If Spain 10 Year > 7.50% Then LTRO 3

At least that is the bogey according to JPMorgan's Pawan Wadhwa, who in a note announced that the ECB may resume SMP purchases if the 10 year hits 6.5% (as in a few hours), much to the chagrin of Germany, which was foosed into believing LTRO 1+2 would mean no more SMP purchases. More importantly, since the 6.50% barrier will be taken down with impunity in days if not hours, and the SMP has proven time and again to be powerless to prevent mass selling, the next big bogey is 7.50% at which the ECB will likely announce another 3-year Discount Window bazooka, pardon, LTRO. What JPM does not say is that with the halflife of each successive LTRO getting cut in half, LTRO 4 will be needed in June, LTRO 5 in July, LTRO 6 in July, LTRO 7 in July and so on. Most importantly, now that banks, who are desperate for some cash infusion from either the Fed or the ECB, know what the critical threshold bogey for action is, they will be sure to facilitate the ECB's life, and send Spanish 10 Years plunging to at least 7.50% and demand Draghi play ball, again. In other words: now that the market knows what the consensus is to get more European QE, it will promptly do it. After all the LTRO was never for the benefit of the countries: it was always and only to benefit Europe's insolvent banks. If that means "Greecing" Spain in the process, so be it.

And some other observations from Wadhwa, via Bloomberg:

  • Stay short peripherals with stop at 5.75% in 10-yr Spain, targeting for 6.25% or spread target of 450bps
  • Specifically recommend to exit peripheral shorts if Spanish 10-yr yield hits 6.25% due to heightened risk of policy response
  • Stay in 3/9 Spanish curve flatteners vs Italy and sell short-dated Spanish CDS-cash basis
  • Domestic banks have reasonable firepower to support sovereign bonds though large upcoming redemptions for Spanish banks suggest their support for sovereigns may be limited
  • Although EFSF now has ability to buy sovereign debt, meaningful EFSF bond-buying program unlikely 
  • Given ECB’s reluctance to use SMP in size, reigniting domestic banks’ demand is only meaningful way to stabilize sovereign spreads in long-run
  • Recommend to position for 5/10 German curve flattening
  • Close Italy overweight vs. Spain after Spanish auction


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