Wednesday, November 23, 2011

Wither German Bunds?

Paul Dobson reports in Bloomberg BusineesWeek, German Auction ‘Disaster’ Stirs Crisis Concern; Bonds, Euro Drop (h/t Tom):
Germany failed to get bids for 35 percent of the 10-year bonds offered for sale today, sending its borrowing costs higher and the euro lower on concern that Europe’s debt crisis is driving investors away from the region.

“This auction is nothing short of a disaster for Germany,” Mark Grant, a managing director at Southwest Securities Inc. in Fort Lauderdale, Florida, said by e-mail. “If the strongest nation in Europe has this kind of difficulty raising capital one shudders concerning the upcoming auctions in other European nations.”

The debt crisis that began more than two years ago in Greece and snared Ireland, Portugal, Italy and Spain has closed in on France and now risks engulfing Germany, the region’s biggest economy. Political leaders are struggling to find a fix for the crisis, with German Chancellor Angela Merkel rejecting proposals for the common currency-area bonds, while the European Central Bank resists calls to boost sovereign debt purchases.

The yield on 2.25 percent securities maturing in September 2021 climbed four basis points to 1.96 percent at 11:37 a.m. London time. The price of the bonds slid 0.40, or 4 euros per 1,000-euro ($1,340) face amount, to 102.520. The cost of credit default swaps on German debt rose six basis points to 107, according to CMA prices. The euro weakened as much as 1 percent to $1.3374.

German ‘Pipedream’

Total bids at the auction of securities due in January 2022 amounted to 3.889 billion euros, out of a maximum target for the sale of 6 billion euros, according to Bundesbank data. The securities were sold at a yield of 1.98 percent. French and Belgian bonds fell for a third day after De Standaard newspaper said Belgium is seeking to renegotiate the break-up plan for lender Dexia SA.

“The notion some people had that Germany could be insulated against market developments was a pipedream,” Fredrik Erixon, head of the European Centre for International Political Economy in Brussels, said in a telephone interview. “The systemic crisis in the euro zone is eating its way into countries that are solvent and have competitive economies, like Germany. But because they are in the euro zone the crisis is spreading to them.”

The rate on 30-year German bond climbed as much as seven basis points to 2.68 percent, the highest since Nov. 9.

Germany’s Finance Agency sees no risk in financing the government’s budget after demand was weak at a debt auction today, Joerg Mueller, a Frankfurt-based spokesman, said today in an interview.

The yield on 10-year French debt increased 10 basis points to 3.63 percent, while the rate on similar-maturity Belgian securities was 14 basis points higher at 5.22 percent.

German bonds have returned 8.2 percent this year, according to indexes compiled by Bloomberg and the European Federation of Financial Analysts Societies. French bonds have gained 0.9 percent and Belgian securities have dropped 3.3 percent, the indexes show.

Stephen Brown and Noah Barkin of Reuters shared similar views in their article,"Disastrous" bond sale shakes confidence in Germany:

A "disastrous" German bond sale on Wednesday sparked fears that Europe's debt crisis was even beginning to threaten Berlin, with the leaders of the euro zone's two strongest economies still firmly at odds over a longer-term structural solution.

Financial markets were also unnerved by newspaper reports that Belgium may be pressing France for an expansion of a 90 billion euro ($120 billion) bailout of failed bank Dexia.

On top of this, a special report by Fitch Ratings suggested France had limited room left to absorb shocks to its finances like a new downturn in growth or support for banks without endangering its cherished AAA credit status.

After one of the least successful debt sales by Europe's powerhouse economy since the launch of the single currency, the euro fell and European shares sank to 7-week lows.

The Bundesbank was forced to retain almost half of a sale of 6 billion euros due to a shortage of bids by investors. The result pushed the cost of borrowing over 10 years for the bloc's paymaster above those for the United States for the first time since October.

"It is a complete and utter disaster," said Marc Ostwald, strategist at Monument Securities in London.

