We don’t quite understand why the bond market seems so weirdly blasé over what the ECB has (not) revealed on its sovereign debt strategy.
On the one hand, we give the ECB points for the market signal it sent via buying Irish and Portuguese bonds even as President Trichet was saying that the Securities Markets Programme would be ‘ongoing’. That’s a good reminder of the old adage about trying to fight central banks.
On the other hand — private investors don’t have to fight the ECB. All they have to do is sell their long-only positions to it — and walk away.
Much as those investors who had driven the Spanish and Italian bond plunges of Monday were doing already. Here’s Morgan Stanley’s Elga Bartsch and Joachim Fels on this inconvenient point (emphasis ours):
It is important to note that the market moves largely reflected selling by long-only investors trying to reduce their exposure, rather than speculative short-selling. We re-emphasise the point that our colleague, Laurence Mutkin, already made a while ago: the bonds of several peripheral countries, while still being government bonds in name, no longer offer the advantages of a government bond – safety, liquidity, low volatility and a negative correlation with risky assets… Hence, investors running a traditional government portfolio are exiting those markets. In short, peripheral government bonds have become an asset class in search of a new investor base.
Note that the ECB’s bond-buying programme was often billed from its very beginning (here and here, for example) as a weapon for punishing shorts, not for salving longs.
That’s a massive problem for the ECB — its bond-buying programme should be opening up liquidity for investors to march back in, not for covering their exit strategies from an asset class that has mutated in several ways since the crisis.
It’s worth bearing in mind that we’ve already had one ‘death’ of an investment rationale for euro government bonds in 2010, when the Greek crisis began to force peripheral bond investors from trading on rates towards trading on credit.
Other rationales have also dying off over the course of the year — for a start, European banks’ carry trade between ECB liquidity and domestic government bonds under the Bank’s post-crisis provisions. Those, we’d note, were once again extended at Thursday’s meeting, but the trade is declining, after the market twigged to the sovereign exposure risk amid post-Greek contagion in May and June. Of course, banks could have to take on government bond holdings under Basel II and III — but then if peripheral bonds begin to receive greater risk-weightings than bunds in response to recent plans for a haircut regime, that’s less sure.
On that latter point, a representative report from Reuters on Thursday:
Banks should no longer be allowed to avoid setting aside capital in case of sovereign debt default after two euro zone countries had to be rescued, a top European Union lawmaker said on Thursday…
Sharon Bowles, chair of the European Parliament’s influential economic affairs committee, said allowing zero-risk weightings has to be reviewed…
So the sovereign-bank asset loop is crumbling, as above, or collapsing in spectacular and sudden fashion, as Ireland has just shown. But then the domestic banks stood in for a sudden drop in foreign demand from 2009 to 2010.
If ECB bond-buying is going to work, foreign investors need to come back even after the late November crisis leap from periphery to core. There were signs before then, at least — but also signs of another substitute.
Here’s a chart from the Spanish Tesoro breaking down foreign demand for its bonds in 2010 up to October (the heaviest month for net issuance this year.) France is well-represented (again) but the chart shows robust demand from Asian investors:
Or rather, recovering foreign demand — non-resident holdings took a knock in the much bigger crisis of May and June. What’s interesting to note, however, is that in those times of crisis (such as this past November) Spanish non-bank investors such as pension funds have come to the fore. Curiously, their buying is starting to offset selling by banks. Ireland’s trying something very similar now, starting from a much scantier domestic investor base.
Meanwhile, here’s Barclays Capital looking forward to November’s Spanish government bond holdings:
The anecdotal evidence in November (where net issuance was much lower at +5bn, but spreads widened dramatically) suggests that nonresident holdings have increased, although not at the past few months’ breathtaking pace. The buying has been more domestic, with nonbanks still being the most consistent domestic buyers. There has been little evidence of wholesale selling of Spain by nonresident holders (apart from hedge funds) recently, with investors holding on to their positions…
Late November might have spoiled this a bit, but the trend is there.
So there you are – chuck this stuff into the pension funds and/or Asian sovereign wealth funds. Although given that funds are already typically crammed with fixed income (and would not be shy about offloading the peripherals if real defaults and real writedowns become a possibility in 2011 or 2012), perhaps not, actually.
Over to you in the meantime, Mr Trichet. Again.
Related links:
Won’t someone think of the eurozone bonds? – FT Alphaville
Financial stability is getting difficult – FT Alphaville
