Market Outlook - BNP PARIBAS - Investment Services India

This section is classified as non-objective researchthis year's funding needs. This means there is aremaining EUR 26bn of issuance until year-end(excluding buybacks for the last four months of theyear for which we have no data yet). With threeauctions remaining (one in October and two inNovember) and one optional auction in December,France can issue an average of EUR 8.7bn perauction and skip the December one. Once weinclude the buybacks to the gross issuance figure weget that France has completed almost 87% of its2011 funding, which is slightly above the 84%eurozone average (Chart 1).For next year the supply picture improves furtherrelative to 2011. We expect gross issuance of Frenchbonds of around EUR 179bn from EUR 184bn in2011. In net issuance terms we expect a fall fromEUR 89bn in 2011 to EUR 80bn in 2012. Frenchbond redemptions are expected to be aroundEUR 99bn in 2012, while the projected deficitestimate is EUR 82bn according to AFT.From a less constructive point of view, the commonstylised fact of this euro crisis is a simultaneousweakness in domestic equity and government bondmarkets, followed by a significant increase involatility, absence of domestic buyers and theeventual ECB decision to purchase bonds (Chart 2).We’ve seen this happening in relatively small as wellas very large markets and economies (e.g. Italy).Pockets of weakness in the architecture of the euroas well as the absence of proactive decisions fromeurozone officials are the main reason for bondmarkets’ underperformance. The dangerous conceptof “Who’s Next?” has crept into investors’ mind.Contagion statsIn terms of total return (iBoxx Sovereign), France isdown 2.8% in October with only Belgium (-4.5%) andIreland (-3.2%) doing worse. Year-to-date, theperformance is around +3%, which puts it at the lowend of the AAA distribution (Germany +6.8%).In terms of price action, we’ve performed acorrelation analysis (Chart 3). Yield correlation toBunds is still around 80%, while spreads remain verycorrelated (e.g. BTP/Bund and OAT/Bund). Onenegative aspect is the increased correlation between10Y BTP yield and OAT (now into positive around20% from as low as -70% before the ECB reactivatedthe SMP). From this analysis, we concludethat contagion risk has recently increased in the AAAsector excluding Germany.Demand stabilisation neededFrom a broader EMU perspective, 10Y Italy is tradingaround 5.90% (Sep-21), i.e. just 20/25bp below thetop despite an estimate 55/60bn purchased by theECB. Market confidence in stabilising forces is quitelow at this stage.706050403020ASWChart 4: EFSF vs EUEU Jun-21EFSF Jul-2110Jun-11 Jul-11 Aug-11 Sep-11 Oct-11Source: BNP ParibasChart 5: Global Demand for EGB at Risk0.20.1Basis points0.0-0.1-0.2-0.3EMU3 vs EMU ALL index yield-0.4-0.52007 2008 2009 2010 201114%12%10%8%6%4%2%Daily iBoxx price returnvolatility (63 days)FranceGermanyItaly2005 2006 2007 2008 2009 2010 2011Source: BNP Paribas400000300000200000100000-100000Chart 6: Excess liquidity and Eonia/Refi0-2000002005 2006 2007 2008 2009 2010 2011Source: BNP ParibasEUR mlnExcess cashSpread ECB/Eonia (RHS)ECB/Eonia (21D avg)In that context, price dynamics of EFSF bonds (Jul-21 @62 z-spread and Bund Jul-21 +120bp, seeChart 4) is worrying as the street is questioning notonly investors' appetite for 440bn of EFSF bonds, butalso the impact that further weakness in OAT andBTP will have on the EFSF's AAA rating (the CDOargument has been already officially denied by Mr.Regling himself in a letter to the FT dated 28February 2011 entitled “No grounds to compare theEFSF with a CDO”).-1.0-0.8-0.6-0.4-0.20.00.20.40.6Alessandro Tentori / Ioannis Sokos / Camille de Courcel 20 October 2011Market Mover28www.GlobalMarkets.bnpparibas.com