This week was expected to be marked by GDP releases, by bond auctions in Italy and Spain and by clarifications over the way the ECB would support the new adjustment programme for Greece. Aside from these, the European Commission’s “First Alert Mechanism Report on macroeconomic imbalances in Member States” (Report here), also highlighted the structural problems faced in EU member states.
This week, four main developments probably dominated the bond markets. The first two were data releases:
- On Monday February 13, the First Alert Mechanism Report on macroeconomic imbalances in Member States highlighted the structural imbalances in the Belgium, Bulgaria, Denmark, Spain, France, Italy, Cyprus, Hungary, Slovenia, Finland, Sweden and the UK.
- On Tuesday, February 14, Eurostat published figures showing that industrial production fell by 1.1% in Euro-Zone, between November and December 2011, by 0.6% in the EU27.
- On Wednesday, February 15, Eurostat published figures that showed EU27 and Euro-Zone GDP falling by 0.3% in the last quarter of 2011. Annually however, 2011 proved better than 2010, and GDP in the EU27 and in the Euro-Zone grew by 0.7% nad 0.9%.
Finally, the public discussion of the role of the ECB in providing further assistance to Greece in the context of its second programme continued.
These insights, should on their own shed some light on the bond yield movements above. Specific developments are highlighted below:
Italian and Spanish auctions
As scheduled, Italy and Spain held debt auctions, on Tuesday an Thursday respectively. The Tuesday auction went very well for Italy, and the alert mechanism conclusions did not add any news, so Italian yields fell on Tuesday. The Thursday auction also went very well for Spain. There’s a good chance that the relief that the successful Spanish auction provided the relief for Italy as well, given how both countries are seen in a tandem. More interestingly, by making these sovereigns more appealing I believe that it made the Belgian and German sovereigns relatively less attractive, thus explaining the symmetries between those countries and Spain, seen in the graphs above.
Portugal‘s yields fluctuated in the beginning of the week before they definitively rose. There might be several explanations for this. However, there are four important data releases that could not have failed to affect these:
- The industrial production figures published on Monday, February 14, were not particularly encouraging. According to Eurostat, Portuguese industrial Production shrank by 1.6% m/m in December 2011.
- GDP figures published the next day showed that, in Q42011, the Portuguese economy had shrunk by 1.3% q/q and by 2.7% y/y.
- On Wednesday, February 16, Unemployment was reported to have reached 14%, a 1.6% increase from the last quarter of 2011. This is an extremely problematic situation. Economically, these are people who are not producing or consuming.
- Unsurprisingly, imports have been decreasing, and even export growth is slowing down in December, according to data released by Statistics Portugal on Friday, February 17. After all, no company supplies only the foreign market.
On related news, the Portuguese state run companies had aggregate losses of up to €1.5Bn in 2011, undermining the credibility of the deficit containment commitments of the Portuguese state.
Ireland‘s Industrial production pointed in the opposite direction of Portugal. Industrial Production rose by 2.5% m/m in December 2011. However, this came in the heels of a fall of 12.5% in November 2011. Unfortunately there was no new data for Ireland’s GDP. However, the bond developments are consistent with positive expectations, which were probably further supported by these positive values. Notwithstanding those positive developments, the Irish Times reported that there had been a 10% increase of mortgages in arrears in Q42011.
Greece continues to suffer for its past, statistically fraudulent sins. Following last Sunday’s scramble (13/02/2011) to pass the austerity measures demanded by the Troika, in exchange for a second adjustment programme, this week continued to be accompanied by controversy regarding Greece. After this, the EU was still not convinced of Athens’ commitments to fiscal sustainability and structural reform. This led to renewed calls for written pledges by its political leaders. In the struggle than ensued Germany, the Netherlands and Finland were willing to refuse to grant Greece the funds to avoid default. Eventually, Greek leaders folded and supplied the required letters to Brussels on Wednesday, February 15, apparently clearing the last European hurdle to this problem. While these are relatively good news, if you assume that we are moving in the right direction, these developments do not translate into falling yields for several reasons:
- First, Greek bond holders’ balance sheet has taken a hit. Privately held Greek debt will be worth around 30% of the value that was paid for it. While this might have been cushioned through trades and through hedging, there is no way that the face value can in any way correspond to the issuance value.
- Expectations about the future are not good. The austerity spiral means that the Greek economy will not grow for the foreseeable, meaning that the government’s ability to levy revenues.
- Despite the PSI deal, there is still plenty of Greek debt floating around. As this article argues, after the PSI deal is translated into balance sheet losses, there are still €150 Bn worth of Greek debt in the market, €109Bn of which is held by the Eurosystem (all the national central banks of the EU, not just those of the Euro-zone).
Finally, the Greek cabinet agreed to target the debt swap for March 8. This is a bit problematic, as it leaves it very little time between the deal and the deadline for repayments. Apparently there are still many issues to solve, which will be debated on the upcoming meeting of Euro-Zone Finance miniters on Monday.
ECB Intervention in Greek PSI – Payouts, Seniority and Monetary Financing
The discussions about the role of the ECB in providing further assistance to Greece in the context of its second programme continued. Unsurprisingly, the main question is about what to do with the extra €109 Bn mentioned above.
- According to BMFNNews twitter feed “ECB’s Coeure says ECB should distribute profits on Greek debt to member states” on February 14, joining his voice to that of Draghi. However, the next day, the same news agency twitted “ECB’s Weidmann says no basis to give up hypothetical Greek profits”.
- This comes off the heels of the PSI talks, and the government bond swaps inherent to it. These Swaps are agreements reached between two parties of a financial contract (equity or debt, but in this case debt) to literally to give up the old bonds in exchange for new ones at a fraction of the original value and with a later maturity.
- The ECB considers any swap at below par (at a fraction of the original value, below 100%) to be tantamount to monetary financing and thus illegal. The ECB holdings of Greek debt will have seniority in the Greek PSI talks. This has created quite a fuss as private holders are outraged. FT Alphaville (here) and ZeroHedge have discussed these issues (here, here and here).