Three months of calm, then back to the eurozone storm - Nomura

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By:
Sid Verma
Published on:

Even with the ECB's grand plan, we could be back to square one by year-end in terms of resolving Spain and Italy's crisis.

Nomura looks set to ruin your weekend. Ahead of a September 14th meeting with eurozone officials and the Spanish government over the conditions for any bailout, Madrid looks set to dig its heels as its borrowing costs fall. The stakes are high, according to Nomura:

"Spain will not request help on14 September, leading the Spanish bond market to start deteriorating again. This should eventually push Spain into a bail out before the end October because of market pressure. Once the rescue is activated, under a best case scenario, ECB buying of 1-3yr bonds in conjunction with EFSF/ESM support for longer maturities, can generate a period of calm that could last until the end of the year." 


Go on:

"...the more immediate risk is that Spain and Italy have not requested aid and yet the markets have priced in imminent ECB buying. As noted above, we fear that Spain will delay requesting aid until October, and hence over the coming weeks SPGB yields will start to rise, potentially sharply after the 14 September Eurogroup meeting. Hence, even if investors are willing to position tactically to be long SPGBs, then better levels are likely to emerge in the coming weeks.

Meanwhile, the problem is potentially greater for Italy. If Spain is expected to delay requesting support, we would anticipate an even longer wait for Italy. In addition, there may be greater problems in getting Italy to agree to strict conditionality which may muddy the negotiation process. Then there is the issue that Spain alone can have the potential to strain the resources of the EFSF/ESM, especially if it requests a full package, and yet Italy is a far larger market. With 2yr BTPs trading at 2.268%, close to what we consider the likely low for front-end yields when the ECB buys, the risk reward for being long the front-end of Italy appears unattractive. Meanwhile, Italy could notably lag Spain if the later asks for aid and the former does not. In many respects, Italy is more of a risk than Spain since official support is more distant."



For these reasons, Nomura fears liquidity risk and shuns strategic trades in Italy and Spain:

"At the outset we need to restate why we shy away from publishing clear trade recommendations on Italy and Spain: while we are comfortable with market risk, we try to eschew liquidity risk, which is often mispriced. Given the economic backdrop, to buy a BTP or SPGB requires an investor to be comfortable that he has an exit strategy. If an investor buys a 1-3yr bond, will the ECB be there to buy this asset when the investor wishes to sell? If an investor bought a 4yr bond with the aim of rolling into the ECB intervention zone, can they be certain the ECB will continue its operations for 12 months?

If an investor buys a 10yr bond, can they be comfortable that the EFSF/ESM will be able to fund themselves enough to support longer-dated bond prices, even if only by buying primary bonds? Given the risks outlined above, we do not have this conviction, and we believe that many investors will share our concerns. We, therefore, believe that the ECB policy announcement will not spur any notable strategic asset allocation decision by international investors into Spain and Italy. Instead, smaller and more tactical trades will likely predominate."