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BTP Futures Trading May Give Euro Bonds New Spin
By Emese Bartha and Christopher Emsden
DOW JONES NEWSWIRES
FRANKFURT -(Dow Jones)- The Eurex derivatives exchange is mulling the launch of futures trading on Italian government bonds, a move that might allow higher- yielding Italian debt to muscle into an area now monopolized by German bunds but also could scotch prospects for a single euro-zone government bond.
Currently, the euro-zone government bond market comprises 16 sovereign issuers. But since the advent of the single currency, real futures trading is available only on Germany's schatz, BOBL and bunds, a fact many say has helped bolster Germany's role as the euro-zone's benchmark issuer.
But a spokesman for Eurex told Dow Jones Newswires that the exchange is considering the launch of equivalent contracts on Italian government bonds, although it hasn't made a decision yet.
If Eurex decides to go ahead, it would open a new market segment with potentially large and strong demand that, by allowing investors more hedging opportunities, could lower the cost of issuing Italian Buoni del Tesoro Poliennali, or BTPs.
BTP futures could add diversity for investors, support BTP prices, and lead to narrower and less volatile spreads between the yields on BTPs and bunds, analysts said.
Luca Cazzulani, strategist at UniCredit said the start of BTP futures would be a recognition that investors expect yield spreads between core and peripheral issuers to remain volatile. Therefore the sooner the launch comes, the better.
"Unless the BTP futures are launched within six months, I don't think they'd be launched at all," he said. "It would be useful now, it would have been useful during the past few months but once the crisis is over, BTP futures may not be needed any more."
Despite a recent rally in risk appetite, few investors think euro-zone government bonds are going back to the extremely tight spreads that prevailed in recent years.
"Economic stress could easily get worse, and ensuing volatility will make a BTP futures instrument all the more useful," said one Milan-based trader who said market participants have already been broadly and informally consulted by Eurex. The trader expects the BTP futures project to be up and running before the summer ends.
Before the global credit crisis began in late 2007, bund futures offered a satisfactory hedging instrument for investors buying all sorts of European government debt. Tight correlations meant that bund future hedged from 79% to 98% of the risk on non-German euro-zone bonds, depending on the country, Cazzulani said. The lowest figure of 79% refers to Greece, while the highest to France but even Spanish debt was 97% hedged with bund futures.
But since the financial crisis began, yield spreads between different euro- zone sovereign issuers spiked to historical highs, making bund futures a less useful hedging instrument.
In the past three months, bund futures effectively hedged only a third of the risk on Greek bonds, 40% on Irish debt, 62% on Italy's BTPs, and 78% on Spanish bonds, according to Cazzulani's calculations.
Part of that seismic shift was due to rapidly deteriorating fiscal conditions in countries where real estate markets imploded, such as Spain and Ireland, both of which lost their triple-A ratings in recent months, and growing doubts about the long-term sustainability of high public debt levels in countries such as Italy and Greece.
While German debt benefited from a flight to quality, it was also helped by the extra liquidity offered by bund futures.
Even though they are issued in the same currency, yields on German government bonds are much lower than their Italian equivalents, with the spread or gap ranging from 0.7 percentage points at the relatively short three-year maturity and rising to above one percentage point at maturities of 10 years or longer.
If Eurex does launch the new future platform, "it would be supportive for BTPs, as it would increase liquidity and could lead to more expensive price levels," said Nordea analyst Jan von Gerich.
He noted, however, that it may take time to achieve solid liquidity levels in the new product, which could hinder or delay its success.
BTP futures could also be used to hedge bonds from other peripheral euro-zone issuers.
But analysts said their introduction, while taking away some turnover from the current bund futures to the benefit of peripheral euro-zone issuers, would likely be a blow to a joint euro-zone bond, the idea of which has quickly faded without support from Germany.
"BTP futures would be a recognition that individual issuers have their own dynamics," said UniCredit's Cazzulani. "In that sense it's a step away (from a euro-zone joint bond)."
A single euro-zone government bond would eliminate the fragmentation problem that many global investors say hobbles the single currency as a competitor to the U.S. dollar.
While various finance ministers in the euro area have given vocal support to the idea, including Italy's Giulio Tremonti, as has the International Monetary Fund, German officials have been notably cool to the idea. Standard & Poor's said such a common instrument would be rated at the level of its lowest contributors - Greece and Italy - which would remove much of the attraction.
The rapid growth of credit default swaps, now traded for all euro-zone countries, offers some of the same qualities as futures.
But because the BTP market is so large - total Italian public debt is larger than Germany's - a specific futures market could prove very useful to fixed- income fund managers as well as large institutional investors.
