IFR-Advent funds Priory buyout with cheap high-yield bond

Fri Jan 28, 2011 6:19am EST
* Advent funds Priory deal directly via bond market
* Advent equity cheque lower-than-expected at 33 pct
* Largest sponsor-backed sterling deal since April 2007
By Natalie Harrison

LONDON, Jan 28 (IFR) - U.S. private-equity firm Advent
International funded the buyout of the Priory healthcare group
on Thursday with a GBP600m high-yield bond which undercut the
more expensive leveraged loan market.

The bond, split between a GBP425m 7-year senior secured
issue and a GBP175m 8-year senior unsecured tranche, is the
largest sponsored-backed sterling deal since the 3-part GBP640m
bond in April 2007 which backed Apollo's purchase of UK estate
agent chain Countrywide, a banker familiar with the matter said.
It is also the largest sterling deal since Virgin Media's
(VMED.O) GBP875m senior secured issue 12 months ago, which came
with the same coupon as Priory's secured issue at 7 pct, the
banker said.

Unusually for an M&A transaction, the bonds will pay for the
purchase directly without bridge financing. The funds will be
held in an escrow account until Advent receives regulatory
clearance, expected in about six weeks time, the banker said.
If the M&A process fails to close, those funds are released
back to the bondholders.

The financing has reinforced expectations that the
high-yield bond market will fund a significant chunk of an
expected rise in merger and acquisitions.
"The bond market is pricing very competitively, with bonds
pricing inside of where senior loans can get done in certain
cases," said Eric Capp, head of global high-yield syndicate at
the Royal Bank of Scotland (RBS.L), former owners of the Priory.
Both the secured and unsecured issues priced at par with
respective coupons of 7% and 8.875%, which were at the tight end
of initial guidance set at 7-7.25% and 9% area respectively.

The sale is part of the majority state-owned bank's strategy
to sell non-core assets and trim its balance sheet.
The final price tag of GBP925m was below the GBP1bn that RBS
had initially been seeking, but brings to an end a long-awaited
sale by the bank, which inherited the business after its merger
with Dutch bank ABN Amro in 2007.

FURTHER GROWTH
The all-bond financed deal was quicker to arrange than a
loan might have been and also gives Advent more leeway with
respect to covenants if it decides to make further acquistions,
bankers said.
Source: Reuters.Com

READ MORE - IFR-Advent funds Priory buyout with cheap high-yield bond

Canada : Good for the economy, bad for bonds

Good for the economy, bad for bonds 
A significant sell-off has taken hold of the U.S. bond market since mid-October. The yield of 10-year
Treasuries climbed from 2.38% on October 8 to 3.48% at the close December 14. Their return over the period was a negative 7.88%. The sell-off gained momentum from President Obama’s compromise tax plan, which would add about $900 billion to the federal debt over the next two years if approved by Congress in its
original form. Bond traders got shivers down the spine from the impact of Mr. Obama’s proposal on borrowing requirements and from the lack of any medium-term plan to get the U.S. fiscal house on a sustainable longterm path. Furthermore, a stronger economic growth outlook was also pushing up long-term real rates.

Since November 3, when the FOMC announced the details of QE2, the real yield to maturity of 10-year
Treasury Inflation Protected Securities (TIPS) has risen 80 basis points at this writing compared to 90 basis
points for nominal bonds.


Given the amplitude of the correction, we do not exclude the possibility that the 10-year yield has gotten ahead of itself. But while some short-run consolidation cannot be ruled out, on the back of the Fed potentially buying up to $63 billion of Treasuries between December 16 end year-end, our fair-value model suggests that
investors should be cautious.

We are confident that the combination of the fiscal stimulus Congress is likely to adopt and Fed monetary
stimulus will lead to significant improvement in the U.S. labour market in the coming months. We now expect
economic growth of roughly 3% in 2011 and slightly more than that in 2012. If we are right, the fear that the

U.S. will find itself on the deflation path followed by Japan will be replaced in 2011 by renewed talk of
whether the FOMC will get its exit strategy right. The yield curve is being shifted up not only by expectations
of stronger GDP growth but also by a 2011 borrowing requirement that could be roughly $300 billion higher
than was expected back in November.

According to the Flow of Funds Accounts, outstanding Treasury securities increased $1.4 trillion over the 12-
month period ending in Q3 2010. A look at who financed the U.S. deficit shows that households provided 32% of the Treasury borrowing, a significant increase over the previous year. Foreigners were also large lenders but accounted for a smaller share than last year.


Looking forward, the Fed with its planned purchase of $600 billion in Treasuries will be a significant source of
funds. On the other hand, if economic momentum remains supportive of higher interest rates in 2011, it
can be questioned whether household appetite for Treasuries will be as strong next year as it has been
recently. The same could be true for pension and retirement funds. Further, if European leaders agree to
change the European Union treaties to create a permanent financial rescue system for the euro zone,
the U.S. dollar could resume its downtrend, making Treasury holdings less appealing to foreigners.

Bottom line:  Although when QE2 was introduced it seemed large enough to make a significant dent in the
10-year yield, the proposed fiscal stimulus means that borrowing requirements are likely to be considerably
larger than market participants assumed at the time.

Meanwhile, the economic and inflation outlook will become less supportive of low interest rates. When

these considerations are factored in, our fair-value model suggests that 10-year Treasuries will be trading
around 3.48% in Q1 2011 and heading to 4.17% by the end of 2011. In other words, the Treasury may not find it as easy to tap the pool of private funds as it did in 2010. We expect increased volatility around auction
time.

