This note was originally published at 8am on December 28, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.
“The only time I have problems is when I sleep.”
- Tupac Shakur
In Greek mythology, Hypnos is known as the god of sleep. His palace was a dark cave where the sun never shone. The palace itself had no gates or doors, so that he would never be awakened by sounds from doors opening and closing. Unlike Hypnos, global macro markets, especially in these interconnected times, never sleep.
The most noteworthy news overnight, not surprisingly, comes fromEurope. The first Italian bond auction of the week was held this morning and it was, on the margin, successful. Italysold 9 billion euro of 6-month bills at 3.25%, which was dramatic improvement over the last auction on November 25ththat sold at a yield of 6.5%.
As Greek mythology tends to work, Hypnos’ brother was Morpheus, the King of Dreams. So, while you may still be asleep, especially given the holiday shortened week, the paragraph above is not a dream. The Italians actually did have a better than expected bond auction this morning. If there was any disappointment, it was likely in the tranche of 2013 zero coupon Italian debt that was auctioned this morning. The Italians were able to sell only 1.7 billion euro of the maximum allotted 2.5 billion euro.
Certainly though, we need to jot down this auction as a positive data point in our notebooks, as it is a sequential improvement. The true test of whether there is an improved appetite for Italian sovereign debt will occur tomorrow. In tomorrow’s auction, the Italians will attempt to sell up to 8.5 billion euro of 3, 6, and 10-year debt. In theory, if the Long-Term Refinancing Operation, or LTRO, of the ECB is even moderately successful, then tomorrow’s auction should see some improvement over the prior comparable auction.
Yesterday in an intraday note to our subscribers, we wrote a note titled, “The LTRO is No Bazooka” (email email@example.com if you’d like a copy) and highlighted the following key points:
“In the chart below, we’ve highlighted the ECB liquidity facility going back one year and in the inserted chart going back roughly one month. The key takeaway is that the ECB liquidity facility, which is used by European banks to effectively park money, hit a new all-time high at 411 billion euros this morning and has been increasingly rapidly since the inception of the LTRO just over a week ago. In fact, the day before the LTRO was put into effect, the ECB facility was at 265 billion euro and as of this morning has increased by 146 billion euro, or more than 70% of the incremental liquidity from the LTRO.
So, not only is the LTRO not being used as a bazooka by the European banks, but these banks are parking the borrowed LTRO money with the ECB rather than using it to buy sovereign debt, and thus are experiencing a negative yield on the trade.”
Given the results of the Italian bond auction this morning, there is some evidence the LTRO is being used as the fabled bazooka. Ironically, though, the amount of money parked at the ECB’s liquidity facility increased dramatically overnight to a record of 452 billion euro. This is an increase of 41 billion euro from the prior day. We would caution reading too much into the “successful” Italian bond auction as clearly the risk aversion trade remains in full effect.
In other European news, the prominent Spanish newspaper, Expansion, is indicating that Rajoy may force Spanish banks to cut the valuation of the real estate assets on their books by up to 20%. The fact that Spanish banks still need to write down real estate assets on their balance sheets should not be terrible surprising to anyone.
Spanish home ownership rates are above 80% on the back of cheap long-term mortgages, often up to 40 and 50 years. As well, the government encouraged home ownership by making 15% of mortgage payments a tax deduction. The Spanish real estate bubble makes Phoenix and Florida housing look like a value investment.
Unfortunately, the Spanish real estate market isn’t likely to improve anytime soon. Specifically, in October, Spanish real estate loans decreased for an18th straight month and were down 43.6% year-over-year. Our long term analysis has shown that demand for mortgages is one of the best predictors for future real estate prices. Therefore a 20% cut in the valuation of real estate assets for Spanish banks seems more than reasonable.
On the domestic front, Bloomberg this morning is predicting that 2012 could be the biggest year for IPOs since 1999. Given the current filings, internet IPOs may raise more than $11.0 billion in the coming year. In the face of heightened volatility and a 2011 that was lackluster in terms of equity offerings, raising only $156 billion in 2011 versus $252 billion, the onslaught of internet offerings seems a bit excessive. Undoubtedly, even Dionysus, the Greek god of partying and excesses, would agree with that.
Keep your head up and your stick on the ice,
Daryl G. Jones
Director of Research