Thursday, 6 January 2011

Play it again Sam ! - European problems not going away in 2011...

Portugal came back to the market today and auctioned 500 millions euros worth of bills repayable in July. The yield stood at 3.686% from 2.045% back in September 2010 for similar maturity bills.

A year ago Portugal was only paying 0.592 % to borrow for six months.
Portugal need to raise 20 Billions Euros this year and it is not going to be cheap for them to do so.

On the 23rd of December, Portugal was downgraded by Fitch Ratings from AA- to A+. S&P might downgrade further Portugal to A- in April, which will automatically increase its cost of funding.

Moody’s said on Dec. 15 it may cut Spain’s Aa1 credit rating and on Dec. 16 placed Greece’s Ba1 bond ratings on review for a possible downgrade. Ireland’s credit rating was cut by five levels by Moody’s on Dec. 17.

Below table displays the European Government spreads versus Germany in early 2010 and the situation at year end:

Early 2010:

By year end:

2011 is the raising money race year. Competition between Sovereigns and Banks to raise money fast will be furious. It is already happening. Deutsche Bank and Rabobank kicked of the race on the 4th of January by selling US bonds. Deutsche bank issued 1 billion USD of 5 years notes paying 3.25% (130 bps more than comparable Treasuries), while Rabobank sold 2.75 USD billion of securities, according to data compiled by Bloomberg. On the 5th of January, it was the turn of Societe Generale and Intesa to tap the market and issue bonds.

Europe Banks Race Sovereigns to Bond Investors:

“There are several European government bonds paying more than banks for debt so it’s hard for lenders to raise cash in this situation,” said Serafi Rodriguez, a fixed-income trader at Banc Internacional d’Andorra.

Both funding costs for banks as well as for sovereigns is going up as reflected in the widening of CDS spreads we saw last year.
Evolution of CDS spreads between the 21st of September until the 21st of December:

European Sovereigns CDS spreads widened:

Asian Sovereigns CDS spreads were stable:

The risk of "Crowding Out" is alive and real. I previously posted on this very subject in February 2010: Crowding Out.

Banks need to raise 1.1 trillion USD this year.
From January 2010 until December 2012 the amount needed to be raised by banks amounted to 2.2 trillions Euros.

The important issue of rising global yields is a very important one. Debt markets are going to be more and more discriminating. This has serious implications in the development of the government finance bubble. Some cracks appeared with Greece in 2010 and you can expect similar cracks to show in 2011. After Greece and Ireland, Portugal seems to be the most obvious next weakest link to unfold.

In this race to funding, and with the markets becoming more and more selective, the competition will be fierce in 2011. The implications for public finances will be great. The era of cheap funding is definitely over.

Western countries are still trapped in a secular bear market. Particularly the US. Unemployment is still hovering around 9.8% after 4 trillion USD increase in government liabilities in just 9 quarters in conjunction with an extended near zero interest rate policy. Dear Ben, there is nothing to be proud of and QE2 is not going to be the remedy for the structural issues and housing mess which are still plaguing the US economy.

In this environment, Gold can continue to rise in 2011 as illustrated by the current term structure for Gold futures:

In relation to the evolution of yield on 10 year European Government debt, Ireland and Greece have reached new highs:

Evolution of Greek 10 year yield in the last 6 months until the 5th of January 2011:

Evolution of Ireland 10 year yield in the last 6 months until the 5th of January 2011:

Play it again Sam...

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