Wednesday, November 23, 2016

Keep Your Eye On Spreads

Like it or otherwise it's mostly a north-south world.

In California, the most populated state in the United States, the north has most of the water. The same holds for those sub-Saharan regions; they have little water compared to those in the northern hemisphere. It's the same in the European Union, the poorer countries are in the south.

So a decent question is why would it be any difference in the bond market? It isn't. Other factors accounted for, take a look at bond yields and their spread, say, between 10-year Italian and 10-year German bonds. Market gurus like to break it down a bit differently calling things risk on and risk off investing.We witnessed  a lot of that, particularly in Asia, leading up to the U.S. election and also post-Brexit.

Your seeing the same thing in the exchange markets now with the euro and the UK pound. It was  even worse when all those EU joiners had their own currencies competing against the Deutschmark and such.One of the European Union promises was to put an end to all that. Well, it hasn't happened and the bond market it saying so right now.

Both 10-year Italian and 10-year German bonds supposedly represent sovereign debt. But your sovereign debt as your dirty laundry is not necessarily mine. That's just one of the reasons the EU will ultimately fail. The big boys up north have gerrymanders things when they need to but are unwilling to grant those underlings in the south any slack for the most part. Some would call it crumb tossing slack. Now the south is not especially rank innocents either.

Most of us dislike spring cleaning. Politicians hate it the most. In the currencies' market when you're talking safe harbors of late, it's the Swiss franc, the yen and the dollar. Of late in the bond markets it's been Germany and the U.S. Bonds are sensitive to interest rate changes or so-called perceived changes. Rates in the U.S.were perceived to be going up even before the Donald pulled off the upset  of the 21st Century so far. Not so in the EU. Magic Mario is still tossing soft pitches for the most part.

Part of the problem is political uncertainty. wsj.com/moneybeat/2016/11/21/italys-looming-referendum-risk-splits-southern-europes-bond-markets

In the latest bond market selloff, a new trend is becoming ever more clear — a divergence between southern Europe’s two biggest economies, Italy and Spain.

Italian 10-year government bond yields are currently at their highest since early 2012, around half a percentage point above their Spanish counterparts with two weeks to go until the country’s constitutional referendum. In the selloff since the U.S. election, Spanish yields also ticked up, but at a slower pace than Italy’s.

The country goes to the polls Dec. 4 to approve or reject reforms to the country’s upper house of parliament. A “yes” vote would weaken the country’s senate, reducing its control over some policy areas and meaning it can no longer oust governments. In times of economic stress, yields on the European periphery — the more economically troubled countries that suffered most during the euro sovereign debt crisis — tend to rise relative to countries in Europe’s core, particularly Germany.

“The significant underperformance of [Italian government bonds] in the last two months is by and large a reflection of the higher political premium in the run up to the Italian referendum,” said a note from Morgan Stanley’s interest rate strategists late last week.
A loss — currently projected by most polls — would weaken Italian Prime Minister Matteo Renzi’s economic reform efforts. Earlier in the year, Mr. Renzi suggested he would resign in the event of a “no” vote.

Italy’s brand new 50-year bond is another illustration of the challenge for investors. The debt security has dropped in price by more than 12% in the last month.

 
But it isn’t just a relative absence of political crisis that’s helping Spain — the country’s economy has also shown more strength than Italy’s. HSBC’s analysts believe that in time Spanish bond yields could converge towards French levels.

Spain was considered one of the most damaged European economies during the eurozone sovereign debt crisis, but has rapidly repaired its reputation among investors.
Though the economy took an enormous hit during the euro crisis, the country’s GDP per capita is still 14.2% higher than when the euro was launched in 1999, whereas Italy’s is 3.8% below those levels.
“With the political situation in Spain having turned less uncertain lately, the looming December vote has driven Italy’s policy uncertainty higher,” said Bank of America Merrill Lynch analysts in a recent note.

“We are no longer in the peace and quiet’ of 2015,” the note added. “From now to the referendum, we think Italy will be walking on thin ice.”
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So keep you eye on the spreads. 

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