Credits Rally Without Credibility

The CDS spreads tightened significantly, Tuesday, and the rally gained momentum through the afternoon as investors placed their bets on a Greek “yes” to more austerity measures. Banks also rallied in spite of rumors that as many as 15 institutions will fail the upcoming stress test.

“The markets are aware that the banking books aren’t being tested for sovereign defaults, leaving a sizable credibility deficit.

Gavan Nolan

Well, here at the Econotwist’s we are just as skeptical to this rally, as we are to the stress test. Even if the Greek should accept another round of crippling austerity, the market participants are still pricing an 80% chance of a national default. And the banks? Hahaha…suckers!

I guess most of you are familiar with terms like “suckers rally” and “pump&dump.”

However , I won’t stretch that any longer – we’ll just have to wait and see, okay.

Now; according to Markit Financial Information,  the so-called “French proposal” for private sector participation in Greece’s bailout appears to be gaining traction, with reports that the German banking association sees the French model as a potential solution.

Fitch Ratings have declared that the proposal would still be regarded as a default by the agency but  the market didn’t seem to give a damn.

The Greek parliament have been debating the austerity bill while the country is paralyzed by a two-day general strike and protesters are raging in the streets of Athens.

Inevitably, the protests have turned violent again and ought to serve as a reminder that the government will find it difficult to implement these measures,  even if they get the votes they need tomorrow and Thursday.

“Nonetheless, the markets were content to ignore the unrest and rally,” credit analyst Gavan Nolan at Markit Credit Research writes in his Intraday Alert.

Adding: “Participants might be looking to add risk ahead of the vote in expectation of a relief rally if the government wins.”

The Markit iTraxx SovX Western Europe index was about 9 bp’s tighter, at 233,5 basis points, driven by the peripheral EU countries.

Spreads in Spain – perhaps the most important gauge of contagion – tightened significantly,  and closed at 288 bp’s.

Italy also rallied. The sovereign sold EUR7,885 billion of government bonds this morning, close to the upper end of the target range.

“Demand for the debt was solid and higher than the previous auctions, though the 1.32 bid-to-cover ratio for the 10-year BTP was relatively weak,” Gavan Nolan points out.

The tightening in the peripherals seemed to fuel a broader market rally.

The Markit iTraxx Europe closed about 2,5 bp’s tighter, at 113,25, and it was companies based in the EU periphery that drove the rally, like Gas Natural and  Telecom Italia.

A considerable skew has opened up in the index in recent days, the largest since the roll in March, according to Markit.

“The history of the index suggests that this will narrow relatively quickly,” Mr. Nolan writes.

That means that the iTraxx Europe most likely will widen again over the next days.

In another seemingly outburst of irrational exuberance banks also rallied, in spite of news reports claiming that between 10 and 15 of the 91 institutions who are subject to the stress tests are set to fail.

“If true, it could give the tests some much-needed credibility,” Nolan writes.

“But the markets are aware that the banking books aren’t being tested for sovereign defaults, leaving a sizable credibility deficit,” the Markit analyst concludes.

And that’s a nice and polite way of putting it.

  • Markit iTraxx Europe S15 113.25bp (-2.5), Markit iTraxx Crossover S15 425bp (-10)
  • Markit iTraxx SovX Western Europe S5 233bp (-9.5)
  • Markit iTraxx Senior Financials S15 175bp (-4.5)
  • Markit iTraxx Subordinated Financials S15 298bp (-10)
  • Sovereigns – Greece 2025bp (-40), Spain 288bp (-18), Portugal 795bp (-24), Italy 191bp (-14), Ireland 775bp (-38)
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