Successful Auctions And Chinese Buying

From Peter Tchir of TF Market Advisors

How many times can we rally on the same story.  Back in April of this year, there were big stories about Chinese buying European sovereign debt.  At the time the Greek 10 year bond was trading at almost 60 then.  It is below 40 now.  The Greek 2 year bond was at almost 70, now it too is at 40.  The Italian 5 year bond yielded less than 4%, today it is almost back to its highs of 5.5%.

I am quite positive that I can find articles quoting Chinese support for Greece going back to March 2010 when Greece issued a new bond in what was deemed a VERY SUCCESSFUL auction.  I have written about it before, but it seems worth mentioning again.  In March 2010, Greece issued a 5 billion EUR 10 year bond.  It had a 6.25% coupon and was priced at 98.942    It traded up and the whole market breathed a sigh of relief that the auction had gone so well. 

It is hard to count the number of times that China has come in to buy European bonds or that a successful auction was a sign that the crisis was over, I only have so many fingers and toes after all.

None of those actions was enough to save Greece from some from trading at prices far below what investors a year ago thought were conservative recovery rates.  And Greece only has about 330 billion EUR of debt. 

How is China going to save Italy with 1.6 TRILLION EUR of debt?  It doesn't  seem logical to expect ploys that couldn't protect a much smaller country to work on one with even more debt.  China could buy up all the  156 billion EUR of Portuguese debt if it wanted to solve the "contagion" there.  They haven't done it. China may need to diversify away from US Treasuries, and it is prudent for them to do that, and some of that money can even go into weaker European bonds, but are they really prepared to invest in a meaningful way? 

Again, if this was new news, or had shown any sign of working in the past, I would be more excited.  This seems like a story that is trotted out every few months, provides an initial pop, and then bonds return to their grind lower in price. 

I am more curious by the choice of Italy to sell 1.2 billion of 4% 9 year bonds at a price of 90.2.   I will admit that I don't follow Italian bond auctions that much, but Sept 2020 seems a slightly weird maturity.  A 10 point discount sounds like something a junk rated issuer does, not a sovereign. In fact, a 10 point discount on a 10 year bond may even raise original issue discount tax problems if it was done in the US.  It seems weird, though it does seem a good fit for anyone who bought 10 year Italian CDS last September when EFSF was initially announced and Ireland and Portugal had been allegedly saved.  In fact the discounts that the new issues were done at seem to have the most use for CDS traders.  It makes the basis package more attractive.  Insurance companies and other "cash" investors tend to prefer higher coupons and more current income.  CDS and basis traders prefer the convexity of lower prices.  I wonder how much of this auction went to cover CDS short positions?  I suspect a lot, and the low coupon/low issuance price supports that view.

One thing I struggle with more and more by the day is how there can be so many stories of individual Chinese company fraud, so many stories of ghost towns, yet complete faith in the nation as a whole?  It seems to me that a country that has allowed so much fraud to perpetuate at an individual level, may not be as "truthful" at a group level.  The fact that investors have been willing to overlook fraud after fraud at the individual company level doesn't give me much faith we would spot it at the country level.  For now, I am still willing to take the Chinese data and stories without too much of a grain of salt, but it is becoming harder to rationalize the frauds as just a few bad apples and not a sign of much deeper corruption.

Anyways, I guess its time to go buy stocks since if China doesn't give enough money to Italy to make a dent, then we will rally on Merkel or someone saying Greece won't default, in spite of all the evidence to the contrary, or if worse comes to worse, the NYSE will just change their hours so they open as Europe closes for a half hour trading session, and then re-open for another session from 3:30 - 4:00.  That would pretty much ensure S&P 1500 in a matter of weeks!

In the meantime, back in the real world we all need to deal with the fact that once again the S&P futures have traded in a 2% range overnight.  Let the fun begin.


China Open to Buying More Bonds of Indebted Euro-Area Countries
2011-04-21 12:28:03.994 GMT

By Jonathan Stearns

April 21 (Bloomberg) -- China is open to buying more bonds of indebted euro-area nations as part of a strategy to bolster the European Union economy and diversify away from investments in U.S. debt, said the Chinese ambassador to the EU.

Song Zhe said China owns “several billion euros” of bonds sold by Greece and Portugal and might embark on another round of purchases of sovereign debt in the euro area.

“In the next step, it is possible we will purchase more sovereign debt” in Europe, Song told reporters today in Brussels. “We hope to see financial stability and sustained economic growth in the euro zone.”

Song said China believes the EU can overcome the euro area’s debt crisis, which was triggered by Greece last year and has since engulfed Ireland and Portugal. With the International Monetary Fund, the EU organized a 110 billion-euro rescue of Greece last May and an 85 billion-euro bailout of Ireland in November and is now preparing 80 billion euros in emergency aid for Portugal.

The fundamental aim of Chinese investments in Europe is to protect China’s “huge” foreign-exchange reserves, according to Song. “We do have confidence in the currency and it will remain one of our choices for investment.”

China’s foreign-exchange reserves jumped to a world-record $3 trillion in March.

China is in discussions to invest in the restructuring of Spain’s savings banks, Foreign Ministry spokesman Hong Lei  said today, after a four-day visit by Spanish Prime Minister Jose Luis Rodriguez Zapatero to Asia.

China already holds 25 billion euros of Spanish sovereign debt, up from 6 billion euros in 2009, Zapatero said on April 15 at the end of his Asian tour. That’s equivalent to 12.5 percent of the Spanish debt in foreign hands, he told reporters.


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