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Or, imagine foreign holdings of eurozone sovereign debt turning back the clock some 15 years… to before there was a eurozone.
A few charts from Rabobank on Friday (click to enlarge):
The first pair of charts make the point that this is via foreign holders selling into the LTRO-related buying by sovereigns’ domestic banks. The orangey charts here need some annotation…
In the Italy one, Rabo’s fixed income analysts Richard McGuire and Lyn Graham-Taylor extrapolated the average rate of decline in foreign holdings over the last six months, which is 0.8 percentage points. It is an extrapolation but we think this is a useful heuristic. It implies that international holdings in the world’s third-largest sovereign debt market will hit 1998 levels by July 2013.
In the Spain one, they didn’t use the average rate of decline over six months (2.66 percentage points). This would have implied zero – nothing, zilch – international holdings of Spanish debt by June next year. And before that, pre-euro levels of holdings by November this year. We should point out that for the sake of this exercise, Rabo count the ECB SMP’s Spanish and Italian debt holdings as non-resident. So for that reason alone it can’t go to zero, right? Rabobank assume that foreign bondholders jump ship from Spain at a lesser pace, but still in larger flows than from Italy.
Rabo’s charts aren’t the only way you can graph ‘de-euroisation’. This was an effort from JPMorgan’s Flows & Liquidity analysts a few weeks back, looking at eurozone banks’ holdings of bonds not issued by their own governments (click to enlarge):
That is – late 2011′s market carnage already took bank holdings of other eurozone sovereigns’ debt back to levels last seen early in the days of the euro. The way the LTROs work, the cost of credit protection on holdings of another sovereign’s debt, those kinds of thing — they don’t suggest these holdings will recover. (Update: one thing with this chart — the foreign, non-bank selling that might be continuing now would be taking place in a far more orderly secondary market for sovereign debt than when banks were selling. That’s something which we think is important to note.)
At any rate, here’s the Rabobank conclusion on why it all matters:
This evidence of the ECB funding a switch of peripheral debt from foreigners to domestics, in turn, supports our earlier view that rather than promoting some form of fiscal unity (the solution to the crisis in our view), the LTROs have encouraged financial disunity or de-euroisation. Another way of looking at this is that the LTROs were used to counter a run on peripheral banks (i.e. the ECB stepped in to finance banks' own looming redemptions) and, in doing so, have facilitated a run on their respective sovereigns. The recent resurgence of pressure upon the Spanish and Italian curves implies this "sovereign run" has accelerated of late.
Bit of a quibble here — bank runs, left unchecked in H2 2011, would have torn the fabric of the eurozone a lot faster. ECB board member Benoît CÅ“uré could almost have been responding to the financial disunity point in a speech on Friday: ’The direct purpose of the ECB's intervention has been to ensure that each bank "“ irrespective of its location in a particular euro area country "“ has sufficient reserves to deal with the possibility that creditors may refuse to roll over loans to that bank.’
Meanwhile the “sovereign run” itself still depends on the cash domestic banks can deploy on government bond auctions. In the Spanish case we’ve seen that could be considerable for covering foreign outflows.
The longer-term consequences for a common eurozone capital market — one to ponder.
Related link: Pierre Lagrange on the LTROs – FT
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© The financial Times Ltd 2012 FT and 'Financial Times' are trademarks of The Financial Times Ltd.
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