May 19, 2010
If there was any doubt about where futures will open tomorrow, the following article from the Telegraph should assuage all doubts: “Traders greeted the move by BaFin, the German regulator, with a mixture of anger and astonishment. One bond trader said he expected Wednesday’s trading session to be one of the most volatile in living memory: “It will be complete chaos, I really don’t know what the Germans think they are doing.”
We couldn’t have summarized it better if we tried.
One immediate effect was that the cost of insuring European government debt fell as markets were hit by a so-called “short squeeze” where investors with short positions are forced to offload their holdings and buy the bonds, causing the price to increase.
This is certain to please the German authorities, who have waged an increasingly hostile war of words with supposed speculators.
BaFin said the ban was being introduced due to “extraordinary volatility in debt securities issued by eurozone countries”.
In a statement, it said short-selling had led to excessive price movements “which could have led to significant disadvantages for financial markets and have threatened the stability of the entire financial system”. However, traders said that the measures, which will also prohibit the naked short-selling of shares in major German financial institutions, such as Allianz. Commerzbank, and Deutsche Bank, could lead to an immediate backlash from investors around the world.
They added that the ban was likely to be effectively unenforceable. It will not stop traders from shorting the bonds and shares using other European markets.
“Without the two-way flow the German market is likely to become utterly dysfunctional,” said one London-based bond trader. “Nobody ever thought they’d do this in a million years and it raises the long-term question of who is now going to want to buy their debt.”
Analysts at Bank of America Merrill Lynch summed up the mood with a note titled What’s Germany going to ban next? Rainy days, harsh words, the Macarena?
If this pans out as expected, look for Bunds to collapse tomorrow, and wipe out a few billion from Pimco’s NAV. We warned in February that the flight to safety in Bunds was both shortsighted, and too good to last. Now that trading in Bunds may be effectively prohibited altogether, we will be very curious to see where market clearing occurs, if anywhere. Because the only thing worse than a low price is no price.
This article was posted: Wednesday, May 19, 2010 at 3:27 am