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Category: Economics

Why the eurobond trail of destruction leads to Brussels, not Rome

Christopher Cruden writes for Glint on why he believes it won’t be the Italian political crisis that undoes the EU economy but euro denominated...

14 April 2019


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Christopher Cruden writes for Glint on why he believes it won’t be the Italian political crisis that undoes the EU economy but euro denominated bonds and the ECB

Don’t worry. Italy will not unleash financial Armageddon. At least not today. Probably.

That particular role is the preserve of the euro. This is one case in which all roads do not lead to Rome; they lead to Brussels.

Of course, the somewhat frightening leap in two-year Italian government bond yields was somewhat eye-catching (or eye watering depending on what side of the trade you might be on) but this is the symptom not the disease.

We tend to forget that, due to the inverse relationship between yield and the price of bonds, the “rise in yield” is a loss of capital for someone somewhere. It just sounds better to say “yields have gone up” rather than say “prices have gone down”.

The larger problem exists within the global bond market itself. This was perfectly described by Bill Blaine of MINT about 3 weeks ago. Consider what he wrote:

“Before Lehman’s collapse in 2008 the size of the US Corporate Bond market was $2.8 trillion, and bond dealers kept inventory of around $260 billion. Today the US bond market is over $5.3 trillion, and dealer inventory is less than $40 billion. 10% liquidity wallet then… 0.7% now.”

What Bill is saying is what we all know but refuse to remember: liquidity is absolutely, completely, totally vital. And now it’s gone.

Central bank interventions, in all their manifestations, may have worked (temporarily) but the price has been a near total loss of market liquidity.

So, if that’s what the liquidity of the US bond market looks like, what does the liquidity of the European bond market look like?

Well, the Italian bond market is about €1.6 trillion ($1.85 trillion). Hmmm…

Just imagine this for a moment: At some time in the near future, there you are, sitting on a pile of illiquid euro denominated bonds with the suddenly (not so) reliable buyer-of-last-resort (the ECB) doing a tortoise impersonation. It’s probably time to redefine the definition of “whatever it takes”.

But first…

Plan A will be to dump the bonds (if you can) and while you are at it, dump the euro in which they are denominated (if you can). Incidentally, Plan B will look the same as Plan A but at lower prices.

Now what about those pesky euro stocks…? It is reported that George Soros has already begun dropping the sell tickets.

And what about the algo traders? Moves of the size and suddenness we have recently seen play havoc with algorithmic systems. Often the default setting is to close positions (that means “sell”).

And what about Spain, Greece, EM’s, Korea(s), Trump and all the other bumps in the road that are too numerous to mention? The spiral begins and feeds upon itself.

Over the next few weeks and months the airwaves will be filled with beautiful and well harmonized music. There will be a symphony of beautiful B-eurocratic mood-music for the credulous. There will be a chorus of erudite voices singing from their own song books. As usual, the percussion section will be made up of tub-thumping political opportunists.

Turn a deaf ear: they are whistling through the graveyard and this time, they may not make it all the way through.

Christopher Cruden is principle director of Insch Capital Management


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