Italy leans on primary dealers

LONDON: The Republic of Italy saw its borrowing costs jump to the highest level since September 2008 on Tuesday. While the country managed to raise EUR6.75bn of 12 month money, market participants said the treasury had left nothing to chance and asked primary dealers to step in and take some of the bonds in order to ensure success.

The T-Bill auction comes ahead of Thursday debt sales which are in the longer part of the curve.

This morning's Italian 12 month T-Bill auction raised EUR6.75bn at an average yield of 3.67pc, 1.55 times cover. This compares to the last 12 month T-Bill auction on 15 June, when EUR6bn was issued at an average yield of 2.147pc, 1.71 times covered.

"The Italian treasury called us looking for us to take some of the Italian T-bill that is out today which is really unusual," said a DCM banker.

However, other market participants said the move was not a departure from standard market practice. "The role of the primary dealers was no doubt significant, although this is not unusual for most European sovereign debt sales and in the context of the current market environment, is secondary to the longer dated bond sales due later this week," said another DCM banker.

The Tesoro confirmed on Monday that it was planning three longer-dated auctions. The on the run BTP sales will be for EUR750m-EUR1.25bn each of the April 2016 and March 2026 issues, accompanied by EUR1.5bn-EUR2bn in total of the August 2017 and August 2023 issues, to raise up to EUR4.5bn in total. Some earlier estimates of the supply had been up to around EUR7bn.

The ability of Italy to sell debt this week is only the first instalment of EUR113bn it still has to raise this year and the extent to which its auctions are scrutinised is unlikely to diminish.

The reluctance of traders to provide interbank liquidity through the automated MTS platform this morning will add further poignancy to Thursday's auctions as the withdrawal of prices by the street is generally viewed as a factor which adds to spread volatility.

The situation is reminiscent of the loss of covered bond liquidity in 2008 which resulted in the end of the quasi-government nature of the asset class and its ultimate repositioning as a credit product.

This transformation was accompanied by a EUR60bn ECB purchase programme which is precisely what some sovereign bond participants are suggesting- albeit in much larger size- to restore liquidity within the Eurozone.

The problem with this is twofold: firstly, direct intervention doesn't imply improved liquidity if there is only one buyer in the market, and secondly, which body would be deployed to undertake such a programme?

Sovereign supply started with this morning's sale of between EUR1.5bn-EUR2.5bn of the Netherland's 10-year DSL. The outcome saw EUR1.835bn raised within a 27 minute period.

The initial offer posted by the DSTA was at 101.70 which was subsequently reduced to as low as 101.40 as non-German assets sold off. The average sale was at 3.058pc or 101.633.

Early spread movements saw Italian 10-year yields approaching 6% with its five-year CDS up to 50bp wider earlier in the session at a new record wide of 350bp (the cost of protection was at 180bp a week ago).

Every single peripheral name has reached new wide in protection markets earlier this morning, with Spain trading 40bp wider at 385bp, Portugal and Ireland both 85bp wider at 1200bp and 1100bp, while Greece was 125bp wider at 2450bp prior to rumours of ECB intervention.

Cash spreads have also subsequently recovered on rumours that the ECB has intervened in the peripheral markets buying Portuguese assets for the first time since late March. Subsequently China has been mentioned as being the buyer behind the ECB- another unconfirmed suggestion.

As a result the earlier 20bp widening of Portuguese 10-year spreads have been reversed with Spain at 344bp over Bunds and Italy at plus 312bp also both well off their earlier widest levels.

Despite widening in common with the rest of Europe, the Dutch or German 10-year spread is currently at plus 48bp, compared to plus 57bp earlier which was 24bp wider than last Tuesday.

The move back from the wides is largely viewed as no more than a respite unless more tangible action is undertaken and the concerns over Italy in particular are a variation on the previous Spanish focus.

"It's really scary and unlike the previous widening episodes, we are seeing real selling because everyone was long Italy," said a SSA syndicate banker.

In terms of non-sovereign supply, FNMA had been scheduled to announce a new benchmark deal tomorrow but this is increasingly expected to be put on hold. In addition, KfW was also expected to mandate leads for a new US dollar deal.

This was initially thought likely after last Friday's US employment report although with yields falling, a possible 10-year trade soon became a three-year deal which may surface following this evening's USD32bn three-year note sale.

"Despite the drop in three-year yields to 0.58pc a new KfW issue would offer around 1pc if priced currently at mid-swaps flat with swap spreads at 40bp," said one syndicate banker.

"Whether this would be appealing in an environment of ongoing uncertainty and rising swap spreads might be questionable at this point in time."

"In addition with 70pc of KfW's funding complete, the issuer has no immediate need for further funding and would most likely benefit from waiting for better timing," he added.

"The fact that the USD5bn three-year deal sold by the EIB last week at mid-swaps plus 2bp initially tightened to trade below swaps, but this morning is at plus 2bp also suggests that KfW would currently have to pay up to ensure a successful deal," another banker suggested.

Copyright Reuters, 2011