Italy to tap the market in difficult circumstances

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Flight-to-safety dominates: Puerto-Rico joins Greece

Yesterday, global core bonds opened very strong on the surprise weekend from Greece (see yesterday’s Sunrise and flash report). This was more than enough to inject a big dose of risk-off sentiment into the various markets.
However, calm returned soon and the Bund, which opened near 153 fell to about 151.50 where it stabilized until US traders joined the fray. Similar reactions in the equity markets that recouped some of the heavy early losses and in the euro, where the initial drop in EUR/USD was completely reversed. During the early US session, markets continued to retrace some of the moves of earlier in the session. However, equities were soon sold again and the safety bid returned in the market, obliging core bonds to turn back up and ending the day with juicy gains. EMU political leaders made no attempt to bring Tsipras back to the negotiation table, but repeated that solidarity and reforms go together in the union. They said that Greece didn’t want to accept this sacro-saint principle. They remain ready to negotiate also after the referendum. However, default chances are still increasing. In a daily perspective, the German yield curve bull flattened with yields up to 12.6 bps lower. US yield changes amounted from -2.3 bps (2-year) to -14.8 bps (10-year). In late US trading, S&P cut the Puerto Rico rating to CCC- negative outlook (like Greece), as its governor urged the US to save it from bankrupcy ($72B). While this looks a minor event, it is not trivial especially as some insurance companies, like MBIA, a familiar name during the 2008 crisis, are heavily involved. US equity indices are nearing key support levels, as are European ones and needs monitoring.

As expected, Greek bonds were heavily sold. Greek yields traded sharply up (about 1500 bps 2-year, 436 bps 10-year (14.74%) according to screen prices), pricing in a high risk of default. In other peripheral markets, spreads widened sharply at the opening, but these levels should be ignored as there were barely actual trades. Shortly afterwards, peripheral spreads stabilized in a narrow range, but widened again when risk-off flared up at the end of the European session. In a daily perspective, the Portuguese 10-year yield spread widening amount to 49 bps, Italy and Spain about 36/37bps. Semi-core (Belgium/France) and non-German core yield spreads rose by 4/7 bps. 10-year swaps were little changed versus Germany, but outperformed other EMU bonds.

Eco calendar heats up

Yesterday, German HICP inflation data showed a sharp slowdown in inflation from 0.7% Y/Y to 0.1% Y/Y. Today, the euro zone inflation data are forecast to show a more limited slowdown, from 0.3% Y/Y in May to 0.2% Y/Y in June. Contrary to the German data, inflation picked up in Spain and Belgium. Still, we believe that the risks are for a downward surprise. Core inflation is forecast to have slowed from 0.9% Y/Y to 0.8% Y/Y. Also here, we believe that a downwards surprise is not excluded. In the US, Conference Board’s consumer confidence is expected to have increased for a second straight month in June. The consensus is looking for an increase from 95.4 to 97.4, but we see risks for a stronger outcome supported by higher wages and a strengthening labour market. The Chicago PMI is expected to show a rebound, from 46.2 to 50 in June, reversing most of the May drop. Also here, risks for an upward surprise.

Italy to tap the market in difficult circumstances

The Italian Treasury taps the 1.5% June 2025 BTP for an expected amount of €2-3B and the 0.7% May 2020 for an amount of €1.5B. The shorter BTP is at somewhat richer levels versus shorter bonds while the 2025 BTP outperformed the overall curve. There was little pre-auction cheapening. Given the recent spread widening due to risk off, the BTP credit curve may steepen. However, in the current climate we can only urge caution for this auction.

Overnight, Asian stock markets trade in positive territory. Greek PM Tsipras suggested on TV that he (and/or) his party would resign (elections?) if the outcome of the referendum is “yes”. Treasuries trade little changed overnight, while the Bund opened slightly down.

Regarding today’s trading, the eco data are a bit mixed. We see upward risks for US eco data (see higher), but risks for lower EMU inflation. As such, the stronger US data are a Treasury negative, but markets are currently more focussed on developments in Greece and Puerto Rico. We probably will get polls on the Greek referendum and maybe more comments. We follow closely equities as these are approaching key levels and are a good indicator for the sentiment on risk. Until now, the market reaction on Greece should be considered as ok, not too heavy with no real sign of substantial contagion. Given these elements, it is difficult to see the direction of markets today. It things turn worse, like yesterday, the flight to safety will be substantial and policymakers will become nervous. However, Asia suggests that yesterday’s sell-off may for the moment haver cleared the horizon. Cautiousness remain the key advice. Further spread widening in the peripherals opens buying opportunities, while a decline of 10-year Bund yields to e.g. 0.50% offer selling opportunities.

In general, we favour higher yields, but first the Greek issue should be resolved one way or another.