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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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Greece Ends Week In Absurdum

In spite of the alleged deal of another bailout package for Greece, the spreads on Greek CDS rose to the absurd level of 2150 basis points, that is 21,5 percentage points above the benchmark – the German bonds. Yesterday Chinese Prime Minister Wen Jiabao arrived in Europe to check on China‘s investments. Dear God!

“Given its obvious interest in the stability of euro zone it will be keen to find what progress, if any, has been made in tackling the region’s fiscal problems.”

Gavan Nolan

"Reductio ad absurdum" by Rodion Tikhomirov

The Chinese premier Wen Jiabao arrives in Europe Friday, and the main topic of discussion when he meets Europe’s leaders is likely to be Greece. China has been taking a keen interest in Europe’s periphery over the last few years.

The European Council on Foreign Relations estimates that 40% of Chinese investment in the EU is in eastern Europe and the peripherals, excluding Ireland.

  • In Greece the Chinese shipping company Cosco in 2008 signed a 35-year lease on a container port in Piraeus.
  • Jiabao’s deputy Zhang Dejiang visited Greece in 2009 with more offers of investment.

Of course, the reason China is so interested in Greece at the moment is that it is at the heart of the euro zone debt crisis.

China has made several public proclamations of support in favor of Greece and the other peripherals, though it is not clear if it has backed this up by buying large amounts of government bonds.

“Nonetheless, given its obvious interest in the stability of euro zone it will be keen to find what progress, if any, has been made in tackling the region’s fiscal problems,” credit analyst Gavan Nolan at Markit Credit Research writes in his weekly Market Wrap.

Of course, the reason China is so interested in Greece at the moment is that it is at the heart of the euro zone debt crisis.

China has made several public proclamations of support in favor of Greece and the other peripherals, though it is not clear if it has backed this up by buying large amounts of government bonds.

“Given its obvious interest in the stability of euro zone it will be keen to find what progress, if any, has been made in tackling the region’s fiscal problems,” Gavan Nolan points out.

So, what will Wen Jiabao find?

Well, the news that Greece and the EU had agreed a new five-year austerity plan last night was trumpeted as a great success.

But according to Markit the market participants are aware that the passage of the austerity bill through the Greek parliament is far from a formality.

Prime minister George Papandreou is in a stronger position after winning the no confidence vote earlier this week.

“But his control over his own party is still tenuous,” Nolan notes.

Another member of PASOK  declared Friday that he would vote against the bill, shrinking the already slim majority.

The vote begins on Tuesday but could last until Thursday.

Greece’s spreads closed the week at an unprecedented  record of 2150 basis points, reflecting the political uncertainty.

“But that is not the only doubt that the CDS markets are grappling with,” Nolan writes.

“The extent and form of private sector participation in the proposed bailout are still not clear. It seems that there will be an “informal and voluntary” rollover of debt similar to the Vienna Initiative.”

Nicholas Sarkozy and other European leaders have said Friday that they have been in discussion with financial institutions about a rollover, and there will be “no difficulties or concerns”, according to Sarkozy.

“But it remains to be seen just how “voluntary” this rollover is, and how they will incentive bondholders to participate,” Nolan comments.

Adding: “The answers to these questions are crucial for the CDS market and will influence spread direction. It should also be remembered that the total net notional outstanding for Greek sovereign CDS is just over EUR5 billion, and has been falling for some time.”

“This is small beer compared to the government bond market.”

“Unfortunately there have been several media reports that have been quoting the misleading gross notional figure; the lessons of the Lehman Brothers credit event auction clearly haven’t been learnt.”

China, on the other hand, has seen a considerable increase in its CDS net notional, particularly in recent months. It is now the 10th largest sovereign in terms of CDS exposure, according to DTCC figures.

The sovereign’s spreads have also widened in recent weeks, though they are nowhere near the levels they reached in the darkest days of the recession.

Premier Jiabao declared victory over inflation in an op-ed article in the Financial Times, Friday.

“Perhaps he is right, but the activity in the CDS market suggests that the Chinese economy faces more than one challenge in the months and years ahead,” Gavan Nolan concludes.

See also:

Markit Economic Research: HSBC Flash China Manufacturing PMI. 23062011.

Markit Economic Research. China PMI Flash Comment. 23062011.

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European Credit Market: Close To Panic (Update)

While investors in the European credit market more or less capitulated last week, the situation is now more like a total panic. ECB President Jean-Claude Trichet says that the risk to the financial system is as high as it possible can be, putting the mark in RED zone on the new colorized risk meter.

“This did little to boost confidence in a market that already had concerns over the Greek government’s ability to get its austerity measures through parliament.”

Gavan Nolan

The Markit iTraxx SovX Western Europe breached the level  of 240 basis points for only the second time on record. Greek spreads blew up 213 bp’s, to 2100. Portugal gained 50 and are now trading at at record wide levels – 825 points. Other peripherals also widened sharply.

Contagion watchers will have been concerned by the significant moves in Spain (305bp, +22) and Italy (200bp, +20).

The latter sovereign went above 200 basis points  for the first time since January.

See also:

After ECB president Jean-Claude Trichet said that the risk to the financial system is as high as its gets. Trichet also said that the newly created European Systemic Risk Board was planning a “risk dashboard” with a color-coded warning system. And when asked what the current color would be, he answered; “on a personal basis, I would say it is red”.

“Unsurprisingly, this did little to boost confidence in a market that already had concerns over the Greek government’s ability to get its austerity measures through parliament. The conservative opposition declared that it would vote against the bill. This was to be expected and was consistent with its recent position. But there are signs that members of the ruling socialist PASOK party could also vote against the bill, placing its passage in doubt. Even if the government gets the measures through parliament it faces a considerable challenge in implementing them,” analyst Gavan Nolan at Markit Credit Research writes in today’s Intraday Alert.

Adding: “Talk of a “black hole” in the austerity plans added to negative sentiment.”

But the peripherals didn’t have just Greece to contend with, Nolan continues.

“The markets were already in a bearish mood after Ben Bernanke’s cheerless assessment of the US economy, and yet more disappointing economic data was unlikely to be shrugged off. So it proved with the release of Markit PMIs this morning.”

Recession Is Back?

Overnight the Markit/HSBC Flash China Manufacturing PMI came in at 50,1 –  a significant drop from the previous month,  and an 11-month low.

“A hard landing for the Chinese economy is one of the main fears of investors, and sentiment hasn’t been helped by the Sino-Forest scandal,” Gavan Nolan explain.

Growth momentum also appears to be slowing in the euro zone.

The Markit Flash Euro zone PMI fell to 53.6 in June, the lowest level since October 2009.

The core-periphery dichotomy is still evident, but worryingly the rate of growth in German manufacturing slowed sharply.

Output in the euro zone, excluding Germany and France, contracted for the first time since September 2009.

The data underlined just how difficult it will be for the peripheral countries to reduce their debt burdens through growth.

Volatility in the commodity world added to the tension.

Brent crude was down by over $6 a barrel to $107 after the International Energy Agency announced that its members were releasing 60 million barrels of oil from their emergency stocks.

Glencore – 302 bp’s, +36 – the world’s biggest commodity trader was the day’s worst corporate performer.

Here are copies of the latest Markit PMI survey:

Markit Economic Research: Eurozone PMI. 23062011.

Markit Economic Research: PMI and CBI surveys compared. 23062011.

Markit Economic Research: HSBC Flash China Manufacturing PMI. 23062011.

Markit Economic Research. China PMI Flash Comment. 23062011.

MORE@Scribd

Related by the EconoTwist’s:

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