… and in Canada 
In December the Bank of Canada kept its overnight rate unchanged at 1%. It is true that the Canadian
recovery appeared slightly weaker than expected and that U.S. domestic demand was picking up only slowly.
But a dominant reason for not raising the policy rate was increased risk to global financial stability from
sovereign debt concerns. Not only was this risk noted in the rate-setting statement, but the December 2010
issue of the Bank’s Financial System Review put it at the top of the list of risks to the Canadian financial
system. Also identified as contributing to overall risk was a growing vulnerability of households due to rapid
expansion of credit in an environment of low interest rates. The Bank could have leaned against personal
credit expansion by raising its target rate. It chose instead to keep considerable monetary stimulus in place. The choice showed which systemic risks really keep Mr. Carney awake at night.

In early December, according to the Financial Times, credit default swap prices were implying five-year
default risks for Greece, Ireland, Portugal and Spain of 54%, 38%, 31% and 23% respectively. In light of these odds and discussions among European leaders for a permanent mechanism for emergency funding to
countries facing liquidity problems, we expect that the odds of disruption of the global financial system will
fade as European finance ministers deliver on their commitments to fiscal responsibility. Such a development would allow the Bank of Canada to refocus on domestic factors in setting its target rate. In the meantime, the Bank is reaping the benefits of its well-established credibility on the inflation front. While waiting to see how the debt problems of the euro-zone periphery play out, the Bank has so far been able to keep its overnight rate below 12-month core inflation without creating undue pressure at the long end of the yield curve.

Back in October the Bank downgraded its 2011 growth projection for the Canadian economy to 2.3% from
2.9%. This revision reflected its expectations of a deceleration in household expenditures and of weak U.S.

demand for Canadian goods. At the time it had just cut its 2011 U.S. growth forecast to 2.3% from 3.0%. Since then, however, the U.S. political environment has evolved quite significantly. President Obama’s initiative on the fiscal front could force the Bank to reassess its policy stance.

The White House compromise with the Republicans, if approved by Congress, is likely to lift GDP growth by 0.5 to 0.7 percentage points in 2011. Moreover, the unwinding of fiscal stimulus in Canada is likely to be
somewhat more gradual than the Bank expected in October. Finance minister Jim Flaherty recently suggested that he will extend funding for nearly completed infrastructure projects beyond the original March 31 deadline.

It will take time to see how much lift the U.S. economy gets from QE2 and from Mr. Obama’s fiscal package. However, we think our trade balance will benefit and further withdrawal of monetary policy stimulus is likely to come sooner than we assumed a month ago. At this stage, we think the Bank will use its April Monetary Policy Report to set the stage for a resumption of rate hikes in May rather than in July as we previously forecast.


However, in an environment where large international imbalances persist, our central bank will have to keep an eye on international developments as it removes monetary stimulus. This suggests to us that along the way
to an higher overnight rate, the Bank is likely to take several pauses to assess economic and financial trends at home and abroad.

Although monetary policy normalization will be felt more strongly at the front end of the curve, long bonds will also feel some added pressure from a softer U.S. bond Provincial revenues got a boost from stronger-thanexpected GDP growth coming out of the last recession.


Quebec and Ontario each reported budget deficits about $1 billion lower than previously estimated for the fiscal year ended last March 31. This month we have revised up our Canadian GDP growth forecast for 2011. We now expect the economy to grow 2.8% from fourth quarter to fourth quarter, up from 2.1% previously. Much of the upgrade is due to upward revision of external demand. A decent economic outlook for next year leaves us confident that provincial public finances are generally likely to improve further. With current provincial spreads to Canadas still wide by historical standards, we think there is room for further spread compression.


Although corporate bonds significantly underperformed comparable Canadas during the second quarter of 2010, they have added value year to date. From December 31, 2009 to December 14, 2010, long corporates generated a total return of 10.58% compared to 8.64% for long Canadas. For maturities of 5 to 10 years, corporates have returned a total of 6.56%, or 122 basis points more than comparable Canadas. Though supply headwinds could arise from large refinancing needs around the world, our economic scenario and equity-market expectations remain supportive of the corporate bond market.



Bottom line: The North American economic outlook has evolved quite significantly since Mr Bernanke opened the door to QE2 back in August. We now expect that the combination of a second round of quantitative easing and fiscal policy stimulus will lead to a considerable improvement in the U.S. economy and labour market. The bond market may have turned around abruptly in the last two months, but the 10-year Treasury yield is still no  higher than it was when the economy was emerging from the great recession. Under these conditions we think interest rates across the yield curve will be higher 12 months from now. Given this outlook, we will seek opportunities to bring portfolio duration shorter than benchmark duration. Still, healthy financial positions and sustained economic growth argue for a continuing overweight position in corporate and provincial bonds.
http://www.nbc.ca/
Full report: Canada : Good for the economy, bad for bonds

READ MORE - Canada : Good for the economy, bad for bonds

Bond market ready for strong growth

The bond market is now priced for strong growth 
Long bond yields have continued up in the past week, although the pace of the sell-off
seems to be slowing. Solid macroeconomic data and optimistic sentiment continue to add
pressure on the fixed income market in relatively thin pre-Christmas trading. In the past
week a very strong US retail sales report and solid PMI data for Euroland added further
evidence that the recovery is speeding up again.

The sell-off continues to be driven by the US, but with significant rub-off effects on
Europe. In most European countries 10-year government bond yields are now back at
April or May levels. With the Fed, the ECB and BoE still on hold this has left the curves
significantly steeper.

