Cover Your Shorts, Baby!

Credit spreads bounced back Wednesday, driven by a strong short covering rally in sovereigns. The strong tightening of spreads was triggered by comments from ECB president Jean-Claude Trichet at the European Parliament yesterday, where he hinted that the central bank’s bond purchase programme could be extended. The markets are aware that the EU’s policy levers are limited, and are looking for the ECB to do more.

“The expectation that it will do so at its governing council meeting tomorrow led to many investors scrambling to cover their short positions.”

Gavan Nolan

The Securities Markets Programme (SMP), launched in May, has been sterilised by extracting liquidity out of the system elsewhere, and it is highly unlikely that this policy would change. But a significant increase in the scope of the programme – along with a possible extension of unlimited 3-month ECB funding into next year – would be welcomed by investors.

“The expectation that it will do so at its governing council meeting tomorrow led to many investors scrambling to cover their short positions,” credit analyst Gavan Nolan writes in Wednesday’s Markit Intraday Alert.

A “better-than-expected” Portuguese T-bill auction also helped support the rally.

The sovereign sold $500 million of 12-month bills and the bid-to-cover ratio of 2.5 could be seen as a relatively healthy, given the volatile conditions.

However, the sovereign had to pay a higher yield but that was to be expected.

Aside from the now ubiquitous sovereign turmoil, investors were also focused on several important economic releases.

European markets woke up to another strong HSBC/Markit Manufacturing PMI. The headline index was up to 55.3 in November, with new orders up to a seven-month high.

“On the negative side, input price inflation was the fastest since July 2008, stoking fears of further monetary tightening,” Gavan Nolan writes.

Leading indicators in Europe also pointed towards a strengthening in growth.

“The Markit Eurozone Manufacturing PMI rose to a four-month high of 55.3 in November, slightly below the earlier flash estimate but still well above the neutral 50 level. However, the data showed that this is a recovery led by the core of Germany and France, with the peripherals lagging well behind,” Nolan points out.

Adding: “The equivalent PMI for the UK was even more impressive. The index rose to 58 in November, its highest level since September 1994 and significantly above the 55.4 reading last month. The coalition government will have been pleased by the expansion in exports, though whether this can be maintained over next year is open to question.”

The US ISM Manufacturing index completed the picture. The November report showed the index rising to 56.6, down from last month but still firmly in expansion territory.

“Economic data is likely to take a back seat tomorrow as investors await the ECB’s announcement,” Gavan Nolan concludes.

Spreads tightened sharply in late trading on further short covering.


  • Markit iTraxx Europe 112.5bp (-5), Markit iTraxx Crossover 503.5bp (-22)
  • Markit iTraxx SovX Western Europe 190.5bp (-12)
  • Markit iTraxx Senior Financials 161.5bp (-10)
  • Sovereigns – Greece 925bp (-31), Spain 315bp (-52), Portugal 475bp (-71), Italy 228bp (-43), Ireland 570bp (-44), Belgium 190bp (-14), France 95bp (-10)



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