One senior ratings agency official said the rise in its own borrowing costs could even give Germany a pause to re-examine its refusal to embrace a broader solution to resolve the debt crisis.

"It's quite telling that there has been upward pressure on yields in Germany - it might begin to change perceptions in Germany," David Beers of Standard & Poor's told an economic conference in Dublin.

The new bond promised to pay out a 2.0 percent interest rate -- the lowest ever on an issue of German 10-year Bunds. The average yield at the auction was 1.98 percent, down from 2.09 percent at the last sale of the previous benchmark in October.

Signs that European banks are increasingly shut out of credit markets and reliant on the European Central Bank for funding have added to pressure for the bloc's leaders to find a broad and lasting solution to the crisis.

But Germany and France clashed again over whether the ECB should take bolder steps to ease the pressure on debt markets in Italy, Spain and others which is now at the heart of the crisis.


In a forceful speech to the Bundestag lower house of parliament, Chancellor Angela Merkel issued one of her starkest warnings yet against fiddling with the central bank's strict inflation-fighting mandate. She also hit back at proposals from the European Commission on joint euro zone bond issuance, calling them "extraordinarily inappropriate."

"The European currency union is based, and this was a precondition for the creation of the union, on a central bank that has sole responsibility for monetary policy. This is its mandate. It is pursuing this. And we all need to be very careful about criticizing the European Central Bank," Merkel said.

"I am firmly convinced that the mandate of the European Central Bank cannot, absolutely cannot, be changed."

Shortly before she began speaking, French Finance Minister Francois Baroin offered a polar opposite view on the ECB's role, telling a conference in Paris that it was the central bank's responsibility to sustain activity in the currency bloc.

"The best response to avoid contagion in countries like Spain and Italy is, from the French viewpoint, an intervention (or) the possibility of intervention or announcement of intervention by a lender of last resort, which would be the European Central Bank," Baroin said.


The very public jousting underscores just how divided European leaders are on how to resolve the turmoil which has accelerated to engulf big countries like Italy and Spain, and pushed out leaders in Rome and Athens.

Baroin pointed to market intervention by the U.S. Federal Reserve, Swiss National Bank and Bank of England as a model for the ECB. But Merkel said it was impossible to compare the role of the ECB, which sets monetary policy for 17 countries, with those of national central banks.

With time running out for politicians to forge a crisis plan that is seen as credible by the markets, the European Commission presented a study on Wednesday of joint euro zone bonds as a way to stabilize debt markets.

Some leading European politicians, including Luxembourg Prime Minister Jean-Claude Juncker, support the bonds. But Berlin has rejected them outright as a near-term solution to the crisis, saying they would raise Germany's borrowing costs and reduce incentives for other euro zone countries to get their fiscal houses in order.

In her speech, Merkel pointed to repeated violations of the EU's Stability and Growth Pact in the currency area's first decade, saying they had damaged market faith in the bloc's ability and willingness to crack down on fiscal rule-breakers.

"And this is why I find it extraordinarily inappropriate that the European Commission is suggesting various options for euro bonds today -- as if they were saying we can overcome the shortcomings of the currency union's structure by collectivizing debt. This is precisely what will not work," Merkel said.


The German leader also sent a clear warning to Antonis Samaras, the leader of conservative New Democracy in Greece, who has resisted pressure to join other political parties and make a written commitment to painful austerity measures.

Merkel said Greece would not receive an 8 billion euro aid tranche it needs to avert a default next month unless Samaras signed the pledge.

Merkel raised pressure on the bloc to finalize plans for a "leveraging" of its rescue fund and a recapitalization of vulnerable banks, saying guidelines were needed by the time European finance ministers meet on November 29-30.

"The fact that we have been talking about (bank recapitalizations) for weeks but still have no clarity is not very reassuring, and yesterday we saw with the example of one German bank how fragile the banks themselves are," Merkel said.

Shares in Germany's second-biggest lender, Commerzbank, tumbled on Tuesday after people close to the bank told Reuters it needs considerably more capital than previously expected to meet the core capital targets demanded by the EU by mid-2012.

