European Government Bond Market "Frozen" says Bank of Italy Managing Director; ECB Steps in But Rally Fails to Hold

Mish’s Global Economic Analysis,

16 November, 2011

An official for the Bank of Italy says Bonds Bids, Offers Show Government Bond Market "Frozen".

Spreads between bid and ask government bond prices indicate markets are “frozen,” said Franco Passacantando, Bank of Italy’s Managing Director for Central Banking, Markets and Payment System in Milan today.

The European Central Bank is “almost exclusively buying Spanish and Italian bonds,” he added.

ECB Steps in But Rally Fails to Hold 

Yield on 10-Year Italian bonds opened above 7% for the second consecutive day but the ECB acting as buyer of only result stepped in to push the yield down to 6.75%. The rally failed to hold, and the 10-year Italian bond yield now sits at 6.95%.

Bloomberg reports Italian Yields at 7 Percent for Second Day as ECB Rally Fails to Hold

Italian five- and 10-year bonds yielded more than 7 percent for a second day as the securities failed to hold an earlier advance after the European Central Bank was said to step up purchases of the nation’s debt.

Spanish 10-year bonds fell for a third day amid speculation yields will surge at tomorrow’s auction of up to 4 billion euros ($5.4 billion) of securities due in January 2022. German bonds declined after the nation got fewer bids than the maximum sales target in an auction of two-year notes, and Chancellor Angela Merkel said the country is ready to cede some sovereignty to strengthen the euro area.

“There’s still no credible backstop for Italy and Spain and the ECB buying on the current scale is just far too small to have any impact,” said Jamie Searle, a fixed-income strategist at Citigroup Inc. in London. “There’s a Spanish auction tomorrow, which will be a pretty clear test of appetite. The yield level is likely to be pretty punitive.” 

The ECB was said by two people with knowledge of the trades to have bought larger-than-usual sizes and quantities of Italian debt under its Securities Market Program today. It also bought Spanish bonds, the people said. A spokesman for the ECB in Frankfurt declined to comment.

‘Binary’ Market

“The European bond market is becoming very binary, and ECB-dependent,” said Mohit Kumar, head of European interest- rate strategy at Deutsche Bank AG in London. “Whenever the ECB steps in, the market likes it, when it steps back, you see pressure. There are no real buyers.”

"Risk-Free" Market is Frozen

A quick check shows Spanish 10-Year bonds at 6.40%, the high yield of the day, up about 6 basis points.

Spanish 2-year government bonds yield 5.40%, up 10 basis points and also at the high of the day.

Bond Market Spits in ECB's Face

  

Spanish 5-year bonds opened at  5.82%, a euro-era tie for record high, improved to 5.62% but now sit  at 5.77% back close to the high. The bond market is effectively spitting in the ECBs face.

Please recall that European banks are leveraged to the hilt on these bonds, because they are considered "risk free", with zero chance of default.