The European Central Bank might have hinted that it’ll buy up Irish, Greek, Portuguese and perhaps even Spanish bonds, burning shorts aplenty after Tuesday’s horrific core contagion sell-off.
But there are some bonds the ECB won’t be buying. German ones.
So guess where the market might have gone to express its periphery fears on Wednesday — details from a friendly broker:
- Very disappointing demand in German Bund auction. Bids for the €5b on offer amounted to just €4.13b. With the Bundesbank holding back €870m for market smoothing purposes the official bid to cover ratio was 1.1x, down from 1.6x in the previous auction. Still all in all bids did not cover the full amount on offer…
- This is the second disappointing auction in 2 weeks after the new 10Y issued last week fell short of expectations.
To fail one bund auction in a fortnight may be regarded a misfortune…
…To fail two looks like someone is starting to bake in some credit risks based on those Germany is taking on from guaranteeing the EFSF.
Here, for example, is the latest RBS estimate of how much it would take for the EFSF and its backers to bail out Spain (click chart to enlarge):
We arrive at a total bailout package of €546bn, including wholesale funding rollover support for the banking system. However, allowing for potential [€80bn] ECB support and sale of non-core assets results in a net requirement of €446bn… Given Portugal’s rising bond yield and increasingly challenging fiscal position, we assume external assistance of €50bn will eventually be required in advance of Spain.
Not that RBS believe Spain will call on the EFSF’s funds immediately. That would be because, in part, Spain would break the EFSF as its funding currently stands (see chart):
Told you the EFSF wasn’t saving anything. Unless around €100bn of Spanish bank subordinated bondholders (or even €140bn of senior unsecured debt) would be thrown in to share the burden of a bailout.
Hence why RBS is looking for a ‘deus ex machina’ to restore confidence and take the market’s eye off Spanish bond yields. More specifically, an ECB purchase programme of €2bn of peripheral bonds per day, Spain included.
However — the problem with asking the ECB to move from promising stuff to doing it, is that you quickly realise the Bank didn’t like doing it when it first started, that doing it on the now-required scale and pace extends well beyond what has been done before, and that doing it for much longer raises questions about how sustainable this all is.
Concerns well expressed by Stephen Lewis of Monument Securities on Wednesday, particularly with regard to the additional problem that the ECB may not be restoring liquidity to bond markets: instead, it may be merely providing an exit for trapped longs. As Lewis notes (emphasis ours):
ECB asset purchases could not credibly be presented as monetary easing; they would, quite plainly, be monetising government debt. The markets would hardly believe the ECB was happy with this course and might reasonably fear the ECB would terminate its purchases as soon as it could. Consequently, holders of high-yielding government bonds would have good reason to dispose of them quickly, while the ECB continued to stand in the market as a buyer. Either the ECB would, in short order, wind up holding most of the debt of peripheral euro zone governments or, if it tempered the pace of its purchases, it would have only limited success in bringing down yields on peripheral sovereign bonds.
For if the holders of such bonds believed the ECB’s willingness to buy them was finite and fell some way short of the total amount in issue, they would continue to demand a yield premium to reflect the risk that they might not be able to unload the bonds before the ECB closed its purchasing facility. Indeed, unless it were understood that the ECB would go on purchasing peripheral sovereign bonds indefinitely and would hold the bonds it bought to their maturity, even ‘core’ euro zone bond markets might suffer…
The problem of turning from a hawk to a dove at breakneck speed, we guess. There are plus sides to ECB buying — first, using earlier figures calculated by Willem Buiter, we’d estimate that Bank really does have €2,000bn to burn if it felt like it (and has been rumoured ahead of the ECB’s press conference on Thursday). Second, the risk that the ECB is going to see its purchases haircut one day could be more manageable if there’s now more detail on the post-2013 Stabilisation Mechanism for government bonds.
There are plenty of other obstacles out there, however. For a start, it’s maybe a good time to remind readers of a small sterilisation problem…
Related links:
Eurobutton – Macro Man
Is this the way the ECB’s bond-buying ends? – FT Alphaville
A martingale over Europe – FT Alphaville