Further reflections on that German bund action fail from RBS rate guru Harvinder Sian.
He says there are lots of excuses and explanations for Wednesday’s flop ( it’s year-end for primary dealers, the bond was off-benchmark, uncovered German bond auctions have popped up fairly regularly). However, Sian, a bund bull, concedes it was disappointing result.
That said, he’s wary of the headlines (like the one above) that will inevitably follow and believes bunds will see new highs before a big-sell off.
Is this the start of German credit erosion, the point at which Germany finds out that it is only the first class passenger on the Titanic? The media headlines in the next few days will point this way.
I essentially see much more market stress before Bunds are able to sustain a sell-off. More specifically:
1. Do not expect the ECB to capitulate on demands to ease the debt crisis as a lender of last resort any time soon. This should become obvious at the 9th December EU Summit. The pain threshold for the ECB and Germany is far higher and will likely involve concerns that some countries are about to pull out of the Euro, bank runs or both. Think blind panic and you are close to the picture that I have in mind. I see this as a necessary condition for some type of solution effort given the political failure to get ahead of the crisis.
2. Greece risks a hard default, mostly likely in Q1-12, as the PSI will fail to get enough private sector contribution and other EMU countries will be reluctant to pile in more cash. The default risk is likely to remain elevated into year end if the Greek ND leader Samaras does not fully back the IMF/EU deal.
3. The German view is hardening towards using conditional rescue entities for countries in need (EFSF/IMF) and Germany still looks fully behind the idea that countries with unsustainable debt can see haircuts. This is the logic of the ESM and this is a far cry from the debt mutualisation that is the current consensus. This is important in the German credit assessment.
4. From a flow-of-funds perspective, we expect to see a continuation of ex-EMU residents dump all debt, including Germany. The EMU region is however self-financing. Over 75% of debt issued in EMU stays in EMU and that number can and will get higher. As such, many of those exiting periphery and weaker AAAs will need some exposure to debt markets, with Germany still the de-facto location. Buying Treasuries (or Gilts) over Bunds makes sense as a trade; but not the macro data.
As such, my ongoing bullish Bund conviction rests on the idea that the market is too hopeful on a near term solution, is not prepared for hard default risks, and ignores the closed economy nature of the Euro region.
In other words, the time to sell bunds will be when Germany finally realises the game is up and reluctantly props up the Eurozone, probably via the printing presses of the ECB.
Unfortunately, that won’t happen until Eurozone has a near death experience with countries threatening to leave the currency union and customers lining up outside banks demanding their money back.