The DEBT markets in Europe renewed the sombre tone of a collapse of Italy and Spain. In the early part of the European trading day, the Italian BTP was holding on to last week’s gains and outperforming the BUNDS to the upside. As the day wound to a close, the “negative” news out of the Merkel’s CDU conference pressured the DEBT markets as new fears arose that the German Chancellor had her party’s support for the jettisoning of some of the weaker peripherals.

THE DECEMBER BUND/BTP contracts retraced Friday’s rally and created profit taking on the RISK-ON trades. Merkel’s CDU vote seems to be superfluous and is mainly a basis for the party platform and at this time has no legislative strength, but the media will never let the possibility of a good headline go to waste. More important is that Merkel seems intent on pushing for a “NEW EUROPE” built on a tighter fiscal union as the major leap to a more “PERFECT” political union. If Germany is going to be Europe’s paymaster, Europe is going to live by the same standards of frugality that exemplify the good BURGHERS of BAVARIA. Merkel is invoking the GOLDEN RULE: SHE WHO HAS THE GOLD MAKES THE RULES.

***Today’s Italian BTP was under pressure as the 10-YEAR GAINED 25 basis points. The Spanish 10-year also gained 25 basis points, but to underline how much the tension has moved to Spain before Sunday’s election, last week the Italian/Spanish spread was out to 150 basis points, while during the last three days the spread differential has narrowed to 61. The European debt markets are/will be in flux for a long time, but the ability of the DEBT TURMOIL to generate volatility should not be underestimated. For those with CQG machines, place the BUNDS and BTPs next to each other and watch how the fluctuations of the two drive the risk-on/risk-off trade. In a thin market its impact is magnified and I warn that exhaustion will set in by 10 a.m. (CQG symbols are DBZ1 and FBTPZ1)

As the Italian/Spanish 10-year has narrowed, the German/French spread widened to its largest differential since 1993 when Trichet defended the D-MARK/FRENCH FRANC cross by raising French interest rates to chase the speculators away from pressuring France’s currency. This policy was known as Le Fort Franc and Trichet would send France into recession rather than risk devaluing the FRANC. Some things never change. The German/French 10-year closed at a difference of 163 points, while just 10 days ago it was flirting with 100. France is under pressure due to its banks having so much SOVEREIGN DEBT on their books. Also, German Debt is in demand as it is the highest quality DEBT that is sought by the REPO market.

***Readers were e-mailing me about last night’s view on the strength of the YEN. Several people noted the YEN was highly desirable because it has the highest real yields on 10-year debt in the G-7. As Japan has reentered a period of DEFLATION, the 100 basis point yield on JGBs results in the effective real yield of 2%. The yield would be beneficial to Japanese investors but not to non-domiciled YEN investors. If foreigners were piling into JGBs they would be the best performing DEBT INSTRUMENTS. On a global basis they definitely fall short. For the calendar year BUNDS are up 10%, U.S. 10-YEARS ARE UP 8% and even the BRITISH GILTS ARE UP MORE THAN 9%. THE JAPANESE 10-YEAR JGB IS UP A MERE 1.5%. There is a disconnect in that the STAR has way underperformed, which again raises the question, WHO IS BIDDING FOR YEN? The Swiss National Bank has been very effective in its intervention techniques to halt the rise of the Swiss Franc, while the Bank of Japan has failed miserably in its efforts to curb YEN STRENGTH.

Many questions are left unanswered but if the Japanese realistically desire a weaker YEN they are going to have to get very creative in their intervention techniques. When the U.S. DOLLAR was very overvalued in the late 1960s and then again in the 1980s U.S. Corporates went on a foreign buying spree and bought up global assets at a relative cheap price. If the YEN is as overvalued as corporate Japan claims, now is the time to be buying U.S. and European assets with your overvalued currency. Let the GAMES BEGIN! In the 1980s, the Japanese were throwing YEN at all types of “conspicuous consumption.” This time put the money to work in a productive capacity. Oh well, they will always have EUROPE!

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5 Responses to “Notes From Underground: SPANISH MISSTEPS TRIP UP ITALIAN DEBT”

  1. rohrintl Says:

    This is where the Germans are full of both hot air and hubris.

    How easily they forget that their much-lauded austerity was only a huge success because they were allowing the profligates to borrow and spend. Now that they have a huge pile of reserves they feel empowered to tell everyone else, “Why can you be like us?” Arrogant imbeciles.

    Let ’em kick out the profligates, and see how they like EUR/USD at 1.80! And the ultimate hubris is Merkel suggesting at that same conference yesterday the way forward is a Europe that is united politically… WHAT?! Well, it is a way to allow that a lot more work needs to be done while the rest of the world is told to remain patient.

    Kick the can down the ‘road’? …why not hypothesize an entire super highway to buy stalling room? And let’s not forget what happened the last time Germans thought they knew how to ‘perfect’ Europe.That they are doing much the same now with financial dominance doesn’t make it any less damaging: across-the-board austerity is a recipe for the next Depression.

    Here’s a bit of German (sort of) for you Frau Chancellor: Narrishkeit!!

  2. JediTrader Says:


    How would you trade the euro crisis through fixed income? I am thinking I would purchase CDS on Spain and Italy, essentially taking a position that they would default. But what about hedging? Would a better move be to not only take the long side of CDS, but then to purchase and hold a smaller position in Spanish and Italian bonds…. the idea being that these countries have broken the 7% yield mark and if there is an intervention it would drive down yields and minimize losses from a non default from the CDS position. Could be way too late to the party anyway but though i’d ask.

    Thanks for the post!

  3. yra Says:

    Jedi–the fact that nobody has gotten paid on the Greek CDS,a la Bear Stearns,that play wouldn’t work—sell teh EURO on all rallies or just play the Italian BTP from the short side and be quick for the ECB will drive you crazy.The fact that the leadership is jumping ship at ISDA makes the CDS market in reference to Europe very questionable

    • rohrintl Says:

      Good perspective Yra. The equities capitulation will likely also put govvies up to new highs once again (yes, even if there’s a US debt downgrade.) But being so much less distended in its trend of late, the euro short is likely the much better opportunity.

  4. JediTrader Says:

    Yra and rohr,

    Thanks for the feedback! I am a big fan of KISS, keep it simple stupid, but as i learn more I’m trying to think of as many different ways to express the same theme.


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