The Agence France Trésor of the French government reported on May 7 that its bond auction of Obligations Assimilables du Trésor (OAT) across three maturities was lightly subscribed. That wasn’t their assessment, of course, as the government simply reports the figures and the credit market makes value judgments. The October 2023’s were bid-to-cover of only 1.58; the May 2025’s were bit-to-cover 1.69; and, the October 2027’s were bid-to-cover 1.89. The stop price on the 2025’s was just 95.35%, even though the €8.5 billion or so for the total auction lift wasn’t in any way out of line with recent borrowing trends.

The overall European bond market took the weak auction as another in a series of indications for the weak bond market that has developed since mid-April. On April 29, a German bund auction was technically uncovered, though that isn’t as rare an occurrence. But in the context of the growing nervousness about the ECB, ECB QE irregularities and a whole host of economic muddle, these auction results appear to be self-reinforcing of the negative trend.

Just two weeks later, Agence France Trésor issued much more well-received paper, as European yields were somewhat more settled in mid-May, but their last auction on June 4 was maybe as bad or worse than their first in May: May 2025’s (again) were bid-to-cover 1.76 with a stop price of only 92.72%; May 2030’s were bid-to-cover only 1.58.

ABOOK June 2015 Eonia Bund 10s

Clearly the auction process is being unsettled by the broader disruption in credit markets as a whole. We have been told that is just these markets adjusting to QE’s positive effects, where “inflation” will be better, the economy is already picking up, and the “fear trade” unwinding (again). I doubt any of those are true, as more likely there is Greek all over this process in a manner far different than the rehearsals in 2011 and 2012. Back then, as now, the economy was supposed to be doing the exact same, only with massive LTRO’s standing in for the massive QE that occurs this time around.

When the LTRO’s were first announced in December 2011, German 10-year bund yields were about 2.25%; by the time Mario Draghi was “forced” to make his promise in late July 2012, bund yields were a then-record low of 1.22%. Clearly then, unlike now, German bunds were the safe-haven that everyone assumes, but without extrapolating very real limitations to that very view. A bund at even 1.22% offers some protection through yield, even the potential for a little further price appreciation; a 10-year bund at 7 bps of yield does not on either account.

In other words, it appears as if German bunds went too far, exited the realm of “safe haven” and entered the territory of every other risk asset. That would include peripheral sovereign debt, the notable, if somehow forgotten, PIIGS. Spanish 10s, for example, traded to an unbelievably low 1.05% by March 12 – but have been moving higher ever since.

ABOOK June 2015 Eonia ESPs WA

In terms of “risk” spreads, it seems pretty clear that risk overall has been at least a primary factor in the selloff in bunds as well as PIIGS. Again, this reverses the dynamic that played out into the middle of 2012 where spreads rose instead of being conjoined.

ABOOK June 2015 Eonia ESPs Spreads

To further that point, one need only to chart Eonia’s course during this disruptive period. While the overall trend in Eonia had been decidedly downward going back to the ECB’s QE announcement, there is a clear impression of the recent bond selloff in the interbank liquidity market.

ABOOK June 2015 Eonia

To be sound in analysis we need to be clear on what Eonia at and around -15 bps is and what it is not. This sounds like a flood of liquidity, particularly as it comes during the actual QE buying period, but such a negative interbank rate indicates reduction in risk appetites among larger bank participants. Rather than using this liquidity for “risky” purposes, like funding new lending as the ECB intends from these “portfolio effects”, it is clear that banks are at least doing the opposite preferring to hold useless ledger “cash” at steadily and increasingly eroding rates of “return” (again, they only do so because it is far costlier to invoke convertibility; for now).

It is not just Eonia and the O/N rate, term interbank rates have been sinking in tandem with Eonia suggesting broad risk avoidance.

ABOOK June 2015 Eonia Corridor Hierarchy

While the ECB starting “buying” bonds on March 9, the overall interbank market did not cross into this depressed threshold until later in April. This action is contradictory to the pattern that prevailed under the LTRO’s, which produced a more stable interbank existence (if only artificially) right away, where the spread between Eonia and the MRO deviated only by a few bps throughout the whole period.

ABOOK June 2015 Eonia MRO

Thus the volatility interbank seems to echo if not cause the wider credit market disorder these past few months. I tend to think the credit market starts from PIIGS yields and spreads and has moved from there, entangling interbank and liquidity considerations further on, but there may be some chicken and egg here especially as it relates to feedback effects.

Nothing much is assured, however, which even suggests that Greek fears might not be the defining issue in the first place. It seems most reasonable, but there is little to trace directly especially now that QE in Europe has obliterated any sense of a baseline. In my view, all this adds up to a credit market “atoning” for being overassertive on risk, and that re-assessment amounts to concerns over destabilization rather than embracing the optimism of QE toward re-stabilization. With repo rates persistently negative too, there is no defining the corrosiveness with which a highly and durably negative interbank paradigm might reach.

One final point in that direction of risk re-assessment: with German bunds skyrocketing in yield, the Swiss curve isn’t excessively redrawn since mid-April. While the 10-year bund has gone from 7 bps in yield to 1%, the Swiss 10-year yield has only moved up about 25 bps; the entire front end of the Swiss curve from about the 6-year maturity on in is almost completely unchanged.

ABOOK June 2015 Eonia Swiss