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Vicious cycle of sovereign bond selling is hard to stop [ClearOnMoney]
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Vicious cycle of sovereign bond selling is hard to stop

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Commentary

Vicious cycle of sovereign bond selling is hard to stop

8 Nov 2011 by Jim Fickett.

As Italian bonds (among others) drop in value, banks in Europe, the UK and the US are reducing holdings, causing bond prices to drop further. Current ECB intervention is insufficient to halt the slide, and Germany remains strongly opposed to current proposals for expanding the ECB role, all of which imply monetizing losses. In a clear warning of contagion, HSBC today noted that deleveraging at European banks is likely to reduce credit availability in Asia.

Stockholder pressure is forcing banks to reduce holdings of European sovereign debt. From Bloomberg yesterday

BNP Paribas, France’s biggest bank, booked a loss of 812 million euros ($1 billion) in the past four months from reducing its holdings of European sovereign debt, while Commerzbank took losses as it cut its Greek, Irish, Italian, Portuguese and Spanish bonds by 22 percent to 13 billion euros this year.

Banks are selling debt of southern European nations as investors punish companies with large holdings and regulators demand higher reserves to shoulder possible losses. …

European banks cut their foreign lending to the Greek public sector to $37 billion as of June 30 from $52 billion at the end of 2010, according to the most recent data from the Bank for International Settlements. European banks’ lending to the Irish, Portuguese and Spanish public sectors also fell, according to Basel, Switzerland-based BIS. …

Barclays Plc (BARC), the U.K.’s second-largest bank by assets, said on Oct. 31 that it cut sovereign-debt holdings of Spain, Italy, Portugal, Ireland and Greece by 31 percent in three months. Royal Bank of Scotland Group Plc (RBS), Britain’s biggest state-controlled bank, said on Nov. 4 that it reduced central- and local-government debt of those countries to 1.1 billion pounds ($1.8 billion) from 4.6 billion pounds at year-end.

And from the Financial Times today

Riccardo Barbieri, economist with Mizuho International, said deleveraging by European and US banks was taking its toll on Italian bonds. He said the MF Global bankruptcy was the largest case in point but that on Monday the US investment bank Jefferies was also forced to liquidate its European government bond positions that were largely Italian, in order to stem strong selling pressure on its stock.

Of course the ECB is doing its best, within a very limited program, to halt the slide. But it seems the effects of its intervention are short-lived:

Buying by the European Central Bank helped push yields back down to 6.59 per cent, and this sparked a broader improvement in market sentiment.

But political turmoil has revived the angst. The 10-year yield is now 6.70 per cent and traders are trying to work out the implications of Mr Berlusconi losing his majority.

Germany remains staunchly opposed to expanding the ECB's role, as all specific proposals to date clearly imply eventual monetization of losses:

The ECB has so far bought 183 billion euros ($253 billion) worth of distressed nations’ assets which it neutralizes, or sterilizes, by draining the same amount of money from the banking system. As yields soar to euro-era highs in Italy, the region’s third-largest economy, some politicians and economists have called on the ECB to commit to buying as many bonds as it takes to calm markets.

Irish Finance Minister Michael Noonan said yesterday the ECB must stand ready to provide a “firewall” as the debt crisis escalates.

Weidmann welcomed the German government’s opposition to using the central bank’s gold and currency reserves to bolster Europe’s 440 billion euro rescue fund, the European Financial Stability Facility.

“I am glad that also the German government echoed our resistance to the use of German currency or gold reserves in funding financial assistance to other” euro-area members, he said. “Proposals to involve the Eurosystem in leveraging the EFSF – be it through a refinancing of the EFSF by the central bank or most recently via the use of currency reserves as collateral for a special purpose vehicle buying government bonds – would be a clear violation of this prohibition” on monetary financing.

The EFSF, even in its current form, is both too slow to catch up to markets and too opaque for investors' tastes:

European finance ministers ended two days of meetings in Brussels agreeing they need to move quickly to erect new firewalls to prevent the turmoil in Greece from further infecting Italy. But they also acknowledged those new firewalls are unlikely to be in place for at least another month. …

Mr Regling acknowledged that uncertainty over how the fund will be leveraged and over how much of its resources will be devoted to Italian bond purchases, had raised questions about the EFSF in investor circles.

On Monday, the EFSF was forced to pay close to 3.6 per cent – or 177 basis points higher than German 10-year bonds – for €3bn in cash needed for Ireland’s bail-out, far higher than any previous EFSF bond auction.

In a clear warning of contagion, HSBC today warned that deleveraging at European banks is likely to reduce credit availability in Asia.

Continental European banks were responsible for 21 per cent of the $2,520bn of international bank loans outstanding in Asia excluding Japan as of the second quarter of 2011, according to the Bank for International Settlements.

“The strong increases in credit availability in Asia that has supported demand growth cannot continue indefinitely,” said Mr Gulliver [CEO of HSBC], who was speaking in Hong Kong the day before his bank announces its third-quarter results.

“Any reduction in credit availability is likely to be gradual – but it remains a risk policymakers will need to manage. And we need to be careful to monitor the risk of a sharp withdrawal of credit by European banks as a result of events at home.”