Market Outlook - BNP PARIBAS - Investment Services India

This section is classified as non-objective researchand 1(b) and 2(b) EUR 255bn, which coversEUR 850bn of debt (C).Compared to the refinancing needs of Spain and Italy(Table 3), (A) covers 46% of the refinancing needsover the next three years, (B) covers 88% of therefinancing needs over the next three years, and (C)covers all the refinancing needs up to the end of2015.In the (A) case, the EFSF would be leveraged by 1.3as it would be stretched in size to EUR 936bn fromthe initial EUR 726bn (not from the announcedEUR 780bn). In the (B) case, it would be leveragedby 1.6 as it would be enhanced to EUR 1.13trn, andin the (C) case it would be leveraged by 1.8 beingenhanced to EUR 1.3trn (all compared to theEUR 726bn guarantee commitments).What are the potential effects?We are rather sceptical on the effects of this type ofleverage in such an environment: psychology withregard to sovereign debt has changed since the ideaof sovereign bond insurance was first introduced.While it might have been efficient in restoringconfidence back in Q4 2010, systemic risk has risenconsiderably since then, and contagion to solideurozone governments has spread.However, on the positive side, we recognise thatproviding guarantees instead of loans would have thenon-negligible effect of easing the funding needs ofthe EFSF, and therefore decreasing issuanceexpectations. Depending on the portion of guaranteecommitments that would be used for sovereign debtinsurance, should this type of leverage materialise,EFSF debt issuance could be much lower than themarket expects. In addition, considering the recentofficial communication on plans to use short-termfunding, together with upcoming details on thefinancing of the aid to Greece (notably the financingof the defeasance assets), and the final amount to befinanced by the EFSF (likely to be smaller than theEUR 142bn taken into account in the aboveanalysis), issuance expectations have room todecline significantly from what is currently factored inmarket prices.Therefore, should a leverage of the EFSF throughthe use of sovereign bond insurance materialise, atightening of the EFSF from the current historicalhighs should be expected, based on lower issuanceexpectations. One way to play this possibility isthrough the following relative value trade: SellCADES 10y / Buy EFSF 10y. EFSF widened sharplyin September/October with uncertainty peaking withregard to the use of its balance sheet, the potentialleverage of the structure, future issuance, and themanagement of the aid to Greece. EFSF widened tothe extent of exceeding ASW levels of CADES, eventhough the French agency cheapened at the sametime: EFSF Jul-21 is currently 12bp cheaper thanCADES Apr-21 in mid-ASW and 15bp cheaper inmid-yield. Compared to CADES Oct-21, EFSF is 7bpcheaper is mid-ASW and 13bp cheaper in mid-yield.The advantage of this trade is that we don’t seefundamental reasons supporting a furthercheapening of the EFSF, relative to CADES, fromcurrent relative levels, while a richening of the EFSFis likely to come with a re-widening of theCADES/EFSF differential. Therefore, the trade isalso a protected way of playing a richening of theEFSF.Should the EFSF become a bank instead, we believethat this would be very much welcomed by themarket, thereby contributing to a turnaround inmarket sentiment. An improvement in marketsentiment is also likely to trigger a tightening of theEFSF, with a re-widening of the CADES/EFSFspreaddifferential.Camille de Courcel 20 October 2011Market Mover32www.GlobalMarkets.bnpparibas.com