Tuesday, July 12, 2011
Konrad Lorenz once said:
"The bond with a true dog is as lasting as the ties of this earth will ever be."It is perhaps good fortune, then, that Sarko does indeed have a pet dog to chase around the office, because that other bond, to Germany appears to be breaking. The 20d rolling correlation of French OATs to Bunds (see chart below) appears to have decreased quite significantly since the beginning of June, hinting that France is no longer the safe haven it once was. TMM expect a French downgrade is imminent. Now TMM have (painfully) found themselves on the wrong side of recent moves, so their musings should be taken in the context of the latter stages of the Kubler-Ross model (!), but we do find this all terribly worrying...
...as French OATs are plumbing spreads not seen since the early-1990s (see chart below) and liquidity in the BTP market has deteriorated to somewhere between "I'm sorry mate we can't put a price on that" to "I'm an axed seller". TMM occasionally see reports of the Cavalry (aka the ECB) buying BTPs, but even though they sit 20bps off their earlier wides, the past two days have been notable for the reports of long-only selling (i.e. - people just don't want the bonds), and the dramatic spike in bond volatility which (as many, especially the fine chaps at FTAlphavile) have pointed out) kills the risk-adjusted carry argument and exacerbates the sovereign-bank feedback loop. TMM cannot help but think that confidence in the Italian bond market has now gone the way of that of the rest of Club Med. Which, as they wrote on Friday, they find perplexing given Italy's much stronger fiscal position. But as punters saw back in 2008, once confidence is gone, a policy response is needed.
The trouble is, that the A-Team have shown themselves singularly unable to come up with a TARP-like solution that finally draws a line under the solvency concerns (that have got significantly worse over the past week). TMM are also unconvinced that the financial resources exist for such a solution (now that Italy has been dragged into the fray, and French bonds are showing weakness), even if the political will does. So is Italy on its own...? To date, Spooz and the US in general have traded pretty much on their own data - softening, but then again no one is ringing the air raid siren. Yesterday, TMM decided that given the move in the Itraxx European Financials 5 year CDS that the brown-underpants trading paradigm had probably returned as we are getting past the Dec/Jan wides. Failing some maturity and cohesion in Italian politics (teambuilding bunga-bunga party?) it's hard to see things getting all that much better all that quickly...
*STOP PRESS*: Just as we wrote this, the following headline came across the wire:
ITALIAN SENATE PRESIDENT SAYS WILL URGE PARTIES TO APPROVE AUSTERITY PACKAGE IN UPPER HOUSE BY THURSDAY
TMM reckon that unless Italy sorts this mess out themselves, that it risks snowballing into a true systemic crisis given the lack of credible coordinated policy responses from Team Europe. So that means, earlier spending cuts, no tax cuts, public support for Tremonti, a further recapitalisation of the banks (to replace the cash erased by this week's 7% fall in BTP prices) and - most importantly - a return of the domestic bid in the bond market. Something that, after the moves of the past week, will be timid.
Either way, TMM reckon it is worth loading up on September 109.00 Schatz calls just in case they manage to screw it up monumentally.