I wouldn't be surprised to find that the Italian auction received strong demand from hedge funds looking to pick up some cheap bonds to cover their CDS shorts - at least temporarily cover them.  This should have impacted the 5 year more than the 15 year as it creates a quick basis package that the hedge funds know they can sell out of their long over the next week as the underwriters/primary dealers work to support the issue. 

On the other hand, the rating agency comments on the U.S. debt ceiling are just stupid, in my opinion.  If the agencies start to say that a country that has i) this much debt, ii) a debt ceiling, and iii) divisive partisan politics, shouldn't retain a AAA rating, then I would worry, but this posturing around technical default shouldn't spook the market.  I was surprised it did, but that was a quick overnight chance to cut some shorts, nothing more, in my opinion.