What is going on? Wasn't this just a Greek crisis? A "PIIGS" crisis? No stupid, this is a European crisis, it always was a European crisis! And unless mighty Germany steps up to the plate and offers a credible long-term solution, they will be feeling the wrath of the bond market and see their borrowing costs skyrocket from these levels.

While Kyle Bass is warning us of "Christianity without Hell," telling us that he's betting against Japanese JGBs, I happen to think the big money is to be made actively shorting German bunds. That's where Mr. Bass should be placing his wise "asymmetric hedges" if he's really sharp. Why? Because Angela Merkel, the architect of this European debt crisis, is proving once again that she doesn't get it.

I bet you Soros is actively shorting German bunds. He gets it, he always gets it, which is why he's the best hedge fund manager in the world. As long as there is no credible long-term solution to this debt crisis in the form of a eurobond market, yields on German bunds will continue rising. Importantly, the market will reward European unity and punish disunity. It's that simple.

As far as the euro, things get tricky here. First, as funding costs rise, European banks will repatriate euros. So far, they have been able to tap the ECB on dollar funding woes, so this isn't a big concern yet. Far more important in F/X markets is how other central banks react to protect their economy's interests.

The WSJ reports that Japan's new tactics for trying to weaken the yen, mixing highly public forays into the market with stealth intervention, has left investors uncertain over what may come next, which appears to be just what the authorities want. And the Business Recorder reports that Dexia, China PMI hit Asian F/X, intervention seen:

Emerging Asian currencies fell on Wednesday with the Singapore dollar hitting a seven-week low on increasing worries about the euro zone and the global economy, though some regional units were pulled higher by intervention.

The central banks of India, Indonesia and Singapore were spotted selling dollars to bolster their currencies, dealers said.

The rupee, which hit an all-time low on Tuesday, strengthened for the day, bucking the trend of peers.

Currency players were cautious as they weighed the possibility that more central banks will intervene.

With the wariness, some investors were reluctant to sell emerging Asian currencies more aggressively, regarding them as a bit oversold, while short-term investors such as interbank speculators unloaded regional units.

"Fear factor is up, but there is no real conviction right now. I'd rather try to catch falling knives," said a European bank dealer in Singapore, adding he would buy the Singapore dollar around 1.3070 per the US dollar, around the session's low.

Another dealer in Kuala Lumpur said he would wait for "better levels" to buy the US dollar against the emerging Asian currencies, adding the market appeared to hold dollar-long positions.

The dealer said he won't buy dollars now while Asian central banks and exporters are selling them, but later he will accumulate the US currency because there's "too much trouble in the world."

Emerging Asian currencies have slid this month on deepening worries about European debt crisis and signs of rising dollar funding costs.

On Wednesday, regional currencies came under more pressure after a Belgian newspaper reported that the Franco-Belgium bailout of Dexia bank -- the first casualty of the euro zone sovereign debt crisis -- was going to be the subject of new talks.

A preliminary survey on Chinese manufacturing renewed worries of a hard landing for the world's second-largest economy, boosting global recession fears, pushing down emerging Asian currencies further.

The media report and the HSBC flash purchasing managers' index (PMI) dragged down Asian stocks and the euro.

Asian currencies "should fall further because a Chinese slowdown would hurt growth and exports for the rest of Asia," said Dariusz Kowalczyk, senior economist and strategist for Asia ex-Japan at Credit Agricole CIB in Hong Kong.

All this tells me is that the euro will not collapse, but eurozone still needs to get its act together. As long as they keep dragging their feet, Germany's borrowing cost will climb. How high? Nobody really knows but let me assure you Ms. Merkel's office is fielding some phone calls from some very nervous German bankers right now. They see the endgame and it isn't pretty.

Below, leave you with professor Yanis Varoufakis' keynote address at the Crisis in the Eurozone Conference that took place at the Lyndon B. Johnson Graduate School of Government, University of Texas, on 3rd and 4th November. You can watch more speeches from other experts that attended this amazing conference on YouTube here.

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