In the US the steepness of the 2-10 is back at record high levels. Hence, for the sell-off to
continue 2-year yields must also start to move higher. However, that would in turn
involve a more aggressive pricing of Fed hikes. We think that would be inconsistent with
the recent communication from the Fed and most macroeconomic forecasts – including
our own.

Put differently, we think that long bond yields have now priced in a relatively strong
recovery involving growth between 3-3.5% in the US.

New yield forecasts – limited room for higher yields in 2011
This week we published new yield forecasts. We have lifted most of our forecasts for
long bond yields, but do see limited room for higher yields in 2011. With the market
already expecting solid growth, we need either policy tightening or higher inflationary
pressure to push yields significantly higher. Neither are likely to materialise anytime soon
– and in particular not in the US. In fact we think that there remains a good case that once
the market calms down, yields will reverse some of the recent increase.

However, in Europe we see a case for gradually higher 2-year bond yields materialising
already in Q2, as the ECB resumes its normalisation of liquidity measures and eventually
moves toward ordinary policy tightening late next year. This will also tend to add upward
pressure on the long end on a 6-12 month horizon, but it will remain gradual.

Bottom line is that the fixed income markets have now front-loaded their expectations for
growth and delivered all of the increase in rates that we originally anticipated for next
year. This also implies that the market will be sensitive to negative surprises going into
next year. The economies will have to deliver strong growth to justify the current level of
rates.

Short-term focus on US key figures 
With the US Treasuries being the main driver of the global fixed income sell-off, nearterm focus will be on US economic data. During Christmas the calendar is relatively light,
but early next year ISM, non-farm payrolls and the FOMC meeting will be key events.
In Europe the last 1Y LTRO worth EUR97bn expires. Last time a 1Y LTRO expired (in
late September) it drained a significant amount of liquidity from the money market
adding upward pressure to money market rates. We see risk of a repeat.  
http://www.danskebank.com/

READ MORE - Bond market ready for strong growth

Global bonds experienced a calm trading session

On Thursday, global bonds experienced a calm sideways trading session ahead of the Head of States meeting with the Philly Fed and technical reasons responsible for the only movements of the day. German bonds were traded very thinly and officially closed slightly below opening levels. German yields increased 1.2 to 3.6 bps. The manufacturing PMI in the euro zone was significantly stronger than expected whereas the services PMI was significantly weaker.  Investors decided to leave it an open question and ignored (or added up) both indicators. At the end of the session, lows were tested but the Bund rebounded after the official European
closure erasing all intraday losses. We saw a similar pattern in US bonds, at first calm sideways trading pattern but eventually bonds came under pressure, supported by a better than expected Philly fed. The March Note future set new lows but also rebounded and eventually gained some. US yields were down 3.2 to 10.9 bps with the belly outperforming the wings. So, in both the Bund and the US T-Note future, the test of the lows failed.


In the periphery, yield spreads versus the German bonds widened marginally. The decision by the ECB to double its subscribed capital (see lower) didn’t heat up peripheral tensions and was classified as a technical adjustment. The German/Belgian yield spread  outperformed, narrowing by 9 bps as heavy buying was
reported. On Tuesday, Moody’s changed the outlook of Belgium’s sovereign debt rating from stable to negative on lingering political concerns. This week, political parties showed willingness to get back to the table to work on a constructive solution to end the political impasse. Hope springs eternal. This morning, Moody’s rating agency downgraded Irelands foreign- and local-currency government bond rating by 5 notches from Aa2 to Baa1 with outlook negative. The key drivers behind the downgrade are: the crystallization of bank related contingent liabilities, the increased uncertainty regarding the country’s economic outlook and the decline in the Irish government’s financial strength. The negative outlook is based on Moody’s forward looking view that the risk that the Irish government’s financial strength could decline further  if economic growth were to be weaker than currently projected or the costs of stabilizing the banking system turns out to be higher than currently forecasted.


After the approval in the Irish parliament to accept an €85B EU/IMF bail-out loan on Wednesday, the IMF approved on its €22.5B  tranche yesterday. IMF chief StraussKahn expressed himself positive on Spain. He said that the country will ward off the sovereign debt crisis without needing external aid and that there is no threat to the euro currency. “I don’t see that the risks for Spain will be that big in 2011. It doesn’t mean there is no risk… but  I’m not that pessimistic  about the Spanish economy.”

Moody’s rating agency put Greece’s sovereign debt rating on review for a possible downgrade by multiple notches. Currently the Greece’s rating is at Ba1, the highest junk status and equal to S&P’s BB+ rating. Moody’s acknowledged Greece has already made significant efforts by implementing several austerity measures but has its doubts about the future as uncertainty over the country’s ability to cut its debt ratios to sustainable levels still prevails.  “Therefore, Moody’s review will focus on the factors, namely nominal growth and fiscal consolidation that will drive the country’s debt dynamics over the next few years.

Today, the eco calendar contains the euro zone trade balance, German Ifo and US leading indicators. But attention will probably remain focussed on the EU Summit. In September, the euro zone seasonally adjusted trade balance showed a surplus for the first time in five months as imports dropped significantly, while exports rose slightly. In October, the trade balance will probably remain in surplus, but the surplus might have narrowed. The German IFO jumped last month to its highest level on record, although the consensus was looking for a slight decline. After the record level reached last month, the consensus is looking for a slight decline (from 109.3 to 109.0) on the back of a decline in expectations. After yesterday’s strong (German)
manufacturing PMI, we believe however that an upward surprise is not excluded. In the US,  leading indicators are forecasted to have risen by 1.1% in November, which would be the largest increase in eight months. An upward surprise is not excluded due to the contribution of the ISM’s supplier deliveries index.

