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The Negative Feedback Loop

May 10, 2011 8:27 PM ET
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I think I’ve discovered another crack in the EU’s financial defence system, thanks to a little hint from Markit Financial Information. In fact, it might illustrate a global problem that only can lead to an intensified financial – and political – crisis.

It appears that the foreign take-up of the debt was down from the previous auction, meaning that Greek banks were significant buyers.

Gavan Nolan

We know the US FED use it’s primary dealers to buy American debt. The ECB have just recently started to buy European debt through similar arrangements with large European banks. Now we learn that Greek banks are buying most of the Greek debt. Does this mean that governments are putting huge amounts of debt back into an already insolvent banking industry?

To me it looks more and more so.

I really hope it’s not true. That would definitively be like putting out fire with gasoline.

One might certainly wonder who’ll finally end up with the bill…

Today’s session in the credit markets was dominated by Greece and its EU masters, and resulted in risky assets rallying.


Spreads opened tighter after a solid show on Wall Street last night.

But the markets were soon focused on Greece after a wire report stating that a new bailout package had been agreed.

The reports say that EUR27 billion next year, and another EUR32 billion in 2013, would be forthcoming to plug the funding gaps.

And as usual the Greek government officials was swiftly out and denied the reports, but I belive investors have become accustomed to ignoring such protestations.

Sad, but true.

Spreads were tighter on the news and didn’t give back much of their gains after the denial.

That Greece needs external assistance isn’t doubted – the government and the EU have already declared that Greece won’t be able to access the capital markets next year.

What is uncertain is the conditions that the EU will demand and whether there will be a maturity extension on Greek debt, both to the EU and private lenders,
credit analyst Gavan Nolan points out in Tuesday’s Intraday Alert.

And the reports of a further bailout probably influenced demand at Greece’s debt auction this morning.

The sovereign managed to sell EUR1.625 billion of 6-month T-bills, with a bid-to-cover ratio of 3.58 and a uniform yield of 4.88%.

This compared favourably with the auction last month and was quite an achievement given the recent inversion in Greece’s credit curve (see above).

But it appears that the foreign take-up of the debt was down from the previous auction, meaning that Greek banks were significant buyers,
Gavan Nolan at Markit writes.
Adding: The negative feedback loop between the sovereign and the banking sector is as strong as ever.

And there you have it – the negative feedback loop – it can’t be good. In fact, in can be very dangerous. 

Throughout the day, various EU dignitaries weighed in with their comments.
Angela Merkel was circumspect, only saying that she would wait for the results of the EU/IMF review in June.

EU commissioner Olli Rehn agreed that it was premature to ask about Greece’s refinancing needs in 2012. Rehn, however, did say that Portugal’s interest rate would be between 5.5% and 6% and that Ireland’s interest rate would be reduced.

The commissioner stuck to the party line on restructuring, i.e. that they are not being considered.

Spreads in Ireland and Portugal were only slightly tighter, suggesting that market participants are wary of further developments on this front.

If recent history is anything to go by it seems likely that the picture will become more muddied ahead of Monday’s eurogroup meeting,
Nolan notes.
In the US the noise around Greece probably had little impact on sentiment, according to Markit, and points to the news of Microsoft acquiring Skype for $8.5 billion.

Microsoft is a very strong credit that rarely trades in the CDS market – it has a relatively poor Markit Liquidity Score of ‘4’ and it is not in the 1000 top traded entities in the DTCC Trade Information Warehouse,
Nolan writes
Adding: From a credit perspective the Skype acquisition shouldn’t impinge on Microsoft’s credit profile given its enormous cash pile. The company’s spreads were trading around 35-40bp, slightly tighter compared to yesterday.

  • Markit iTraxx Europe S15 97.25bp (-1.25), Markit iTraxx Crossover S15 356bp (-4)
  • Markit iTraxx SovX Western Europe S5 189bp (-6.5)
  • Markit iTraxx Senior Financials S15 135.5bp (-4), Markit iTraxx Subordinated Financials S15 234bp (-9)
  • Sovereigns – Greece 1305bp (-53), Spain 249bp (-10), Portugal 650bp (-6), Italy 156bp (-8), Ireland 672bp (-11)

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