While the headlines surrounding Greece have been relatively bullish, the price of insuring euro zone debt against default has soared back to historic levels.
Good news out of Europe this weekend, at least. The new terms of the debt rescue fund give Greece, Portugal and even Spain a lot more breathing room, and that is a euro positive.
Spanish banks are suffering today after an extremely critical note from UBS warned that rather than being at the end of the credit crisis, these institutions’ woes are just beginning.
The cost of insuring sovereign debt along the edges of the euro zone is increasing again due to a number of political factors
Athens auctioned off around $1.6 billion in three-month bills this morning, proving that the sovereign credit fears of the spring have been almost entirely allayed.
Demand for the offering was heavily oversubscribed — 5.19 times as many bids as the Greek government had debt to sell — and the yield finally priced at 3.75%.
When you consider that the offering was originally set to raise only $1.2 billion but was expanded by 30% once the bids started coming in, the news is fairly spectacular for the Greeks and for the euro zone.
The interesting thing is that more than 50% of the bonds went to foreign investors. This may mean U.S. traders and other people coming in from ultra-low-rate markets looking for a better return on their money.
After all, 3.75% is a lot more impressive than the 0.14% that 3-month Treasury bills currently pay — assuming you can live with the risk that Greece may somehow default on its credit obligations between now and January.
Since that risk seems relatively low, taking the Greek securities is probably a good trade.
Either way, good news for the euro and EU (quote):
Just a week ago traders were fretting about a new wave of European credit quality confessions, but after the last round of debt auctions, there is barely a bearish peep.
Greece, Hungary, Spain, Ireland: most of the troubled borrowers in and around the euro zone sold new debt with few if any problems. Demand seemed steady, effective yields dipped and credit default spreads — the cost of insuring these securities — narrowed.
However, while the week’s auctions represented some progress toward restoring positive sentiment in Europe’s credit markets, a lot of work still needs to be done.
The euro barely budged, as you can see by performance of euro-denominated ETF EU (quote):
Even in the last few months, rising CDS spreads reveal that traders are now more convinced than ever that Greece will finally have to default on its obligations. Hungary, while not part of the euro zone, is also priced as though its credit rating were already at junk status.
And there is a lot of debt on the calendar. All in all, European countries plan to sell around $40 billion in new bonds next month.
Watch Spain on Tuesday, Portugal Wednesday and both Italy and Ireland on Thursday to see if any news from their upcoming offerings move the euro one way or another.
RICHTER seller 30k… block possible
OTP seller 150k.. happy to offer stock
European credit fears have been subdued lately as traders have gotten complacent that whatever happens on the debt-laden periphery, the Germans will bail them out.
However, there are rumblings out there that the euro’s latest round of weakness — down 3.5% against the dollar so far this week — is not so much purely technical as a realization that even the Germans could be facing slower growth. And if Germany slows, the periphery is in trouble.
So far, German manufacturing and export data have been a beacon in a growth-challenged developed world. But watch German GDP tomorrow morning very, very carefully.
A break there means the focus will go right back to sovereign strength (or the lack thereof) and the euro will go right back to where it was a few months ago. In that scenario, we could see $1.20 again.
The U.S. economy does not look hot, but at least we are not in immediate danger of defaulting on our sovereign debt. Let us hope the European economy keeps chugging along, with Germany at its center.
Recent European debt auctions demonstrate that Asia is still in the market for somewhat distressed paper from Greece, Spain and other recently sovereign-challenged borrowers.
China alone has added “several hundred million” euros worth of European debt to its foreign currency reserves in the last few months. According to European Trade Commissioner Karel de Gucht, Spain and Greece have been particular beneficiaries of that buying spree.
Support from China — which has expanded its reserves to $2.45 trillion this year — has been a critical factor in ensuring that the governments of Spain, Greece and other troubled countries can smoothly sell their debt even when Western investors fail to step up.
Ultimately this has been a great source of support for the euro in its darkest moments. China owns an estimated $500 billion in euro-denominated paper and would be unlikely to relish an outright crash of that currency.
Between news of this and progress on the long-awaited European banking stress tests, the euro is stronger this morning. Renewed grousing about the health of the U.S. economy is not hurting; as traders flee the dollar, the euro is one of the main beneficiaries.
Bullish signs for EU (quote).
More good bond auctions have helped Spain start the healing process, but further recovery for the country’s debt markets — and the euro — may be slow as jitters persist.
Today’s sale of $3.8 billion in 15-year bonds followed the now-familiar post-crisis pattern for Spanish fixed income auctions: oversubscribed (by 2.57 times) and supportive in the short term, but at a relatively elevated yield.
The euro is loving this. Between the lack of a new disaster in Spain (or any of the other troubled markets like Portugal, Greece or Italy) and fresh fears that the U.S. economy could be due for a slowdown, the European currency is back at May levels and edging higher.
Whether the euro can recapture the now-lofty-looking $1.35 to $1.37 range it comfortably occupied early this year is another story.
Watching the swaps
The cost of insuring Spanish debt is a decent indicator here. Credit default swaps (CDS) on Spain have gotten a lot less expensive since the April-May peak, which reveals that investors are not as desperate to hedge their default risk in this market. Lower CDS prices mean a lower aggregate sense of risk out there.
However, there are three things to keep in mind:
1. Swaps have more or less flattened out, with today’s auction only knocking 2 basis points off the typical contract. Additional good news will have a harder time producing added incremental results.
2. In the absence of catalysts, the tone is still negative. Before the auction, swaps were trading higher because nobody wanted to be exposed to bad news. Although we have since gotten a short-term relief pop, the trend is still not what you would call constructive.
3. There is still a long, long way to go before Spanish CDS prices are back where they were in March, when we all thought the country was too big to fail. Contracts are running at around 214 basis points, which means that it costs about $21 to insure $1,000 of Spanish debt. Back in March, you could buy the same level of protection for $9.
You can see the same pattern in play for Italian swaps, Portuguese swaps, Greek swaps. Things are getting better, but the going is slow and we have a long way to go before the euro is really back.