Is nothing sacred anymore?
Yields on 10-year German Bunds are rising on Tuesday (up to 2.704 at pixel time, from 2.523 at 8am London time) as those on 10-year Italian government retreat from over 6 per cent.
If a greater fiscal union is the European future — and the enhanced EFSF may be a first step toward it — then this has consequences for the eurozone’s safest haven.
In a short note out on Tuesday, Divyang Shah of IFR Markets argues that in order to save the periphery, the core will have to lose some of its attraction as a flight to safety destination.
This has been the long-running underlying dynamic, of course, and one that gets to the heart of political debates in Germany, Finland and elsewhere. And according to Shah, now’s the time to revisit the price of Bunds.
However, what the crisis response might morph into is going back to revisiting the idea of the EFSF 1) buying Eurozone debt in the secondary market and 2) using the funds to conduct a debt swap of Greek debt at current prices. But this will likely need an expansion in the size of the EFSF and while a formal transfer union is not envisaged this will form a small step closer to this as much of the resources will come from the core countries.
The biggest risk is to the safe haven bid on bunds and we would look to buy puts at this stage of the crisis. Contagion risks remain in play and safe haven related flows can still take bunds higher but holding puts on bunds makes sense. A 126 Sep bund put expiring on August 31 has a theoretical cost of around 40 ticks. Concerns over a move closer to a transfer union might also explain why 5yr CDS on Germany has gone from trading 4bps under 5yr US to trading over by some 12bps.
This is not the highest the spread has been but it has a close correlation with the 10-year Spain/German spread. Had it not been for the US debt ceiling debate this spread would have been closer to 20/25bps. But the interesting thing to note is that 5yr German CDS is close to breaking the highs from Jan this year of just over 60bps, and briefly touched that level during this morning’s meltdown before pulling back.
Introducing, then, the fiscal union put.
Related link:
The Italian panic — rationalisation del giorno – FT Alphaville