The EU Heads of State and government leaders agreed to create a permanent financial safety net from 2013. They will insert two extra lines to the EU Treaty that apparently don’t need to be approved in referenda.  The member states of the euro area may erect a stability mechanism that is activated if it is indispensable to guarantee the stability of the euro area. The decision need to be taken by unanimity. Both the condition of “indispensable” and unanimity seemed to be inserted on demand of Germany that wants to avoid countries asking for help too fast and have a final say on every decision. So, in fact it is only a broad agreement and now the hard work of agreeing a detailed European Stability Mechanism will be started, even if the Finance Minister already painted the broad outline.

The ECB indeed decided to increase its subscribed capital by €5B, from €5.76B to €10.76B. The ECB noted that the decision resulted from an assessment of the adequacy of statutory capital conducted in 2009. It was deemed appropriate in view of increased volatility in FX rates, interest rates and gold prices as well as credit risk.

The maximum size of the ECB’s provisions and reserves is equal to the level of its paid-up capital. So, the decision allows the Governing Council to increase the provision by an amount equal to the capital increase, starting with the allocation of part of this year’s profits. It is the first capital increase and according to the ECB it is also motivated by the need to provide an adequate capital base in a financial system that has grown considerably. We had some fear that such a decision might have caused nervousness in the peripheral bond markets, as it could have been seen as a precursor of some losses (defaults?) on the bond portfolio.

However, markets barely reacted, probably considering the decision a merely technical in nature. Over night, the US Congress gave final approval for the extension of the expiring Bush-era tax cuts, a deal reached by president Obama and the Republicans. The budgetary stimulus to boost job creation at the cost of deepening US debt might be able to add up to 1 percentage point to economic growth next year, due partly to a
one-year cut in the payroll tax and removal of uncertainty about taxes in general.


Peter Diamond, a 2010 Nobel Laureate in economics and possibly future member of the US Fed board said that the US can bring down high unemployment by using every available tool.  “My reading is that right now  I don’t see any signs that we should be worrying about inflation as a reason to limit our reaction to high unemployment.” So, if he is effectively nominated, it seems the dovish aisle inside the Fed will have an extra member.

The Spanish treasury sold €1.78B of the on the run 10-year Obligacion (4.85% Oct2020) and €0.62B of the on the run 15-year Obligacion (4.65% Jul2025). The total amount of €2.4B was in the intended €2-3B range. Bid cover ratios were 1.67 and 2.52 respectively but given the small auction size this doesn’t really mean something. Overall Spain’s last auction for  the year met with decent demand. Given the very high yields the country had to pay, it’s clear that the pressure on the peripheral countries still prevails.

Regarding bond market trading, the calendar is thin with the IFO the only potential market mover. It might be stronger-than-expected, but after the PMI releases, it is unlikely it will have a big influence. The “results” of the EU Summit and the passing of Obama’s tax deal are two factors on which markets may react. On the former, we are not disappointed that the leaders didn’t take additional measures, but in the markets there maybe be some disappointment that may result in some spread widening (also due to rating action overnight) and may have the hugely oversold German bonds moving higher.  The tax deal on the contrary should be bond negative, as it suggests higher growth and further worsening fiscal position. However, bonds have
been heavily sold and both items evolved as one could reasonably have expected. In this context, we think that global bonds might be in for consolidation/correction, but given the thinness of the markets and the possibility of erratic price moves, we wouldn’t get too much engaged in trading anymore.
http://www.kbc.be/
Full report: Global bonds experienced a calm trading session

READ MORE - Global bonds experienced a calm trading session

German bonds consolidate, but US Treasuries cannot find their composure

On Wednesday, German bonds had a somewhat calmer session, but US Treasuries still could not find their composure and tumbled lower in the latter part of the session.  It was mostly a sentiment  and technical driven session. The US eco data were on balance somewhat stronger, good rebound from NY Fed and industrial production and subdued inflation, while the EMU Q3 employment data were still weak. However, the data didn’t play a role.

Intra-day,  the Bund tested the downside in early trading, but the reaction low held and the contract reverted towards Tuesday’s closing levels, which was followed by sideways range trading throughout the remainder of the session. The rating action of Moody’s regarding Spain (negative outlook) ahead of the session was unable to trigger some safe haven flows towards the Bund. The shorter end slightly outperformed the longer end in a daily perspective. 2-and 5-yield closed down 2 basis points, while yields at the longer end closed nearly unchanged. US Treasuries traded moderately positive throughout the session, little affected by the data or the Fed Treasury purchases. However, later in the session, without any particular news, we are aware off,
Treasuries slid lower and the move accelerated when a key technical level (119-00/02+) was broken. A new low at 128.20+ was put on the tables.

In the periphery, yield spreads versus German bonds narrowed with the exception of German/Greek (+12 bps) and German/Portuguese (+4 bps) spreads. Ahead of the Head of States meeting, the Portuguese government proposed a series of measures to increase the country’s competitiveness and to convince Europe
that it can avoid a bailout. FM Teixeira dos Santos said: “We are taking initiatives that are crucial so as to avoid resorting to foreign (aid) mechanisms.”  At the start of the day German/Spanish yield spread went out, after Moody’s announced that it changed the outlook for Spain’s sovereign debt rating from stable to negative, but eventually the yield spread came in 7 bps. Spanish FM Salgado  said that Spain’s current rating (Aa1; only 1 notch lower than Aaa) showed how solvent Spain is and was positive about the future: “I expect that within three months we shall be able to offer sufficient arguments to turn that negative outlook into positive.” The Irish parliament voted for acceptance of the €85B EU/IMF bailout loan.


