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FX Day Trading - 8 November 2011
Narrow ranges with little net movement
Italian government bonds under pressure
Unintended consequences
The UK Border Agency's job is to identify undesirables entering Britain and to keep tabs on them until they establish a right to remain in the country under human rights legislation.
It seems that sometimes agents have been giving passports only a perfunctory glance instead of performing a thorough check. The result has been to allow an unknown number of people into the country who will be allowed to stay here until they establish a right to remain under human rights legislation.
And now it seems the Italians are on the move. European banks are pruning their holdings of Italian sovereign bonds. Partly it is to reduce the risk of loss and partly to help nudge their capital ratios towards the 9% that will be required under proposed EU legislation.
In the olden days banks would hang onto dodgy bonds either in the hope that they would eventually come good or because by the time the bonds matured they would be somebody else's problem. That strategy was encouraged by the practice of valuing sovereign bonds at historic cost.
A bond for which the bank paid £100 ten years ago would be valued at £100 in the books, even if it would now fetch no more than £10 in the secondary market. To sell it at £10, however, would be to realise a £90 loss.
Today, to prevent banks hiding losses in that way, the EU has new rules. Banks must "mark to market". If a bond is changing hands at £10 in the open market it is worth £10. A bank that originally paid £100 for it would be showing a loss of £90; another bank that bought the same bond for £9 would show a £1 profit.
Under the mark-to-market system there is no advantage to holding onto a trashed bond; the loss has already been recognised. Therefore, unless bank investors believe the value of their holding will increase they may as well offload it now because they have already taken the loss.
That law of unintended consequences haunts Italy today. Any bank needing to build up its capital ratio – and they are many – will either have to find new capital (not easy in this climate) or reduce loan assets (for example by selling some of its bonds). And which bonds will they chose to sell? Why, those that are registering a loss, and whose price is falling.
As for buying new ones, investors could choose a German 10-year issue yielding 2% annually or an Italian 10-year that pays 6.3%. On the face of it the Italian bond is the better investment, paying more than three times as much interest per annum as the German one. But you wouldn't, would you? You want your money back.
Monday's FX spread betting market was unutterably dull. Sterling, the euro, the yen, the Canadian dollar, the New Zealand dollar and the rand start today within a dozen ticks of their relative positions at yesterday's opening. Watch for Germany's balance of trade and UK industrial production this morning.
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'FX Spread Betting Markets Rangebound Ahead of German Trade Balance Data', Article by Moneycorp, last update: 8-Nov-11
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