Downward Drift
Research for Online Investors

12/28/11

Italy sold $11.7 billion dollars in six-month notes this morning at an average interest yield of “only” 3.25%, down from the record yield of 6.5% they paid last month.  Italy also sold $2.2 billion in two-year bonds, yielding 4.85% compared to 7.81% last month.  They have another debt sale tomorrow of three and ten-year debt.

The Financial Times reports that while interest rates dipped on news of the successful debt auction, they quickly bounced back higher.  Nicholas Spiro, managing director at Spiro Sovereign Strategy told Reuters “The ECB’s new liquidity measures have clearly helped today’s sale and augurs well for tomorrow’s more challenging auction of longer term paper.”

The market has been soft today in spite of the successful debt sale by Italy.  Tempering the good news is the European Central Bank’s overnight deposits from banks are at an all time high.

The $637 billion pumped into the banks last week with three-year notes doesn’t have a place to go.  French President Nicolas Sarkozy suggested banks could borrow from the ECB at 1% and buy sovereign debt at higher rates to make money on a wide interest rate spread.  Forcing banks to take losses on Greek sovereign debt has created some distrust in bond buyers.

Investors want the return of their money, and then return on the money is factored into the decision to buy bonds.  If sovereign debt is not viewed as a safe haven asset, buyers are not anxious to buy it at any price.

It appears eurozone banks are less than enthusiastic to buy other country’s sovereign debt after the principal write-downs on Greek debt.  An SEB strategist told Reuters “Several European banks recently have made a point of publicizing the large reductions in their exposure to Italian and Spanish government debt…Hence it seems likely that banks outside of Italy will show any meaningful interest in the upcoming auctions.”

As sovereign debt migrates onto the balance sheets of each country’s banks, I believe the eventual breakup of the eurozone becomes more likely.  Unpopular austerity measures will eventually drive politicians to give the public what they want.  Leaving the eurozone, and the fiscal discipline that requires, will be the popular answer to escape budget and entitlement limits.

Once a country exits the eurozone, they would establish their own money…and devalue it through inflation.  Since outstanding sovereign debt would be denominated in euros, principal and interest payments would have to be made in euros if paid outside their borders.  This diminishes the advantage a country gains when it establishes their own currency and devalues it, but any debt held in a country’s banks could be paid off with the devalued local currency at the “official” exchange rate.

If I am right, it is ironic that the fixes the eurozone and ECB are pushing on troubled countries like Greece, Italy, Portugal, Ireland and Spain will actually hasten the break-up of the eurozone.

The market had the lowest trading volume of the year on Dec. 23rd.  Then lower again on Dec. 27th.  This week is custom built for a low volume drift in the market.  So far it appears the drift will be downwards.

I read over the weekend that 80% of professional money managers are underperforming the S&P 500 this year.  Since bonuses are paid on performance, which way do you think professional money managers would like to see the market move this week?

The mailbag:
I have telephoned you in the past.  Now I simply wish to thank you for the warm message in your Home Alone MarketToday article.  Have a wonderful New Year!---subscriber S.G.

The information presented in this newsletter is based on generally available news releases, corporate filings, current events, interviews and the editor’s opinions.  It may contain errors and you should not make investment decisions based solely on what you believe you have read here.  Do your own research, it is your money.  If you lose it, it is your responsibility, not ours or your grandmothers!  The editor may or may not have a position in any securities discussed.  The editor may have held a position in a security earlier, or in the future.

MarketToday Archive

Back to Top