Today the IMF will decide on approving its €22.5B aid tranche to the former Celtic Tiger. The finance spokesman of the main opposition  party Fine Gael, who will probably be FM in the next Irish government, said that losses should be imposed on investors who hold bank senior debt that is not covered by a government guarantee, which amounts around €15B. This way the amount of the bailout loan could have
been lowered. The proposal might just be a political move to make the current government even more unpopular, ahead of next year’s elections, given that the pride Irish people opposed international aid very strongly. Current FM Lenihan reacted sharply that  “Those who think we can unilaterally renege on senior bondholders against the wishes of the ECB  are living in fantasy land.”  If the next government would decide on such a measure it would be on collision course with the EU/IMF/ECB as it would be against the bail-out package.

Also today, the eco calendar remains well-filled with the first estimate of the euro zone PMI’s, the final figure of euro zone CPI inflation, the US housing starts and permits, weekly claims and Philadelphia Fed index. Spain will tap the market, but markets might probably look mostly forward for the EU Summit which starts at 5pm. Last month, both euro zone manufacturing and services PMI surprised on the upside of expectations due to strength in Germany, while sentiment across the peripheral countries remained sluggish. For December, the consensus is looking for a slight decline in both manufacturing (55.2 from 55.3) and services (55.2 from 55.4) PMI. While German activity will probably remain strong,  there is some uncertainty regarding the peripheral countries. After the significant increase last month, we believe therefore that the risks might be on the downside of expectations. In the euro zone, the final figure of November CPI is forecasted to confirm that inflation rose from 1.8% Y/Y to 1.9% Y/Y. Interesting will however be the core reading, which is expected to stay unchanged at 1.1% Y/Y confirming that inflationary pressures remain muted, but also that deflation fears are overdone.

In the US, housing starts are forecasted to show a 6.0% M/M rebound in November after falling sharply in the month before. Building permits are expected to show a slight increase in November (by 1.5% M/M).  Both starts and permits remain however close to the lows, which might cause some swings in the percentage data. Nevertheless, as inventories of unsold houses are high, credit tight and unemployment remains elevated, it will take time for the housing starts and permits to recover. In the week ended December the 11th , US initial claims are forecasted to show a slight increase (by 4 000 to 425 000) after a significant decline in the week before. Also continuing claims are forecasted to show a slight increase after dropping to a two-year low. The week under review was the first week since the expiration of emergency and extended unemployment insurance benefits (1st  of December), which was however renewed last week and therefore we have no idea what  impact it will have on the continuing claims. The Philly Fed manufacturing index is forecasted to drop from 22.5 to 15 in December, after a sharp improvement in November. We believe however that the decline might be smaller.

Today, the Spanish treasury taps the market with the on the run 10-year Bono (4.85% Oct2020) and the on the run 15-year Bono (4.65% Jul2025) for an amount of €2-3B. This is less than the normal auction size of the Spanish treasury. This weekend, Spanish FM Salgado warned that Spain will have to pay a considerable price for its debt.  “It’s true that we might have to pay  a little more for bond issues than we have in the past. For that  reason we have said we will  reduce the volume until the markets stabilise.” On Tuesday, the treasury had to pay 100 bps more for 12- and 18-month bills than they did in November.


The EU Summit of the Heads of State starts this evening. It is a very important moment for the EU in crisis time. At the end of October, the European Council agreed on the need to set up a permanent crisis mechanism, the European Stability Mechanism (ESM) to safeguard the financial stability of the euro area. The ESM is based on the EFSF that provides financial assistance under strict conditionality. So the ESM will complement the new framework of economic governance that will focus on prevention and will substantially reduce the probability of a crisis in the future.

Rules will be adapted to provide for a case by case participation  of private sector creditors, consistent with IMF policies.  The ESM loan will enjoy preferred creditor status, junior only to the IMF loan. Assistance provided to a country will be based on a programme of economic and fiscal adjustment and on a  rigorous debt sustainability analysis (by EU, ECB and IMF). The Eurogroup ministers will take a unanimous decision on providing assistance. For countries considered solvent, the private creditors would be encouraged to maintain their exposure to the country. In case of insolvent countries, the country needs to negotiate a comprehensive restructuring plan with its private creditors with a view to restore debt sustainability. If debt sustainability can be reached through these measures, the ESM may provide liquidity assistance. To facilitate this process, collective action clauses will be included in the terms of all new euro area government bonds starting in June 2013. EU president Van Rompuy will put a proposal on the table of the Summit on a limited
Treaty change.  While the latter is important and might bring some surprises, according to the press (FT), the Summit may take other decisions to address the euro crisis, notably an overhaul of the $440B EFSF. The FT suggested that the EFSF may start buying bonds of distressed governments (to replace the ECB?). Another possibility is for the EFSF to provide ST lines of credit to countries struggling to borrow money but in no need of multi-year bail-out packages. However, still according to the FT, German officials said they want to wait until early next year to table new measures and on Friday to concentrate on the Treaty changes that are needed to put the ESM on the rails. We have become more suspicious on the FT reporting regarding the EMU crisis, after the journal misled us ahead of the ECB meeting, by suggesting that the ECB would announce a QE-1 sort of package to address the stress in the peripheral bond markets. While the measures the FT now suggests might be under consideration, they have a number  of downsides that make them unlikely to be adopted in  the form that they are presented. If the EFSF start buying bonds, there will be less money available for bail-outs and rating agencies might be critical and put the AAA rating into question. Short-term loans might become LT loans and who will decide and on what condition, which countries may get money without an adjustment package?          

