Contagion fears grow over ‘too big to bail’ Spain
By Sam Jones
Published: November 17 2010 20:12 | Last updated: November 17 2010 20:12
For some of the world’s biggest hedge funds, typically regarded as the savviest traders in the market, there is now one big question facing the eurozone: what is going to happen to Spain?
While Europe’s politicians are grappling with the crisis unravelling in Ireland, hedge fund managers are already turning their attention to the issue of how – and if – a peripheral crisis in Ireland could leap via Portugal and Spain to become a systemic crisis for the eurozone as a whole.
“The Irish problem will be contained,” says Guillaume Fonkenell, chief investment officer at Pharo, one of Europe’s biggest and most successful macro funds, which specialises in trading on macroeconomic events and trends. “For us contagion is the issue . . . If the market loses confidence in Spain, then all bets are off. Spain is too big to bail.”
For some leading hedge funds, however, the bets on precisely such a scenario have been on for some time.
In a note sent to clients, the publicity-shy Bridgewater, the world’s biggest hedge fund, warned in February that Spain was its biggest eurozone concern.
“Spain’s having the euro as its currency is akin to its being on the gold standard,” it said. “As expected, the Spanish government decided to run big budget deficits that have been funded with big borrowings, but the more the debt increases, the closer this approach is to coming to an end.”
It added: “We judge Spanish sovereign credit to be much riskier than is discounted because it seems to us that there is a high risk that Spain won’t be able to sell the debt that it needs to fund its deficits.”
Bridgewater’s conclusion was that “on the basis of fundamentals alone” Spanish credit default swap spreads, the cost of protection against default over five years, should be trading at close to 650 basis points. The spread currently trades at 257bp. A recent note from Credit Suisse analysts warned that 650bp was the point at which Spain would lurch into a crisis. Mr Fonkenell says: “Six hundred basis points is the benchmark for me. It is the point of no return.”
Hedge funds have already begun to hoover up credit protection against Spanish bonds, expecting a crisis for Spain in the first quarter of next year. Few managers are trading with absolute conviction, however.
“The short positions are quite crowded so they are not performing well,” says Mr Fonkenell. Another hedge fund manager says: “It is dangerous right now because you can be so blindingly bearish that you lose your shirt. These are not functional markets.”
Spanish ministers, while admitting that the country’s 2009 budget deficit of 11.1 per cent of gross domestic product was among the highest in the eurozone, argue that financial markets have failed to grasp the underlying solidity of the country’s public finances when compared with the rest of Europe.
Spain’s public debt as a proportion of GDP was 53 per cent at the end of last year, below the eurozone average of 79 per cent. It remains one of the lowest among the western economies in spite of heavy issuance in recent months.
While few managers doubt what will play out – the biggest crisis the eurozone has ever faced – how it will do so is another matter. The obvious position for most hedge funds, including US managers, is to be bearish on the euro. Indeed, many funds have begun ramping up their bets against the currency in recent weeks.
With concerns about Ireland, Portugal and Spain all expected to weigh on the currency, some managers are willing to go short now and take the pain arising from a rebound should there be an Irish bail-out in the next few days because they believe the currency will inevitably fall before the end of the year.
“Respite will be short-lived,” says one manager, adding that, on a trade-weighted basis, the euro should fall by at least another 5 per cent by the end of the month.
But betting against the currency is almost as difficult a game as playing in sovereign credit, not least because of the complications in foreign exchange markets caused by the US Federal Reserve’s latest bout of quantitative easing.
The third option hedge fund managers have been watching is the complex interplay between the eurozone banks and the region’s peripheral economies.
Selling short eurozone banks is again being seen as an attractive trade for hedge funds to execute, even with the European Central Bank standing by to prevent outright defaults. Some hedge funds believe it is actually ECB policy that has made the eurozone debt crisis so acute.
As Citigroup analysts point out, the effect of the ECB’s liquidity operations, rolled out in 2008 to help mitigate tension in the eurozone banking system, has been to incentivise the area’s banks to load up on eurozone government debt.
Banks in peripheral countries have increased substantially their holdings of domestic government bonds over the past year, by 88 per cent in Portugal, 20 per cent in Greece and Ireland, 13 per cent in Spain, and 20 per cent in Italy, according to Citigroup’s October note.
Now, in Ireland, just as in Greece, banks that loaded up on such debt in the past 18 months are being forced to stump up additional collateral to keep it on their books or dump their bond holdings in the market.
Desperation from banks looking to sell, coupled with the pull-back of long-term investors willing to buy is precisely what is making bond markets so volatile. While fund managers have for the most part already been short the government bonds, the issue now is just how seriously the crisis will feed back once more into the banking system.
Enviado: 26/11/2010 18:36
, posso dizer:
