Wednesday, February 27, 2013

Get this right and you'll make a few bucks

Italian Election.
Unexpected outcome.
What happened then?

Basically 10y BTPs +40bp for the day, closing at the highs (yield-wise).
And 2y BTPs +45bp for the day. Same story.
Bear-flattening in italian bonds.
SX7E Eurostoxx Banks fell 5.23% for the day.
Banks crashed.
Intesa San Paolo was halted, limit down. Consob, italian regulators, banned short-selling.

German bonds skyrocketed.
French yields x German yields, on the 2y tenor (here, I mentioned I thought a good trade) +3bp for the day @ 12bp premium France x Schatz.

Spanish SPGBs +20bp on both 2y and 10y ends of curve.

Basically political problems caused this. Lack of consensus. Lack of support from population to "do things right". Italians basically supported Berlusconi's party more than people expected and the political parties involved in power are too different from each other to sit around a table to reach agreement to rule the country. And Berlusconi doesn't get along with Merkel much. And German elections are in September, I guess.

So basically... if you get this right: will the clown, the party monster and the dull agree on something and get Italy going or not?
You have the direction of the overall markets for the next few weeks.
Why is that?

Because of the transmission mechanisn the shape and level of the yield curve has on banks and therefore credit.

Not a single italian bank repaid LTRO money. That's what I read today.

So when there's a bear flattening (bond prices going down, but the short-end yields rising more than the long-end's) means:
a/ More expensinve short-term funding for banks
b/ While it reduces its net-interest-margin (banks lend longer term) reducing outlook for profits...
c/ And get their bond books crushed due to the rising yields on the long-end of the curve, marking their loans to market negatively = hurt current profits.

So that means less profits for banks.
So less appetite to lend.
And with less credit around the economy.... less aggregate demand, investments, etc.
That means less confidence, and go back to "rising yields further" due to global fears towards the country.

So if you know a lot about politics and have a strong view on this... it's a good time to act. It's all close to highs while economic activity isn't quite there yet.

The funny thing is, contrary to August last year ( , when I mentioned the left-tail of the market was gone because of Draghi's bumble-bee speech, OMT... now italians don't even have leadership to, if needed, reach an agreement to request aid to OMT.


*Disclaimer: charts and data are presented as I receive/see them. Sources are usually not checked for validation and my own calculations are of 'back of the envelope'-type. I am aware that some math that I do myself might be wrong and/or misleading to some extent. In financial markets the rate of change of economic data is often more important than the actual level and the perception of 'what is priced in' is more important than 'what is actually going to happen'. This is actually the way people pick entry and exit points. So... yes, sometimes you might say 'This guy is an idiot, this is way wrong!' with a high conviction, being right. Not to worry. Markets are made of expectations and the clash of conviction between its participants. Portfolio managers know that being an idiot is sometimes profitable and being smart is often a bad choice. It is all reality, sometimes good, sometimes bad. By the way: corrections to my analysis and intelligent debate is welcome. theintriguedtrader AT gmail do com

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