In the past days, rumours have emerged that the ECB would request a capital increase, some saying it might want to double its capital (currently €4B). German government sources already said that it would answer positively towards an eventual demand, showing that it is more than a rumour. Taken into account provisions and the general reserve fund it would raise the total amount of its capital buffer to €16B.

The ECB has taken a lot of credit risk on its books (collateral, covered bonds and SMP bonds), but a large part might be recorded in the ESCB (European system of central banks) and not at the ECB. The SMP bonds have already been bought at lower prices, protecting the ECB (and ESCB) to some extent to eventual defaults. Of course the ECB has no mark-to-mark obligation and thus should not have to recognize losses, but provisioning might be an appropriate prudent practise. The whole issue is very technical and the move may be inspired by creating the possibility to up the SMP bond purchases, even if we think that the ECB is reluctant to do so, but the situation may oblige  the ECB to be more active at some point. So, we are eager
whether such an ECB request will be formulated. The ECB should be careful to explain why it deems it necessary, to avoid renewed fears in the bond markets after defaults. If a request is done, we suspect the Head of States will approve it.  


Regarding bond market trading,  the consolidation we counted on mid last week, didn’t concretize, at least not in the US Treasury market. In the Bund, there was some consolidation that remains however tentative. For today, the European PMI’s may be bond friendly, but the Philly Fed may be stronger than expected and thus Treasury unfriendly. However, we still think that sentiment and technicals will be in the driver’s seat. The Spanish bond auction is a challenge, but all in all it shouldn’t be too negative for the core bonds in case of a success, while it would be a positive in case of a failure. However, the Spanish government might have secured enough demand in advance of the auction. The EU Summit starts when European trading is
ending. A demand of extra capital by the ECB should intrinsically be mildly positive for the core bonds, we think, as it might stoke some fears about potential defaults.

Regarding the technicals, both the picture of the Bund and Treasuries are bearish, but hugely oversold conditions may be at play, even if it didn’t do much in recent sessions. Reiterating our weekly view, flows have thinned and will do so further out, making it very difficult to see which market moves are due to “fundamentals” and which to year-end positioning. The latter may easily be reversed early 2011. In this context, we feel uneasy to give short term guidance that might be nothing more than guessing. Our medium term stance is still that one shouldn’t fight the bear run that is ongoing, while short term we thought/think
that some consolidation was/is likely.  
http://www.kbc.be/dealingroom
Full report : German bonds consolidate, but US Treasuries cannot find their composure 

READ MORE - German bonds consolidate, but US Treasuries cannot find their composure

Spain tests investor confidence with its bond offering

Economic Data

- (IN) India Central Bank (RBI) maintained its key interest rates unchanged as expected

- (IN) India Primary Articles WPI w/e Dec 4th Y/Y: 13.3% v 12.7% prior; Food Articles WPI Y/Y: 9.5% v 8.7% prior

- (FR) France Dec Preliminary PMI Manufacturing: 56.3 v 57.9 prior; PMI Services: 54.1 v 55.0 prior

- (SP) Spain Q3 Labor Costs Y/Y: -0.3% v 1.2% prior

- (SP) Spain Q3 House Prices Total Homes Q/Q: -2.2% v 1.6% prior; Y/Y: -2.2% v -0.9% prior

- (TU) Turkey Nov Consumer Confidence: 91.3 v 89 prior

- (SZ) Swiss Q3 Industrial Production Q/Q: 1.8% v 0.9%e; Y/Y: 5.8% v 5.0%e

- (SZ) SNB Interest Rate Decision: maintains its 3-Month Libor Target Rate at 0.25%; As expected

- (HK) Hong Kong Nov Unemployment Rate: 4.1% v 4.1%e

- (GE) Germany Dec Advanced PMI Manufacturing: 60.9 v 58.2e; PMI Services: 58.3 v 59.0e

- (SW) Sweden Nov Average House Prices (SEK): 1.998M v 1.951M prior

- (SW) Sweden Nov Unemployment Rate: 7.1% v 7.3%e

- (NV) Netherlands Nov Unemployment Rate: 5.2% v 5.2% prior

- (NV) Netherlands Retail Sales Y/Y: -1.7% v 2.9% prior

- (RU) Russia Gold & Forex Reserve w/e Dec 10th: $482.8B v $481.5B prior

- (EU) Euro Zone Dec Advanced PMI Manufacturing: 56.8 v 55.2e; PMI Services: 53.7 v 55.2e; PMI Composite: 55.0 v 55.3e

- (IT) Italy Nov Final CPI (NIC incl. Tobacco) M/M: 0.0% v 0.0%e; Y/Y: 1.7% v 1.7%e

- (IT) Italy Nov Final CPI EU Harmonized M/M: 0.0% v -0.1%e; Y/Y: 1.9% v 1.8%e

- (AS) Austria Nov Consumer Price Index M/M: -0.1% v 0.2% prior; Y/Y: 1.9% v 2.1% prior

