Wednesday, 19 September 2018

On the zero-coupon perp for Greece

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  • Peters 475px June 2014

Anthony Peters sees a virtual suspense account for Athens.

Why do I keep thinking of that battle-cry of the Parisian students of May 1968 “Soyez raisonable; demandez l’impossible!”? The answer came over the radio this morning where the BBC interviewed a German economist, the name of whom I sadly missed but when quizzed about his position on Greece used the analogy of a mad-man on the roof of a tall building threatening to jump off. Not only does one instinctively try to prevent him from doing so but the madder he is, the harder one tries.

Risk markets rallied hard on Tuesday, driven in part by a huge leap in oil. Brent settled at US$57.91 which represents a rally of 28% from the recent low. However, stats are stats and even at that level it is still down just a smidgeon under 50% on the June 2014 high. Another part of the rally was, inevitably, due to the sense that the Greece situation has passed through the darkest section of the tunnel. The Tsipras and the Varoufakis charm offensives seem to be bearing fruit in the same way as the Papandreou trip to Berlin did four years ago. By scaring their political peers with the threat of blowing a huge hole into the side of the “Good Ship Eurozone”, whether above or below the waterline is surely being left to the imagination of the listener, the Syriza leaders a smoothing a path to a “whatever it takes” response.

I suspect that what was once frivolously being bandied about by jokers as a zero-coupon perp solution might prove to be closer to the truth than any of us would have expected.

When I began work as a cub banker in the late 1970s, a loan classified as “without formal repayment schedule” was a loan which had been mentally written off but which was held over in a suspense account so that the hit could be taken at the discretion of and according to the time-table of the bank rather than that of the defaulting borrower. The probability of Varoufakis’ growth bonds ever leading to creditors actually being paid back their money remains low. It does, however, help to defer the need to take a hair-cut.

Markets are not populated by people who entered the business because they want to be short, so any opportunity to wheel out optimism will be taken. Thus equities went on a mission, with Athens making double-digit gains and Madrid and Milan posting rallies of over 2½%.

Credit markets had an astonishing day with new issuance flying off the shelf, irrespective of price. I loved the €300m 10-year deal for Air Products which was originally floated as mid-swaps +45-50, which then was suddenly talked at +40 area and finally priced at +37 which has the company borrowing 10-year money at 1%. That’s great, but it also has our pension savings being lent out for 10 years at 1% which isn’t so great. JP Morgan’s 5-year self-led sterling deal found similar response albeit that carrying a coupon of 1⅞% it looks like a positive high yielder. Heathrow Funding joined the fun with a 15-year secured bond which was initially talked at swaps +75 and which finally priced at +63. All good clean fun. Even good old Ireland got in on the act with nothing more than a 2% coupon on a €4bn 30-year sovereign bond, bejeesus.

Heading toward nowhere to go

Secondary markets, however, remain sticky and pretty unpleasant. Now the US Treasury is beginning to express worries that, even in markets for its own bonds, supposedly the easiest in the world to trade and the global safe-haven asset of choice, liquidity is declining and with it risks are increasing.

The “flash crash” of last September displayed the cost of having ripped the guts out of the trading community and its ability and desire to take risk and make markets on a “your size is my size” basis. Irrespective of whether the Fed begins to tighten in June, July, September or not until next year, there will be a day when investors are no longer going to want to be limit long rate risk, and there is fear that they will have nowhere meaningful to go.

The universe of outstanding bonds continues to grow at a time when the ability to trade them in the Street in an orderly fashion continues to decline. Just because there is no visible sign of a fire being about to break out is not sufficient a reason to remove the fire extinguishers from the building.

Regulators and compliance departments are just like those legendary generals who are busily preparing to fight the last war while they are doing nothing to prepare for the next one. Maybe the worries of the Treasury might shake up a few people but, truth be told, I doubt it. Restrictive regulation has developed a life of its own which gets a huge high from demonstrating the power it exercises over those horrid little traders who get paid fortunes for having fun.

If liquidity is supposed to be there until you need it most, what if it isn’t?  Planning for the future? Ba, Humbug.

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