Recap 11-09-11

Main Items:

  • BTPs gapped higher today on expectations that the ECB will upsize the SMP program after aggressive ECB buying. The Italian Senate expects to pass the austerity measures on Friday, and the lower chamber on Saturday, after which Berlusconi will resign.
  • Papademos was named the interim Premier
  • US Initial jobless claims declined to 390k last week vs 400k ep and prev
  • US Import price index declined to 11% vs 11.8% exp and 13.4% prev


  • Swedish CPIF declined to 1.1% YoY vs 1.4% exp and 1.5% prev
  • Australia Employment was unchanged at 5.2% vs 5.3% exp and prev


The Italians came through by fast tracking the passage of austerity measures, and the ECB ‘rewarded’ them with an increase in SMP purchases of BTPs. On the other hand, the French didn’t do anything last night, so their bonds continued to slide, with 10y yields now almost 170bps (+20bps today) over bunds.
The market is now expecting some sort of French downgrade from the rating agencies. This fear is particularly acute after S&P mistakenly announced a French ratings cut, which was later retracted. The last time the rating agencies commented on France was in mid October, when both S&P and Moody’s talked about the possibility of downgrades.
The fact is, however, that despite the wide spreads between France and German debt, current yields on France remain well below current coupon levels, and far away from levels that would trigger margin increases. As a result, the risk of an imminent sharp cut in French ratings looks pretty low, especially since the legislature is trying to finalize various austerity measures.
Next week is option expiry week, which has historically coincided bullish risk asset performance. This positive bias, along with some removal of the EU blowup premium could be good for risk. However, this is all contingent upon the assumption that the Italian parliament passes the austerity measures AND SMP purchases prevent even more BTP yield increases.
Note that the latter can only occur if the SMP is upsized, given that the Italian market is 6 times the size of the Greek market. The big question is: what will happen after the Italian austerity measure passes. Will the ECB ‘support’ Italy by temporarily capping yields, thereby sharply increasing the SMP? Or will it step back once again and allow further haircuts to trigger another round of deleveraging?

NB: There will be no update tomorrow.