- (UK) Nov Retail Sales Ex Auto Fuel M/M: 0.3% v 0.3%e; Y/Y: 1.8% v 1.4%e

- (UK) Nov Retail Sales M/M: 0.3% v 0.3%e; Y/Y: 1.1% v 0.7%e

- (UK) Bank of England (BOE) Quarterly Inflation Attitudes Survey: 3.9% v 3.4% prior (2-year high)

- (PD) Central/Eastern European Dec ZEW Indicator: 22.7 v 31.4 prior

- (EU) Euro Zone Nov CPI M/M: 0.1% v 0.1%e; Y/Y: 1.9% v 1.9%e ; CPI Core Y/Y: 1.1% v 1.1%e

- (EU) Euro-Zone Q3 Labor Costs Y/Y: 0.8% v 1.5e

- (BR) Brazil Dec FGV Inflation IGP-10 M/M: 1.3% v 1.3%e

- (GR) Greece Q3 Unemployment Rate: 12.4% v 11.8% prior

Fixed Income:

- (SP) Spain Debt Agency sells approx €2.4B vs. €2-4B Indicated in 2020 and 2025 Bonds

- Sold €1.78B in 4.85% Oct 2020 Bonos; Avg yield 5.446% v 4.615% prior; Bid-to-cover: 1.7x v 1.84x prior

- Sold €619M in 4.65% Oct 2025 Bonos; Avg yield 5.953% v 4.541% prior; Bid-to-cover: 2.5x v 1.44x prior

- (HU) Hungary Debt Agency (AKK) sold total HUF55B in 2014,2016 and 2020 bonds

- (UK) DMO to sell £825M in 0.625% Indexed-linked 2042 Gilts; Avg Yield 0.763% v 0.607% prior; Bid-to-cover: 1.93x v 1.96x prior

SPEAKERS/FIXED INCOME/FX/COMMODITIES/ERRATUM

Notes/Observations:

- EU Summit begins with task of trying to break the gridlock towards crisis management

- S&P raises China's sovereign rating Equities: Eurostoxx at 2842, +0.03%, FTSE100 at 5891 at +0.15%, CAC40 at 3887, +0.19%, DAX at 7026, +0.14% - European shares are trading cautiously but remained in positive territory during the session. Investors are eyeing EU's leaders summit in Brussels where debt crisis will be tackled. Leaders are expected to discuss solutions to stop contagion risk and to establish a mechanism to a permanent solution to the EU debt crisis and its stability. Expectations for any significant action are low but positive rhetoric or news could trigger a rally in equities and in the single currency. Markets were also on watch for a much awaited Spanish debt auction, which as expected, was onerous after Moody's placed the country on watch for a possible downgrade. Banks were trading lower due to EU debt concerns.

- BP [BP.UK] lost about 2% in the session after the US administration confirmed a lawsuit against the company and the service providers over spill in Gulf of Mexico. The government requested no limit on liability for damages under oil pollution act. As reported in August, the penalties costs faced by BP could be more than $20B. The lawsuit would be in addition to the $20B fund that BP has established in order to compensate individuals affected by the spill. Note that the establishment of the fund led BP to sacrifice its dividends which the company is expected to reconsider in February 2011. As the impact of the federal lawsuit is larger than expected it is yet uncertain how it will impinge on the company's ability to pay dividends. Transocean also dropped by about 1%. Transocean responded to the US lawsuit stating responsibilities from any oil spill should lay with the operator of the oil rig.
Zodiac [ZC.FR] rose over 1% after reporting an increase in revenues and confirming targets for FY10/11. Thales [HO.FR] declined about 3.5% after an article in La Tribune quoted management as saying that the recovery in 2011 margins would be gradual. Laura Ashley [ALY.UK] was up by 8% following its 19-week like-for-like sales reported at 2.7%. Sports Direct [SPD.UK] opened higher by 6% but shed some of its gains in the session although it's trading in positive territory. Pretax and revenues rose on a yearly basis. Despite trading being ahead of management expectations, the company expects the retail environment in the beginning of 2011 to remain tough.

Speakers:

- SNB members commented after the central bank left rates unchanged. SNB's Jordan commented that currency risks were the biggest risks on the SNB's balance sheet and that it was using higher reserves and diversification to reduce balance sheet currency risks.

- SNB Danthine stated that the central bank had diversified its reserves into various currencies including Australian and Singapore dollars. He added that the diversification process had been done in steps and absorbed by the markets. The strong CHF currency presented a heavy burden on Swiss economy

- SNB's Hildebrand commented that the Swiss economic growth would slow in coming quarters. He noted that the deflation threat had declined despite higher CHF currency

- BoE Posen stated that UK still had a large output gap to close. He added that inflation to be significantly below the BOE's Nov forecasts.

- S&P raised both China's and Hong Kong sovereign ratings.

- ECB's Stark believed Germany should not cut taxes

- Germany's Institutes provided their latest economic outlook. Overall they raised their 2010 and 2012 GDP view for Germany. Howver, Germany's IMK Institute commented that it saw a rising risk of recession in 2012.The IMK noted that Germany's economy would continue to recover in 2011 but expressed that slowing growth in Asia and the US and turbulences in the euro zone posed risks that could lead to a recession in 2012. It noted that export growth would slow in 2011 as several Asian countries would dampen their growth to avoid overheating and as the recovery in the United States continues to be lackluster.

- Bank for International Settlements (BIS) stated that large banks had €165B capital shortfall under Basel III capital rules and such banks would require €577B to meet 7% core Tier 1 capital ratio. National regulators could raise the countercyclical buffer over 2.5%.

Currencies: - The EUR/USD mustered up some gains in the session as the EU Summit set to begin the first of a two-day meeting. EU governments appear close to agreeing on a two-sentence amendment to the bloc's Lisbon Treaty. It would foresee a "mechanism to safeguard the stability of the euro area as a whole" with financial aid for distressed governments "subject to strict conditionality". The sub-1.32 area again proved quite formable for the EUR/USD with again Far East sovereign interest said to be lurking below. None-the-less Euro sell stops building below 1.3160 area. The data for the session was mixed with stronger Manufacturing PMI data for the larger countries but soft PMI services. Dealers took note of one of the German Institute comments that its saw a risk of recession in 2012 for Germany. - The SNB maintained their key rate as expected but noted it began a reserve diversification process that included both the Aussy and Singapore dollars. - The GBP/USD was near 1.56 after the UK retail sales and quarterly inflation survey were stronger than expected. - The softer US yields capped the gains in USD/JPY as it retested the 84.00 handle. The US 10-year yield back below the 3.50% level by a few basis points.

- Peripherals were steady in the session as Spain faced a key test of investor confidence. The two-trance auction results were mixed with sharply higher yields but managed to sell within the expected range.

Geo-Political/ In the Papers:

- The Japanese parliament approved the FY 2011 tax plan, as expected. The plan includes the 5% cut in corporate tax rates and a new environmental tax, which is expected to bring in about ¥240 billion per annum. The FY2011/12 budget will be decided later this month on Friday the 24th of December.

- In the Irish parliament last night, the lower house passed its banking reform and restructuring bill by 78 votes to 71. The bill now makes its way to the upper house where it is expected to pass on Friday, and then be set into law by the end of the week. The bill places more authority into the hands of the government, including the ability to appoint managers to financial institutions.

- According to the Financial Times, Spain's 2011 refinancing needs could see the country fall into a debt trap. The higher the yields increase, the more difficult it could be for the country to raise funds. The ECB has only purchased Greek, Irish and Portuguese bonds, though if it were to begin purchasing Spanish bonds, then it would have to on a large scale due to the size of country's debt market. The article does mention that Spain has €20 billion in cash reserves, and the average cost of its total debt load is about 3.5%, which is below current market yields. As a reminder, as of June 2009, Spain's gross external debt totaled about $2.4 trillion compared to Greece's $553 billion.

- There were details released for PIMCO Bill Gross' Total Return Fund, which indicate last month that his position in US government debt increased to 30% from 28%. This was the first time that the fund raised its holdings of US debt since June. In addition, he also increased holdings in mortgage securities 10 points to 49%. Other notable changes include the amount invested into emerging-market debt, which were down to 8% from 12%, and non-US developed nation bonds at 4% from the prior position of 7%. Note the size of the fund is approximately $1.2 trillion.

- In the Financial Times PIMCO's El-Erian stated that he believed depositors and creditors have used the EU's rescue measures to exit their holdings. New investors have been reluctant to purchase certain EU assets due to concerns about debt levels and the lack of competitiveness of certain countries. Lower investment levels in Europe will make it more difficult for governments to achieve their proposed austerity measures. With regards to Germany, he noted that pressures are rising on the country to do more to help the troubled EU countries and as a result, markets have started to signal initial concerns about Germany's fiscal strength.

Looking Ahead:

- (IS) Israel Dec Inflation Forecast: No est v 2.8% prior

- 6:00 (IR) Ireland Q3 Current Account: No est v -€1.1B prior

- 6:00 (IR) Ireland Q3 GDP Q/Q: No est v -1.2% prior; Y/Y: No est v -1.8% prior

- 6:00 (IR) Ireland Nov PPI M/M: No est v -2.5% prior; Y/Y: No est v -0.7% prior

- 6:30 (BE) Belgian Finance Minister Reynders

- 8:00 (PD) Poland Nov Employment M/M: 0.1%e v 0.2% prior; Y/Y: 2.2%e v 2.1% prior

- 8:00 (PD) Poland Nov Avg Gross Wages M/M: 3.5%e v 1.1% prior; Y/Y: 4.5%e v 3.9% prior

- 8:30 (CA) Canada Oct Int'l Securities Transactions: C$10.0B v C$12.3B prior

- 8:30 (US) Q3 Current Account: -$126.0Be v -$123.3B prior

- 8:30 (US) Nov Housing Starts: 550Ke v 519K prior; Building Permits: 560Ke v 552K prior (revised)

- 8:30 (US) Initial Jobless Claims: 425Ke v 421K prior; Continuing Claims: No est v 4.086M prior

- 8:30 (BR) Brazil Nov Caged Formal Job Creations: 125.7Ke v 204.8K prior

- 9:00 (BE) Belgium Oct Trade Balance: No est v €1.1B prior

- 10:00 (US) Dec Philadelphia Fed: 14.1e v 22.5 prior

- 10:30 (US) Weekly Natural Gas Inventories

- 12:00 (TU) Turkey Central Bank Interest Rate Decision: Expected to maintain the Benchmark Repo Rate at 7.00%

- 14:00 (BR) Brazil Nov Tax Collections (BRL): No est v 74.4B prior

- 16:00 (CL) Chile Central Bank Interest Rate Decision: Expected to raise the Nominal Overnight Rate Target by 25bps to 3.25%

https://www.tradethenews.com/

READ MORE - Spain tests investor confidence with its bond offering