Silver as an investment

Flying Pigs

Italian 10 year government bond yield / By Pater Tenebrarum / December 31, 2012

Euro Area Carry Trade – From Disbelief to Consensus?

When we noted about a year ago that the ECB’s LTROs were likely to give banks and incentive to initiate carry trades in the bonds of euro area peripherals, it was an opinion very few people shared. We wrote at the time:

“Is is clear from the above that Spain’s banks – and this goes of course for the banks in all the other ‘PIIGS’ nations too, even though the details of their problems differ from case to case – should be more concerned with getting their leverage down and generally getting their house in order rather than embarking on yet another carry trade. And yet, from the point of view of the banks, things may look a bit different. As noted before, the fate of banks and their sovereigns is in any event closely intertwined. A bank that may one day require a government bailout will go under anyway if the government debt crisis worsens further. So it has actually nothing to lose by adding to its holdings of bonds issued by said government. They will both sink or swim together no matter what.

A new story has emerged yesterday that illustrates what actions governments and banks in the euro area are taking behind the scenes to ease the bank funding crisis. It should be clear that one of the unstated objectives of these activities is to free up money for the purpose of banks adding to their sovereign debt holdings.”

It later turned out that Spain’s banks did both: they deleveraged by reducing their loans to the private sector, but they also jumped on the carry trade opportunity in bonds issued by the government. The same essentially happened in Italy. At the time of the LTROs, most observers disagreed quite vehemently with the idea and we noted in our 2012 outlook (which got a few things right and a few wrong, in almost perfect coin-flip fashion), we were also looking for a bit more upheaval in the first half of the year, which we did indeed get.