The ECB managed to reduce Spanish and Italian borrowing costs on Monday. But both French and German yields rose, and CDS widened. France was apparently one of the most heavily traded sovereign CDS on Monday.
Concerns about France’s exposure to possible EFSF losses have been weighing on the country’s CDS spreads for days now, as this Markit chart shows:
Nomura notes the strangeness of what took place on Monday:
Importantly, bund yields drifted higher in early trading on Monday in an environment of lower equities and a US downgrade. This is not normal. Over the course of the day, German 5yr CDS widened 3bp while the French 5yr widened by 16bp. As eurozone backstop efforts broaden to the large periphery (Italy and Spain), the trading dynamics of core eurozone bond markets may change. This is logical, given that damage to the ECB balance sheet can be assumed to be a cost mainly for Germany and France to pay.
Nomura is dubious about the view that the ECB’s bond buying will only need to be temporary because the EFSF will soon be flexible enough to take on that role on a large-enough scale. And if the ECB has to become more than a “bridge”, they say, then the distinction between quantitative easing and sovereign bailouts will become less clear.
Furthermore, the ECB’s independence could be called into question. Obviously one day of bond buying does not get us there, but this is where we are potentially heading.
Germany and France together accounting for a third of ECB equity.
Another strange occurrence on Monday was the euro falling against both the Swedish and Norwegian currencies — not a typical move when investors are moving out of global equities:
If bunds cannot rally in an environment of intense risk aversion; we should take note. If the euro weakens versus Scandi currencies, in an environment of deleveraging, we should take note. It signals that structural flows are changing direction and that important correlations are about to change. We view these underlying shifts as EUR negative.
Citi’s Steven Englander also stressed the significance of the French CDS move for the euro:
Why the French CDS moved so much is unclear, but in terms of causality it is more likely that either the CDS and EUR move are correlated with a common factor, or that that the CDS move is weighing on the EUR, rather than that the EUR is causing the CDS move. S&P has repeatedly praised France’s fiscal program, but France also by far has the widest CDS of any AAA country.
Meanwhile France’s AAA rating, Englander says, underpins the EFSF’s AAA rating. Since the EFSF is the backstop for Europe’s financial architecture at this point, it all looks… potentially, messy.
Related links:
Eventually, French Spreads Fail (E.F.S.F.) – FT Alphaville
France will feel the impact of USAA+ – FT Alphaville