By Emese Bartha and Christopher Emsden
DOW JONES NEWSWIRES
FRANKFURT -(Dow Jones)- The Eurex derivatives exchange is mulling the launch of futures trading on Italian government bonds, a move that might allow higher- yielding Italian debt to muscle into an area now monopolized by German bunds but also could scotch prospects for a single euro-zone government bond.
Currently, the euro-zone government bond market comprises 16 sovereign issuers. But since the advent of the single currency, real futures trading is available only on Germany's schatz, BOBL and bunds, a fact many say has helped bolster Germany's role as the euro-zone's benchmark issuer.
But a spokesman for Eurex told Dow Jones Newswires that the exchange is considering the launch of equivalent contracts on Italian government bonds, although it hasn't made a decision yet.
If Eurex decides to go ahead, it would open a new market segment with potentially large and strong demand that, by allowing investors more hedging opportunities, could lower the cost of issuing Italian Buoni del Tesoro Poliennali, or BTPs.
BTP futures could add diversity for investors, support BTP prices, and lead to narrower and less volatile spreads between the yields on BTPs and bunds, analysts said.
Luca Cazzulani, strategist at UniCredit said the start of BTP futures would be a recognition that investors expect yield spreads between core and peripheral issuers to remain volatile. Therefore the sooner the launch comes, the better.
"Unless the BTP futures are launched within six months, I don't think they'd be launched at all," he said. "It would be useful now, it would have been useful during the past few months but once the crisis is over, BTP futures may not be needed any more."
Despite a recent rally in risk appetite, few investors think euro-zone government bonds are going back to the extremely tight spreads that prevailed in recent years.
"Economic stress could easily get worse, and ensuing volatility will make a BTP futures instrument all the more useful," said one Milan-based trader who said market participants have already been broadly and informally consulted by Eurex. The trader expects the BTP futures project to be up and running before the summer ends.
Before the global credit crisis began in late 2007, bund futures offered a satisfactory hedging instrument for investors buying all sorts of European government debt. Tight correlations meant that bund future hedged from 79% to 98% of the risk on non-German euro-zone bonds, depending on the country, Cazzulani said. The lowest figure of 79% refers to Greece, while the highest to France but even Spanish debt was 97% hedged with bund futures.
But since the financial crisis began, yield spreads between different euro- zone sovereign issuers spiked to historical highs, making bund futures a less useful hedging instrument.
In the past three months, bund futures effectively hedged only a third of the risk on Greek bonds, 40% on Irish debt, 62% on Italy's BTPs, and 78% on Spanish bonds, according to Cazzulani's calculations.
Part of that seismic shift was due to rapidly deteriorating fiscal conditions in countries where real estate markets imploded, such as Spain and Ireland, both of which lost their triple-A ratings in recent months, and growing doubts about the long-term sustainability of high public debt levels in countries such as Italy and Greece.
While German debt benefited from a flight to quality, it was also helped by the extra liquidity offered by bund futures.
Even though they are issued in the same currency, yields on German government bonds are much lower than their Italian equivalents, with the spread or gap ranging from 0.7 percentage points at the relatively short three-year maturity and rising to above one percentage point at maturities of 10 years or longer.
If Eurex does launch the new future platform, "it would be supportive for BTPs, as it would increase liquidity and could lead to more expensive price levels," said Nordea analyst Jan von Gerich.
He noted, however, that it may take time to achieve solid liquidity levels in the new product, which could hinder or delay its success.
BTP futures could also be used to hedge bonds from other peripheral euro-zone issuers.
But analysts said their introduction, while taking away some turnover from the current bund futures to the benefit of peripheral euro-zone issuers, would likely be a blow to a joint euro-zone bond, the idea of which has quickly faded without support from Germany.
"BTP futures would be a recognition that individual issuers have their own dynamics," said UniCredit's Cazzulani. "In that sense it's a step away (from a euro-zone joint bond)."
A single euro-zone government bond would eliminate the fragmentation problem that many global investors say hobbles the single currency as a competitor to the U.S. dollar.
While various finance ministers in the euro area have given vocal support to the idea, including Italy's Giulio Tremonti, as has the International Monetary Fund, German officials have been notably cool to the idea. Standard & Poor's said such a common instrument would be rated at the level of its lowest contributors - Greece and Italy - which would remove much of the attraction.
The rapid growth of credit default swaps, now traded for all euro-zone countries, offers some of the same qualities as futures.
But because the BTP market is so large - total Italian public debt is larger than Germany's - a specific futures market could prove very useful to fixed- income fund managers as well as large institutional investors.
