Why CCT are priced below par

I take the opportunity of a question from a reader to speak a little about CCT, namely the Italian State bonds at variable rates.

Some day ago I spoke with a colleague of mine who deals with finance for many decades (I have not written badly, just for decades!) and has got a lot of historical experience to: one with white hair, then, that told me he never had seen the prices of CCT, since they exist, so depressed, at levels well below the par, i.e. their nominal value (100), even when, in the early 90s, the old Italian lira came out from the EMS.

Why CCT have lost so much value in recent months? The problems are basically two:


1) more credit risk for Italy

The perception of credit risk relating to European countries called "peripheral", such as Italy, Greece, Ireland, Spain, Portugal, etc. is certainly worsened, and partly was reflected in real downgrade, as the one which caused Spain to lose the triple A.

For Italy, in particular, this has led to a sharp rise in spreads on contracts of Credit Default Swap (CDS) relating to debt securities issued by the Italian Republic, currently at 165, the worst figure among the G7 countries, as demonstrated by the following table (source: Markit).


Certainly the comparison among G7 may leave some doubt, if only you consider that, for example, the CDS on Japan is quoted about one quarter of the italian one, although the japanese government debt levels are, in my opinion, much more worrying than that - so much blamed - of Italy (in terms of debt / GDP ratio, for example, it is almost 200% against 105% of the domestic case).

The Italy risk, however, is well represented also by the asset swap spread of BTP, a value which, in a nutshell, measure the difference between the interest rate of the BTP (the fixed rate italian government bond) and the swap rate for the corresponding maturity: currently is about 90 bps on the ten years maturity.

Similar measure, finally, is the spread between the Italian BTP and German Bund, equivalent to approx. 170 bps on the same maturity, level higher than the previous one, both for rating differences (Germany is Triple A, while the swap curve underlies a rating of AA), and because the German securities have strongly benefited from the so called flight-to-quality.

Whatever the measure used, however, it is clear that the Italian government debt is under pressure, in this historic moment, for a worsening (at least perceived) of the relative credit risk.


2) the indexing to the BOT and not to the Euribor

There is another factor against the CCT, as always, but particularly in recent months: the Italian floater bond is indexed to the interest rate of the Italian BOT (typically at 6 months, with the addition of a spread of 15 bps), rather than to the Euribor which, as you know, represent the financial benchmark reference on short maturities.

Since the financial crisis has forced up the Euribor rates, i.e. roughly since the second half of 2007 and until a few weeks ago, the Euribor-BOT spread has been abnormally positive and thus unfavorable to underwriters of BOT and, indirectly, to those of CCT.

The situation has gradually improved recently, primarily for the rapid fall in Euribor, but the spread remains at very high levels, equivalent to more than 60 bp, and then to about 45 bp on rates of CCT.


CCT still suffering

Both factors (italian credit risk and spread Euribor-BOT) thus play against the CCT and both effects could determine "curious" effects as the one that was afraid by the reader above mentionned: if, for example, the european benchmark rates increased, but, at the same time, the credit spread of Italy and/or the spread Euribor-BOT worsen, the CCT would be penalized again.

My impression is that the prices of CCT are not intended to improve soon: however, for other aspects, this fact represents a potential opportunity, as the securities purchased at a discounted price today will be redeemed at maturity at their nominal value (assuming that there will be no default of our country) and that, in any event, this is index-linked bond that do not suffer much of a (possible) upward move of the yield curve in Europe.


Original post: Perché i CCT sono sotto la pari

About liquidity, but how much is it?

I have spoken many times about money in circulation , but since the issue of liquidity is always on the agenda, I wanna to report a news that has been neglected, even if it's important, in my opinion.

The Federal Reserve announced (see release) review of the measures relating to money in circulation and its components, to incorporate the results of the annual adjustment of seasonal factors, monthly and weekly, in addition to a new quarterly benchmark.

The new data (detailed in the release), compared with those published previously and reviewed, have lowered the growth of M2 for the first half of 2008, while they raised it for the second half.

But above all, they led to a surge in the dynamics of growth of M1, or the liquid component of the monetary aggregates, as represented largely by notes and coins issued by the central bank: without any doubt this growth represents the injection of new liquidity into the system by the Fed on which was written several times.

Here's a chart:

It's more than eloquent in itself, I only have to say that it represents an estimate of the growth of the M3 aggregate, which the Fed is not public anymore.

Au revoir

Original post: Liquidità, ma quanta ce n'è?

ECB rates are falling, but ....

EMU: economy and rates are still braking ...

In recent months the activities in Eurozone have worsened due to the global financial crisis and in particular, due to the consequent weakening of exports, especially to the U.S. and emerging markets. Difficulties also in the property sector.

Spain, Ireland, Portugal and Greece are under stress for some time, but recent data have indicated a sharp deterioration also in Germany, France and, of course, Italy.

The economic downturn will continue for much of 2009, however, differently to what probably will happen in the U.S. and UK, companies and families in Eurozone not have to suffer a prolonged deleveraging and also will begin to benefit for a lower inflation, which should continue to decline (if oil will allow that ...).

In this context, as you know, on 15th January the ECB cut rates from 2.5% to 2% (back to the lowest of 2003 and 2005, when only 3 months ago they were still 4.25%) and, moreover, could further reduce it, although not immediately, to 1%, according to many analysts.

But the ECB seems to fear the ZIRP

What is surprising today, however, is the quite different (and slower) speed of reaction of the Central Bank in Frankfurt viz-à-viz the U.S. Fed, which is typical symptom of a less willingness to adopt a policy of zero interest rates (ZIRP) .

Is good? If you look upon the cross EUR / USD the answer should be negative, given that the market is punishing the European currency, betting, therefore, a greater potential for recovery in the U.S. compared to Eurozone.

But the Euro is suffering also against other currencies, losing 7% against the Swiss franc and 5% against the Yen just last month. In the last 2 weeks, finally, it has lost 8% against the sterling pound, which had marked at 98 pence on December 30th last year, records of all time.

Looking to other aspects, however, seems increasingly anachronistic the attempt of the ECB President, Jean-Claude Trichet, to defend its mandate to fight inflation, arguing that this still leads to greater stability for those countries, such as Italy, that before the Euro suffered in particular for the growth of prices.

I refer specifically to the continued widening of the spread of return on bonds issued by countries less "virtuous" in relation both to the rates of German government bonds, which reached the highest levels since the Euro was created, and to the interbank short-term rates (for which, however, one can truly claim the so called 'euroconvergence")

This - it's important to be clear - is in fact another brake on the European recovery, as it reduces the leeway of the governments plans for any fiscal stimulus. And not only for the much-criticized Italy, of course, but also for many other countries, for example, Spain, where the deficit is expected to reach 6% of GDP, Ireland (7.2%) and Portugal (3.3%). It's no coincidence that the credit rating agency Standard & Poor's recently downgraded Greece (from A to A-) and put under observation the AAA rating of Spain and that of other countries such as Austria and Ireland.

Government bond at risk

While inflation will remain probably low for a long time, and so the short-term rates, I think we will see a gradual rise in bond yields (which push the prices down) over the next 12 months.

The rate cuts made by the Central Bank will not be many, the issue of government bond is expected to increase during the remainder of 2009 and economic activity will begin a phase of recovery. Not least, sooner or later, the tendency to make only safe investments will decline, leaving room for a greater propensity to take risks.

As mentioned elsewhere, government bonds seem to have less appeal from a fundamental point-of-view and, therefore, more and more risk (almost a contradiction, for those who still consider them always the "risk-free" alternative!).

Have good weekend

Original post: Tassi BCE in calo, ma per quanto?