Did ya know?
The European Central Bank — via its Securities Markets Programme — now owns almost 20 per cent of the outstanding government bonds of Greece, Ireland and Portugal.
Unsurprisingly, that kind of scale is impacting the market — in particular the spread between cash peripheral bonds and CDS protection on them, or the CDS-bond basis. As a reminder, a negative basis suggests the CDS spread is lower than the bond spread. A positive basis means the opposite, and tends to be the norm.
From Bank of America Merrill Lynch’s Ralf Preusser and Sphia Salim:
The ECB is distorting market pricing in the periphery, as is evident in the CDS-bond basis. We have seen an extremely sharp richening of cash bonds relative to CDS in the markets targeted by the ECB, in a move reminiscent of the post-Greek bail-out period, when the ECB buying programme started (see Chart 2).
The dynamics of the CDS-bond basis for core countries superficially also resemble the May episode (Chart 1), but crucially, the drivers of the basis are completely different. Back in May 2010, the CDS-bond basis widened on the back of flight-to-quality moves in cash bonds. Today it is widening due to protection buying in core names, as concerns increase about the ultimate cost to core countries of the peripheral crisis (maybe also indirectly reflecting the growing risks to the ECB’s balance sheet).
Quite a big difference then.
And one that might end up worsening for the ‘core’ countries as ECB bond-buying picks up — or as the European Financial Stability Facility gets bigger.
Here’s what the BofAML analysts think, anyway:
We would argue that the CDS bond basis in peripheral countries should correct off the highs either as the CDS market catches up with the price action in cash bonds or as cash bonds re-cheapen on waning ECB support. We like selling the basis in Ireland. In particular, efforts to regulate the CDS market for sovereigns could contribute to a tightening of CDS spreads relative to cash bonds. We would also argue that the basis for core countries such as France and Germany should correct. But given the still low levels of distress, the basis is not really traded actively enough to suggest that a correction from current highs is imminent.
And just going back to that SMP point — we should find out exactly how much the ECB purchased last week (and how much they helped boost that Portugal auction), when the central bank announces its latest draining amounts later on Monday.
In the meantime though, we’ll leave you with this bit of commentary from the BofAML analysts:
The ECB now owns close to 20% of the outstanding bonds of Greece, Ireland and Portugal. Trichet’s hawkish rhetoric on Thursday will, therefore, have been aimed (at least in part) at increasing pressure on politicians to shift the burden of dealing with the periphery away from monetary authorities. Also, this number suggests that EU authorities may have to face the issue of burden-sharing between the private and the public sector well before 2013 unless they want to end up with the majority of the exposure to the periphery. This, in turn, points to the fact that the main elephant in the room remains the post-2013 crisis resolution mechanism, rather than any tweaking of the EFSF.
Related links:
Europe’s corroding core, a credit story – FT Alphaville
What fresh basis the ECB hath wrought - FT Alphaville
Touching negative basis in Ireland – FT Alphaville