Ahead of a much-watched Spanish bond auction plus a key European Central Bank meeting on Thursday, here’s a sign that the Greek contagion effect has penetrated even the furthest corners of European debt markets.
As Barclays Capital’s AAA Investor note explained on Thursday, covered bonds are coming under increasing pressure thanks to Greek fear, plus Portuguese and Spanish sovereign risk:
In light of the renewed widening pressure on swap-spreads of peripheral European covered bonds, particularly affecting Portuguese and Spanish issues in response to the steadily mounting pressure on the respective sovereign debt, investors appear to have started withdrawing from less liquid products. At the time of writing, most covered bonds issued out of Portugal and Spain, were better offered on the secondary market with bids, however, becoming increasingly scarce . . .
Indeed. As these charts (Spain to the left, Portugal to the right) show:
For reference’s sake, these BarCap charts also show that Spain takes a large share of covered bonds outstanding in 2010:
We’ll leave it to BarCap to make the ominous comparison, emphasis FT Alphaville’s:
. . . market makers have started quoting more defensively, thereby causing bid-offer levels of covered bonds to further drift apart. As usually is the case in any such environment, liquidity is rapidly declining, thus leaving its mark on the market participants’ capability to freely operate and effectively forcing them into an ever more defensive mode. Precisely this behaviour could be observed in late 2008, when the market tried to position itself in light of an increasingly uncertain environment.
In short, they conclude, investors are on the lookout for liquidity, sloughing off less-liquid issues, such as covered bonds, in preparation for possible unwinds across the rest of the debt market. Investors could change their minds and start buying again, but not for a while. As BarCap continue:
Provided the spill-over effects gain further momentum, an inversion of the respective credit term structures is an increasingly likely scenario. In Portugal, as illustrated above, this already is the new reality.
A self-fulfilling prophecy, BarCap call it. Oh dear. The very definition of panic.
Related links:
S&P’s sovereign-covered caution – FT Alphaville
Covered bond bailouts - FT Alphaville
Next up for Europe, covered bond catastrophe? – FT Alphaville